Quarterly: Spring 2002

CBQ >> Summer 2002 Issue

Lease Default Considerations
by Colin J. Smith of Watt, Tieder, Hoffar & Fitzgerald, L.L.P.

The Story of Lowe Billings

It is late 1999 and the fictional Silicon Valley law firm of Lowe, Billings & Grief has decided to open three offices in the D.C. area to better represent its stable of booming "New Economy" clients. Since the continued exponential growth of its high tech practice groups is obvious for all to see, Lowe Billings has entered into long term leases in D.C., Reston and Rockville for twice the amount of office space that it can currently fill.

To save time in effectuating its expansion, Lowe Billings has struck its lease deals with the same landlord, using the same office lease document, for all three of its D.C. area locations. The firm was also able to sublease its excess space to some of its "start-up" clients for reduced base rents, but with stock option kickers.

It is now mid-2002 and things haven't turned out quite the way they were planned. With practice group defections and sharply reduced revenues, Lowe Billings is facing a dire cash crunch and is having difficulty making rent payments under its leases. To compound matters, its subtenants have stopped making sublease rent payments to Lowe Billings.

The only good news is that Lowe Billings is close to striking a deal to merge with a rock-solid law firm specializing in bankruptcy, foreclosure and asbestos litigation, Large, Bucks & Prophet. The key question is whether Lowe Billings can hold off its landlord and other creditors long enough to complete its merger with Large Bucks.

While the sad story of Lowe Billings is farcical, the lease law issues implicated by such a scenario are becoming quite real for landlords and tenants alike across the D.C. metropolitan region. The purpose of this article is to highlight a few of the most basic commercial lease default issues in the multi-jurisdictional context of D.C., Virginia and Maryland.

As noted above, Lowe Billings has three leases with the same landlord and the same lease document for its offices in D.C., Reston and Rockville. However, the landlord's rights under its leases with Lowe Billings differ because of divergences in the law prevailing in each of such jurisdictions.

Lease Redemption Rights

Of fundamental importance for both Lowe Billings and its landlord is what, if any, lease "redemption" rights Lowe Billings has (i.e., the right to reinstate the tenant's terminated leasehold interest). The three lease documents each provide that if rent is not paid on the first day of each month, the landlord has the right to terminate the lease.

Lowe Billings failed to pay July rent when due under all three of its D.C. area leases. On July 5, the landlord sent letters to Lowe Billings declaring all three leases to be terminated due to non-payment of rent. On July 8, Lowe Billings tendered to its landlord full payment of July rent under all three leases. Where does that leave Lowe Billings?

Under Virginia law, Lowe Billings' late payment of rent after the termination of its lease is probably too late to save or redeem its Reston lease rights. The Virginia Supreme Court has clearly enunciated that it will enforce commercial leases as drafted. There is no statutory or common law right of redemption for commercial leases in Virginia where the lease document specifies lease default and termination rights.

In contrast, under D.C. law, Lowe Billings has the right to redeem its D.C. lease, notwithstanding the terms of the lease document. Under what is known as the "Trans-Lux" doctrine, tenants in D.C. have the right to "redeem" their leasehold interest by paying the rent due, plus late fees, interest and court costs at any time prior to eviction, even if a judgment for possession had previously been granted to the landlord.

The status of Lowe Billings' Rockville lease is a little more complicated. Under Maryland law, tenants have the right to redeem their lease, pursuant to an explicit statutory provision, by paying all past due amounts and awarded costs and fees prior to eviction. However, the statute is not available for tenants against whom three judgments of possession have been entered in the prior twelve months.

Moreover, many Maryland leases contain an explicit waiver of such right of redemption, and such waivers have been found to be enforceable for commercial tenancies. Therefore, whether Lowe Billings' Rockville lease can be salvaged by its July 8 rent payment will likely turn on whether or not its lease document contains a waiver of the redemption right.

"Self-Help" Eviction

While all three local jurisdictions have specific court proceedings for the eviction of tenants, some landlords seek to regain possession of the leased space without the use of court action.

The primary landlord considerations in this regard are the desire to expedite the process of recovering the premises, to take advantage of a fleeting relet opportunity or to simply avoid tenant delaying tactics and the expense of litigation. These landlord actions can take the form of forcible entry, removal of the tenants' property and the prevention of entry by the landlord (a lockout), and are sometimes generally referred to as a "self-help" eviction.

Under Virginia law, self-help evictions are permitted in commercial tenancies so long as the force used by the landlord to regain possession of the premises is reasonable and so long as no breach of the peace is committed.

In contrast, self-help evictions are strictly prohibited under all circumstances in D.C. The court eviction process in D.C. is considered to be a "summary proceeding" that does away with any historical justification for self-help evictions. In Maryland, self-help repossessions of commercial leased space are permitted so long as they are effectuated peacefully.

There are a number of significant legal risks to a landlord in carrying out a self-help eviction, including the possibility of various tort claims from the affected tenant. However, there are some circumstances where the use, or threatened use, of a self-help eviction can accrue to a landlord's advantage.

The Impact of Bankruptcy

Looming over many of the lease enforcement decisions made by landlords is the prospect of tenant bankruptcy. A bankruptcy filing has the effect of imposing federal bankruptcy law into the already complicated interplay of local law and specific lease provisions. A bankruptcy filing creates an "automatic stay" that prevents landlords from taking any action to enforce the tenant/debtor's lease without the prior approval of the bankruptcy court.

Once a tenant files for bankruptcy protection, the landlord can lose control over its lease in a number of substantial ways, and the enforcement of landlord's lease rights can be significantly delayed. In most cases, however, the landlord can avoid much of the delay and loss of control if the lease is terminated prior to the tenant's bankruptcy filing. This explains, in part, the landlord's desire to enforce its rights quickly in the event of a default before the tenant files for bankruptcy protection.

Sublease Default Issues

A final issue to consider is the legal status of Lowe Billings' defaulted subtenants. How do the lease default issues described above impact upon Lowe Billings' relationship with its now former clients? In large measure, the answer to that question depends upon what the particular sublease documents provide.

Typically, a sublease will incorporate, wholly or in part, the default provisions of the prime lease. In that case, the sublandlord (such as Lowe Billings) will have the same rights and remedies against its defaulted subtenant as the prime landlord has against its tenant.

If the sublease document does not incorporate the default provisions of the prime lease, then the express terms of the sublease, as modified by applicable law, will prevail. One key consideration for any subtenant is that upon a termination of the prime lease, the sublease will automatically terminate as well, and the subtenant can be evicted by the prime landlord. The only exception to this result occurs if the subtenant has entered into a "nondisturbance" agreement with the prime landlord, whereby the prime landlord agrees to "recognize" the subtenant notwithstanding the termination of the prime lease.

It is unlikely that Lowe Billings' landlord would have provided nondisturbance agreements to subtenants who were paying rent at a lower rate than under the prime lease (although, those stock options might have been tempting in 1999).

Conclusion

Unfortunately, current market conditions are forcing landlords and tenants across the D.C. metropolitan area to pay greater attention to lease default issues. As the cursory review of lease default issues in this article reveals, in some cases the jurisdiction within which the leased space is located can be of great importance in determining lease rights under particular circumstances.

About the Author

Colin Smith focuses his practice on commercial real estate transactions, with an emphasis on the purchase and sale of office buildings and on office leasing. Mr. Smith is a member of the Bar in Virginia, the District of Columbia, New York and Connecticut.