Another issue that you need to be aware of both on the landlord side and the tenant side, when you’re signing a lease. Is let’s say, going back to my example of Chip taking over the restaurant. Let’s say Chip, as we all know he was going to do, crashes and burns and he makes like 1 month worth of rent and then it’s disaster, it’s grease fire in the kitchen all of the time. I don’t mean the restaurant burned down, I just mean that it’s not going well. He’s not going to be able to make a go of it, he can’t pay the rent, landlord is going to lock him out.
Well what do you do in that situation? You just assigned that lease to Chip, you should have known better by the way but you did it and now Chip has let the lease go into default. What is going to happen next for you, is you’re going to be contacted by the landlord, and the landlord is going to say, “Hey we’re really sorry that Chip was not able to succeed in that restaurant but we’re more sorry for you than we are for us because you are still on hook for all of the original terms of that lease, just because Chip is not paying doesn’t mean that somebody doesn’t have to pay. And that somebody is you.” I was involved in representing a landlord in just such a restaurant as I have been describing here and it has been assigned, and assigned, and assigned, I mean it had been assigned to 6 or 7 different restaurateurs and the term of the lease was really long.
I can’t remember if it was 20 year lease or something like that, but it was a long lease. After the 7th restaurateur went belly up, my client decided “Okay, we’re bringing Sue in, we’re suing everybody in the line.” All 7 of the previous tenants had obligated themselves to the terms of that prior lease. These people couldn’t believe it, it had been years since they had thought about that restaurant but they had to think about it then, because the landlord, we had a valid claim. And we collected on that claim. I don’t remember how we divided it up among all the subsequent restaurateurs but everybody was on the hook.
Contracts in general do not need to be in writing. That is true in general. There are certain categories of contracts that must be in writing in order to be enforceable, but even though a contract may be enforceable, it’s still best if it is in writing.
The reason why is writing makes very clear in most cases what the terms of the contract are. If you have an oral agreement, that is very susceptible to people having different memories of what the agreement was exactly. There’s nothing quite like a written agreement to clarify what the terms of the contract are.
An estoppel certificate is a device that is used by landlords and by lenders in order to get some certainty as to what their situation is on a property. The lease agreement also should provide for estoppel certificates. It’s one of those terms that nobody understands what it is and people sign it and figure, “Eh, it’s probably not important.”
If you’re a landlord, it’s really important that you include some provision for getting estoppel certificates from your tenants. And that needs to be in your lease. Because as a landlord, there’s a couple of things that you may want to do with that property. You may want to sell a property, you may want to refinance the property, in either case, you are going to be introducing a new party to that property and that party does not know what’s gone on in the premises before they arrived.
Let’s say that you own a strip mall shopping center. You have several tenants in the shopping center and they’re paying the rent and it’s a good investment property. Cash flows. But, for whatever reason, you want to sell it. The buyer is going to come in and the thing that’s going to be attractive to them about your shopping center is its profitability. The way it throws off cash. You’ve got all these tenants that are doing great, paying their rents on time, the rents are nice and high, and it’s really attractive.
However, they’re just taking your word for it. Because they know you, they don’t know those tenants, and they don’t know what’s gone on between you and those tenants. They want some assurance that if they buy the shopping center, that they’re not going to turn around and be faced with a giant lawsuit from the restaurant that’s your anchor tenant in the premises, saying, “Hey, you breached this agreement that we had years ago to put this really expensive, fancy fountain in the parking lot and we were really counting on that because that was going to be a major draw. There was going to be a lot of traffic that would come in as a result of that and we thought some of those people might want to stop by and eat at our restaurant. You promised, you didn’t do it, and now we’re suing you.”
Well, that’s a huge problem for somebody that just came in and bought the property because they didn’t know anything about that promise to build a fountain and they have in fact, succeeded to the obligations of the previous landlord. They now stand in that previous landlord’s shoes. They don’t want to be surprised in that way. They want something from the tenants that says, “We don’t have any secret claims that we’re going to assert against you.”
The landlord can go to his tenants and say, “Hey look, check out our lease. There on page 25 of the lease, that one section you didn’t understand, you just signed it and didn’t get what it meant. It says that you have to give me an estoppel certificate on demand.” The estoppel certificate says, “I’m the tenant and basically, I don’t have any claims against you. Or if I do have any claims, here’s what they are.”
Getting that estoppel certificate allows the landlord to sell the shopping center. He can take that to perspective buyers and say, “Here’s my lease roles, this is how much money I’m making on this building, none of these people have any claims against me, here’s their estoppel certificates, here’s all their lease agreements. As you can see, everybody’s committed for a long period of time, this is a great piece of property for you.” And it’s got a reliable landlord to sell the property. Without that, the landlord may not be able to sell the property at all, or if they are able to sell the property, there’s going to be some risk to the buyer that they’re not going to be able to mitigate against. They’re not going to be able to get as much in terms of a purchase price for the sale of that property. It’s tremendous advantage to the landlord to have a provision that allows the landlord to receive an estoppel certificates from commercial tenants.
The landlord may also want to refinance its loan on the property. Perhaps the property was acquired at a time where interest rates were very high, so the landlord is paying 7% interest on this property. But now the landlord can refinance his property for 4 1/2 and that’s a huge difference to the landlord in terms of their profitability in this investment. But the bank is not going to, just like the buyer of the property, the bank doesn’t want to have its security on the property, the shopping center, potentially subject to claims by disgruntled tenants who’ve got secret claims. Estoppel certificates are very valuable for landlords that are interested in refinancing their property or in selling their property.
A due-on-sale clause is an agreement that usually exists in loan documents where the borrower is representing to the lender that they are going to be using the building or the real estate, whatever kind it is, for certain some purpose, and they are personally going to be using it.
They get the loan and that is one of the representations that the lender is relying on: how are you going to be using this property? Because they want to be make sure that they property is protected and used in the appropriate way, and that it’s value is being preserved. One way they so that is through this kind of a term, a due-on-sale clause.
The due-on-sale clause says if you sell this property, that is secure our loan, we can call your loan due. We can accelerate the due date on your loan and require it all to be paid when you sell. This may be the case even though you may be perfectly willing to continue to make the payments. Even though the deed of trust that the lender may have on the property is still valid and enforceable. The lender still has that provision in the loan document that says, no we can call the loan due if you sell the property.
Occasionally, lenders will use that term for some negotiating leverage where they don’t have any objection to allowing you to sell the property, or allowing the new person to take over the loan, but, they’ve got the power to extract something out of you, so sometimes they will. Say okay, we’re going to waive our due-on-sale clause here, but it’s going to cost you $5,000. Lenders can do that sometimes.
There is a statute in Arizona that calls into question the enforceability of due-on-sale clauses. There’s also some case law in Arizona that calls into question the enforceability of due-on-sale clauses. You’re going to want to look at those before you make any decisions based on some expectations you have of how the law is going to apply to your situation. It may not be as it seems in the loan documents.
Another thing you need to be aware of when it comes to due-on-sale clauses is what constitutes a sale, because sometimes you can trigger a due-on-sale clause unintentional. For instance, an individual may own property in their own name, maybe it’s a husband and wife that owns property in their own name, and then they convey that property into a living trust that’s going to benefit their family. Is that a transfer? Is that a sale? Does that trigger the due-on-sale clause? Well, it may, it may not, but it’s something that you may want to consider before you make a move on that.
Also, you may have an individual, or a husband and wife that own property personally, and they decide hey, this really ought to be owned by the business, it’s our business that’s owning this property. Let’s convey it into the name of our business. You have a similar situation there. The use of the property may not have changed but the actual ownership of the property has changed and there is a risk that you have triggered a due-on-sale clause in that instance. It’s something that you want to be aware of so you can make the best decision possible.
In commercial leases you will usually see, unless the tenant is really well established and an excellent credit risk for the landlord, you will usually see the landlord requiring the individuals who own the business to personally guarantee the lease.
You need both members of the marital community to sign. If you don’t you’re gonna have a really big problem from the lender or landlord’s side, and this is another area in which mistakes are frequently made, because you’ll have a lot of landlords, in fact, you’ll probably see it here more than anywhere. You’ll have landlords who have significant commercial holdings all over the country and they have a building or two here in Arizona, and it’s just not enough for them to have gotten the familiarity with Arizona law. When they signed the lease, they didn’t involve their counsel. They said, “Ah, we know what we’re doing here. We’ve done this a hundred times on a hundred other buildings. And we’ve got all of our forms and they use the same forms that they use everywhere else”.
The problem is that guarantee form that they’ve got, it doesn’t have a place for the husband and wife to sign. It’s only got a place for the husband to sign. It comes time to enforce that guarantee and they are very disappointed to find out my guarantee is not worth the paper it’s printed on.
So go back and watch my video regarding the importance of both members of the marital community sign any personal guarantee.
Another thing that you have to be careful for in contracts is automatic renewals of the contract. These are sneaky because you enter into a contract and perhaps it’s some service that you’re going to be using for a year. Maybe it’s pretty expensive and you’re thinking gosh I don’t know. Do I really want to do this. This is a big commitment and you think to yourself well I will re-examine this thing after the first year of the contract and if it doesn’t work out then I’ll cancel it.
Well not so fast. A lot of times contracts will have automatic renewal terms in them and they will have procedures that you have to go through in order to opt out of an automatic renewal of your contract. Some of them are really tricky. Some of them require some advance notice. Some of them require some special language in your notice to the other party to that contract. If you don’t follow those procedures you run the risk of obligating yourself to a renewal of the contract that you may not want to be in. Even though you may think at the time that you’re initially forming the contract oh I’m going to be on top of this because this is very important, this is a significant amount of money.
Believe me, 12 months is going to come and go before you know it and even though it is something very important to you it’s going to have dropped back into the recesses of your mind and may not be something that you’re thinking about. It’s important that you calendar for yourself some reliable system of examining when your contracts are going to renew and you should be calendaring things timely so that you have enough time to give the notices that you need to give.
Let’s say that you are a commercial tenant. You have leased, let’s say it’s a pad in a shopping center that you are going to use as a restaurant, and you’ve got your restaurant in there for two or three years. Things are great or things are terrible. Either way, you want to assign this lease. You’ve decided you’re going to do something else now. You need to look at your lease agreement that you have with the landlord and determine whether the lease is assignable, and in most cases it will be, but usually there are some conditions on the assign-ability of that lease.
Normally the landlord gets and opportunity to approve or reject the proposed new tenant that you want to bring into the space. You’ve got your, let’s say it’s a pancake restaurant, and you’ve got the best pancakes in town, and the landlord really likes you in there because you’re a good tenant. You always pay the rent on time, and they love having tenants like you in that space. But they also know that not everybody is as good as you at doing what you do, so they’re a little concerned about this plan you’ve got to assign your lease to somebody else and have somebody else take over your pancake shop, because they might not do it as well as you.
You approach the landlord and say, “Hey, I’ve been a great tenant. Now I want to bring in Chip, who’s going to run the pancake shop.” The landlord says, “No, I went into business with you. I trust you. I don’t trust Chip. Chip’s the kind of guy that leaves you hanging.” The landlord may have some real reluctance to doing that, and they do have veto authority on that in most cases.
You may need to do something to sweeten the deal for the landlord. Maybe there’s an increase in the rent. Maybe there is some cash payment by you to induce the landlord to approve the assignment of the lease. It almost sounds like a bribe, doesn’t it? But it’s not. That is a bargained for, perfectly appropriate term that a landlord can demand in connection with whether they want to allow for the assignment of a lease.
Usually if the lease is drafted properly and in a way that’s not totally one-sided for the landlord, it will include language like, “Landlord’s approval to assign the lease shall not be unreasonably withheld.” That’s one of those terms that lawyers can fight about for years, of course. Neither side wants to end up in years of litigation, so having a term like that does give the tenant some negotiating power. If, instead of having Chip take over as the restaurateur, you have some very well established restaurant who has tremendous credit and is not a real credit risk for the landlord, then it’s probably not reasonable for them to withhold approval of the assignment of the lease in that case. That’s one of the issues that you need to be involved with when you’re talking about assigning a lease.
What else can you do to secure your money? You want as many people as you can get guaranteeing that repayment. You may be loaning money to a business. Businesses come and go. People generally survive longer than businesses. You want to get personal guarantees from the people who are going to be benefiting from that business.
Let’s use the example of the lawn mowing service. Lawn mowing services come and go. It doesn’t do you a lot of good usually to have a promissory note from Chip’s Lawn Mowing Service because Chip’s Lawn Mowing Service can come and go, but Chip is going to hopefully be around for a while. Chip is going to be earning wages. You want to get a personal guarantee from Chip. If Chip is married, you want to get a personal guarantee from Chip’s wife as well.
This is a trap really. I see people walking into this trap so often. It’s terrible. In Arizona, guarantees are virtually worthless if they are not signed by both members of the marital community. I will often times see out of state lenders, or any kind of company that is based out of state, that is requesting a guarantee for anything, they’ll send a guarantee to be signed by an individual, but they won’t insist that the guarantee be signed by the individual’s spouse.
If it comes right down to enforcing that guarantee at some point in time, the guarantee is only enforceable against the sole and separate property of the spouse who signed the guarantee. In Arizona, if you have a couple that has been married for any length of time at all, you will usually find that there is no sole and separate property. Everything is marital property, so the guarantee becomes virtually worthless.
I’ve encountered the problem many times. I’ve encountered it also many times in the context of litigation, where I represent a client who is being sued on a guarantee. Husband signed the guarantee. The wife didn’t sign the guarantee. They’re freaked out. They’ve been sued. It’s for a large amount of money. They think there is no way out.
If the spouse did not sign the guarantee, it’s almost a get out of jail free card. That’s something to be very careful about. If you are investing into businesses or if you’re making any kind of investment or loan in which you are requiring the borrower or the affiliates of your borrower to sign the guarantee. Make sure that you get both members of the marital community to sign that guarantee.
One of the terms that probably only lawyers look at in contracts, but can really be very important, is jurisdiction and choice of law and venue terms. We often enter into agreements these days with people who are located all over the world. If you are ever in a dispute over your contract, and you don’t want to be, you don’t want to be in litigation around your contract, but if you do find yourself in that position you would much rather be in litigation right here in your own back yard than in the home court of whoever the other party in the contract is.
Let’s look at an example. Let’s suppose that you are going to lease some expensive equipment for your business. This is a huge investment. This equipment is critical to your operation of your business and there are a couple of different providers out there that do these sort of leases. You find the best deal with this company that is based in Chicago, for instance. You may find that their documents state that this agreement is going to be governed by Illinois law. That’s what they want because that’s what they know. Okay. How do I feel that as your Arizona attorney advising you on this agreement? Well I’m not crazy about it because I don’t know Illinois law. I’m licensed in Arizona but I can almost live with it because I can familiarize myself with probably the most important points and I can also bring in some counsel from Chicago if I need to to look over the document with me. I’m not real happy about the agreement being governed by Illinois law but it’s probably not the end of the world.
Let’s also suppose that the agreement says that the proper venue for any disputes that arise out of this agreement is Illinois. Okay I’m really not happy about that. If you have a dispute with this lessor of the equipment, you’re going to have to fight that out in Chicago. That’s their home court. It’s going to be very difficult for you to litigate that case in Chicago. You don’t have Chicago counsel. There’s going to be a significant amount of travel probably back and forth in connection with this litigation. There’s just a myriad of reasons. That’s a really bad term for you to have your case subject to the jurisdiction of some other state.
This is one that I fight on and it’s also one that I’ve found is negotiable. I mentioned earlier that there are some terms in contracts that are negotiable and some terms in contracts that aren’t negotiable. I find that this is one that can be negotiated and to me it’s a very important term.
Where you really see it is when you’re negotiating prior to litigation. Let’s say there’s a dispute between the parties to the contract and the one party is in Chicago. They’re not happy with something and you’re not happy with something. They know that if this comes to litigation it means they’ve got to go find Phoenix counsel and get all ramped up to litigate this case in Phoenix. They’re not going to like that. It’s a big barrier to them wanting to go into litigation. It puts more bargaining power on your side if the litigation is going to be in your back yard.
I talked about practical oversight, and that’s very, very important. The legalities are also important. You want to make sure that you are securing your investment to the greatest degree possible.
How you can secure that investment will depend, to some extent, on what is the nature of your investment. Is it an investment, or is it actually a loan? In either, case there are things that you can do to protect that investment and/or loan. I’m just going to quickly go through some of the most important devices that are used to secure the source of investments.
One thing that often makes sense to have, I won’t say always, but often, is a promissory note. A promissory note is a promise to pay, and you want to make sure that you have a promissory note and that it has been reviewed by your counsel.
You don’t want to draft your own agreements. I have seen some of the ugliest agreements that you just can’t even imagine. I recall going into one contract review in the context of a partnership dispute where there was a nasty falling out. Guys were once friends and they’re no longer friends. They were once looking at making gazillions of dollars together in this enterprise, and everything had gone terribly.
They were not dumb guys, but they also weren’t lawyers. Drafting contracts is not what they did. Except it is what they did; they drafted their own contract. The one guy who was my client came to me and said, “Okay, here’s our agreement. What do I do? How do I solve this problem that I’ve got?” He said, “I drafted this thing, and I think it’s got all the important terms in here.”
He handed it to me and it was a page and a half long, and this was a significant investment. I thought, “Oh, it can’t have all the important terms in here because there’s just not enough room for the important terms in this page and a half.”
As I looked at the agreement, the heading on the agreement is something that I don’t think I’ll ever forget. It said in big, bold letters at the top “Contractural Agreement,” misspelling the word contractual, had an “r” in there. Anyways, that’s an indication that your contract may have problems. You want to put the protections in place, get a promissory note.