"Leasing Review - Get Your Hands Off My Condemnation Award", originally published on the NAIOP Minnesota online blog.
Often when I negotiate a lease I am surprised when a tenant or its representative skip over the condemnation provisions in the lease form as they deem these provisions as superfluous boilerplate. The prevailing view is that these provisions will never affect the tenant’s rights as the tenant does not own the fee title to the property and the chance that the property will be condemned is so remote that there is no use worrying about a condemnation during the lease term. A tenant may find that when it receives notice of a taking of its premises, it will need to find a new premises and it will not be reimbursed for its moving expenses, loss of business or, most importantly, the thousands of dollars’ worth of tenant improvements that it put into its premises possibly only a few months ago. Tenants should be aware of what they are getting into prior to agreeing to spend a substantial sum of money in tenant improvements, and they should properly structure their leases so as to preserve any rights they may have.
Generally, a tenant is not entitled to receive an award for the loss of its business, its moving expenses (but it may be entitled to relocation assistance), and the cost of removing its personal property and other removable fixtures owned by it from its premises. If the condemnation provisions in the lease are structured properly, however, a tenant will be entitled to an award for the value of the unexpired leasehold interest and the value of the use of its tenant improvements for the remainder of the lease term. A tenant should follow the following specific steps when drafting its lease so as to preserve these rights.
First, a tenant should require that it is the only party who holds a termination right upon the occurrence of a condemnation, and the termination should not be automatic or exercised by the tenant at any time. Most condemnation provisions in a lease either grant both parties with a termination right upon a “taking” of all or substantially all of the premises by a condemning authority, or automatically terminate a lease upon such a taking. Minnesota courts view both such provisions as an automatic termination of the lease entitling the tenant to neither reimbursement for its leasehold interest nor compensation for the loss of the use of the tenant improvements. As the tenant is only entitled to reimbursement for its interests as of the day of the taking, and the tenant no longer has any interest in the premises as of the day of the taking because the lease has terminated, the tenant no longer possesses a compensable interest. The only way for a tenant to preserve any rights in a condemnation award is by requiring that the lease language read that the tenant alone has the right to terminate the lease upon a taking.
Second, a tenant should not terminate the lease upon receiving notice of a taking of its premises. Once the tenant terminates the lease, the tenant extinguishes any right to receive an award for the same reasons as stated above.
Third, a tenant should pay particular attention to how tenant improvements and fixtures are treated in the lease. If a tenant has paid for the improvements, but it will not remove the improvements at the expiration of the lease, the lease should be drafted to state that the improvements remain the property of the tenant, but will become the property of the landlord at the expiration of the lease. By drafting the lease in this manner, a tenant will preserve its right to obtain an award for the value of the use of its improvements for the remainder of the term. Note that a tenant will not be entitled to an award equal to the value of the improvements themselves so the tenant will not be made whole, but by properly structuring the lease in this manner the tenant will be entitled to at least a partial reimbursement.
Fourth, a tenant should require that the condemnation provisions in the lease do not obligate the tenant to pay rent once a taking has occurred. As the tenant will not be terminating the lease, the tenant does not want to be in a position where it has to pay rent for a premises that it cannot use. Note, however, that if a taking renders a tenant’s premises untenantable, and the tenant vacates the premises, the tenant will no longer have an obligation to pay rent.
Finally, the tenant should not agree to any provision in the lease that states that the tenant waives any rights that it may have to a condemnation award. The parties are free to contract out of any rights that they may have. By agreeing to such a provision, the tenant will have waived all rights that it has to receive an award from the condemning authority.
It is true that a tenant’s premises will likely not be affected by a condemnation proceeding. However, the same could be said about the risk that your house will burn down in the next year or that you will be involved in an accident on your way home from work, yet most people find it advantageous to maintain insurance for their home and car. A tenant should devote the same amount of care when negotiating condemnation provisions in a lease.
DISCLAIMER: These articles are to be used for general information purposes only, not as a substitute for in-person evaluations. The information contained herein is not legal advice and no attorney-client relationship is formed through these articles.