Can Owner Use 'Escalation' Clause to Make Tenant Pay Property Tax Increase?

April 27, 2015

Standard commercial net leases require tenants to pay not just rent but a proportionate share of the owner’s property taxes. Of course, property taxes are apt to fluctuate over time. Accordingly, owners typically include an “escalation” or “adjustment” clause in the lease enabling them to pass along to the tenant any tax increases that occur over the course of the lease. But getting a tenant to accept responsibility for a tax escalation is just half the battle; you also have to ensure that the actual escalation clause in the lease is clear and specific.

Standard commercial net leases require tenants to pay not just rent but a proportionate share of the owner’s property taxes. Of course, property taxes are apt to fluctuate over time. Accordingly, owners typically include an “escalation” or “adjustment” clause in the lease enabling them to pass along to the tenant any tax increases that occur over the course of the lease. But getting a tenant to accept responsibility for a tax escalation is just half the battle; you also have to ensure that the actual escalation clause in the lease is clear and specific. The following cases are an excellent illustration of how lease language affects the enforceability of the escalation clause.  

Case #1: Tenant Must Pay Tax Increase

FACTS: An escalation clause “deems” an office building tenant’s proportionate share of any tax increase to be 6 percent. A couple of years into the lease, taxes go up and the tenant’s tax bill more than doubles. The tenant asks the owner to reduce its share and sues when the request is denied.

DECISION: The New York court says the escalation clause is enforceable and throws out the tenant’s case. 

EXPLANATION: The tenant argued that the 6 percent allocation was unfair because it occupied much less than 6 percent of the building. But the court was unmoved. The escalation clause set a clear formula for calculating the tenant’s share of tax increases, the court explained. The lease also included a disclaimer noting that the adjustment formula bore no relation to how much space the tenant actually used. The tenant accepted the formula, and the court said it wouldn’t rewrite the lease to get the tenant out of its bad deal [609 Corp. v. Park Towers S. Co., LLC, December 2004].

Case #2: Tenant Need Not Pay Tax Increase

FACTS: An office lease escalator clause requires the tenant to pay, as additional rent, a portion of increases in real estate taxes based on the property’s assessed valuation for the current tax year minus the “base assessed valuation,” defined as the value determined by the county assessor “without giving effect to any reduction thereof pursuant to any abatement, exemption or other reduction applicable to the Real Property during the Base Tax Year.” After the lease is signed, the owner challenges the assessed valuation for the base year and gets it reduced. The reduced assessment actually increases the tenant’s assessed valuations year to year. So the owner demands additional rent for the increase under the escalation clause and sues the tenant for refusing to pay it.

DECISION: The New York court says the owner can’t use the newly reduced assessment valuations for the base year to recalculate the tenant’s tax obligations under the lease.   

EXPLANATION: During the negotiations, both sides knew that the owner was formally contesting the tax assessment and that a reduction might occur if the owner won its challenge. But they deliberately chose to define “base assessed valuation” in a way that didn’t allow for future modifications. So the owner was stuck with the original base year valuation provided for in the escalation clause [Fair Oak, LLC v. Greenpoint Financial Corp., February 2006].

 

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