Give Strong, Nonpaying Tenant Two Chances Before Imposing Late Fee, Interest Charges

Issue to Negotiate

You're negotiating a lease with a strong tenant. Should you add a lease clause that requires the tenant to pay a late fee and default interest if the tenant doesn't pay its base rent and/or additional rent on time?

Owner's View

You want to impose a late fee and interest charges when the tenant defaults by not paying its base rent and/or additional rent on time. After all, you want to discourage tenants from paying rent late or not at all. Also, you should be entitled to get interest on unpaid rent to make up for not having access to that money.

Tenant's View

A strong tenant will fight you on any extra fee you try to impose—including late fees and default interest charges. The tenant will argue that it pays you enough in rent and other charges under the lease. Plus, it will argue that you shouldn't also be entitled to a late fee and default interest, especially because the building or center benefits by having the tenant there.

Compromise: Tenant Can Pay Rent Late Twice Without Penalty

Don't impose a late fee and default interest the first time the tenant doesn't pay its rent on time. Instead let the tenant avoid these penalties twice in each calendar year, says Paulette B. Peltz, assistant division counsel at Vornado/Charles E. Smith Commercial Realty. That is, the tenant must only pay a late fee and default interest the third time that rent is overdue and each time thereafter in a calendar year, she explains.

You should get something back from the tenant in exchange for this arrangement. A late fee clause typically requires you to notify the tenant each time a rent payment is overdue and give the tenant a chance to pay the rent before the late fee and default interest kick in. With this compromise, you can eliminate the requirement that you must send a rent-overdue notice after the first two times within a calendar year. After the second time, the late fee and default interest will kick in without notice, Peltz says.

Peltz has found that both owners and strong tenants are willing to agree to this compromise. Tenants like that they must pay a late fee and default interest only if they habitually commit nonpayment defaults within a calendar year, she notes. And owners like that the tenant can't completely negate the owner's late fee and default interest protections. Also, owners appreciate not having to send overdue rent notices more than twice in a calendar year because of the administrative hassle involved in preparing and sending those notices.

Cover Three Points in Late Fee Clause

To get this compromise, cover these three points in your late fee clause:

Set out late fee and default interest requirement. Indicate in the late fee clause that if the tenant doesn't pay its base rent and/or additional rent within a certain time period (say, 10 calendar days after it's due), the tenant must pay you the following:

• A late fee. The late fee should be equal to a set percentage—say, 5 percent—of the overdue payment, says Peltz. Call it “liquidated damages”—that's a preset amount that the tenant agrees to pay you if it violates the lease—for your added administrative costs, she adds [Clause, par. a(i)].

• Default interest. Charge the tenant interest at a specific rate—for example, 18 percent per year—on the overdue rent from the date it was due until the date it's paid, says Peltz [Clause, par. a(ii)].

Limit notice requirement. Make it clear that your obligation to notify the tenant that its rent is overdue applies only to the first two times within a calendar year that the tenant's rent payment is overdue, says Peltz [Clause, par. b].

Set out limited waiver of fee and interest. State in the lease that you'll waive your right to get a late fee and default interest only the first two times that the tenant's rent is overdue within a calendar year, says Peltz [Clause, par. c]. Then you're free to impose the late fee and default interest on all other overdue rent payments within that calendar year.

Insider Source

Paulette B. Peltz, Esq.: Assistant Division Counsel, Vornado/Charles E. Smith Commercial Realty, Arlington, VA.