Landmark Decision Clarifies Owners' Repair Covenant Remedies, Rights

Two types of repair covenants are standard provisions in almost all commercial leases. One type of repair covenant specifies what a tenant is required to do to maintain and repair its space while the lease is ongoing. The second type of repair covenant specifies what condition the space must be in at the end of the lease—in other words, what items the tenant has to repair before turning over the space to the owner when the lease is terminated or the lease term expires.

If your tenant doesn't maintain its space during the course of the lease, it's obligated to reimburse you for repairs that you made after it moved out. But what happens if the tenant breaches the repair covenant during the term of the lease? What are your remedies if your tenant allows the space to go into a state of disrepair but continues to operate in it and to pay rent?

A recent landmark California decision, Avalon Pacific-Santa ANA, L.P. v. HD Supply Repair and Remodel, LLC, et al., answered this question by clarifying commercial tenants' and owners' rights when repairs to a space are at issue.

No Recovery for Current Cost of Repair During Lease

“Our case was the first case in California history to address the question of what remedies an owner has if its tenant breaches its repair covenants during the lease,” says Orange County attorney Tom Gibbs. Gibbs and his law firm, Allen Matkins, were retained by a commercial tenant to handle its appeal after it lost a $2.5 million jury verdict. (See California Case Settles CRE Repair Covenant Question.)

Although Gibbs represented the tenant, he believes that the outcome of this case is significant for both sides of a commercial real estate lease: It clarified that the owner doesn't have the right to sue the tenant for the cost of repairs during the lease. That's because the owner doesn't possess the premises and, therefore, cannot repair damage to it.

“Let's say that a broken air conditioning unit in a commercial space where a tenant is paying rent costs $1,000 to repair,” Gibbs says. “If the tenant refuses to repair the unit, the owner could sue it for the cost of the repair—but even if the owner recovers $1,000, it can't go on the property and repair the unit because it doesn't have the right to, nor does it really have the obligation to,” he points out. In that case, the owner would keep the money. However, if the tenant wants the unit fixed later and the owner refuses, the tenant would have to make the repair at its own cost while the owner kept its money, he adds.

“In effect, the owner gets a double recovery,” Gibbs emphasizes. The court in this case determined that this type of situation is unfair and ruled that the owner can't recover the current cost of a repair while the lease is ongoing, he notes.

Consider Three Remedies

Now that it's clear owners can't recover the current cost of repairs from the tenant, the owner and the tenant in this type of situation must focus on appropriate remedies, Gibbs says.

Remedy #1: Terminate

You can assert in a notice of default that the tenant has failed to make a repair and, if the tenant doesn't make the repair, use that as a basis to terminate the lease. When an owner terminates the lease based upon a failure to repair, it has possession of the space and the cost of the repair becomes “real damages” for the owner. That's because the owner would then need to repair that condition before it can use the property or lease it to a future tenant.

Essentially, if you want to recoup the cost of a repair in the tenant's space, you could terminate the lease based on the tenant's default in failing to repair the problem, which would give you possession of the space and the right to repair it to your own satisfaction.

Remedy #2: Compel repairs

If you don't want to terminate the lease based upon a repair covenant, but the tenant refuses to repair the space, you can request a court order compelling the tenant to repair the condition. That is, you can ask the court for “specific performance” compelling the tenant to perform the repair. However, Gibbs notes that no court has addressed that remedy and it is an open question in California law and in other states. But it is also a potential answer to this problem and a potential remedy depending upon the circumstances of your case.

Remedy #3: Wait

An owner that doesn't want to terminate the lease early or use specific performance to compel the tenant to make a repair must wait until the end of the lease, or the time the lease is terminated for some other reason. At that time, the owner can pursue the tenant under the second type of repair covenant that deals with the conditions of the premises at the time of the turnover of the space and then sue the tenant for any needed repairs.

“My own view is that the real choice for the owner is to say ‘I'm either going to terminate this tenancy based upon a breach of the repair covenant, or I'm going to keep the rent and wait and see what happens at lease termination,’” says Gibbs. “To me, that's the fair and correct result and the one that I think prudent owners need to follow,” he stresses.

Avoid Repair Covenant Conflict

Negotiate these repair provisions in your lease to prevent conflict arising from repair issues:

Provision #1: Right to make repairs during lease

Owners should negotiate for the right to make repairs while the tenant is in the space. Despite the new precedent that has been set that prohibits owners from entering and making current repairs to a tenant's space, it's still possible to draft a lease that is favorable to the owner in this circumstance.

“The owner can include a right in the lease allowing it to go onto the premises during the lease term to make the repairs if the owner thinks that there has been a breach of a repair covenant,” says Gibbs.

Provision #2: Additional rent

Owners that want to make sure that their premises are being repaired and maintained can put into the lease a covenant that says that in the event that the tenant does not make repairs, the owner can go onto the premises, make those repairs, and add the owner's costs for doing that as a form of additional rent.

“That's important because additional rent is a form of rent upon which you can pursue a claim against the tenant,” Gibbs points out. “This is enforceable, which can help prevent expensive litigation,” he adds.

Provision #3: Arbitration and mediation

“I find it very helpful to have a binding expedited arbitration provision for problems that arise during an ongoing lease,” says Gibbs. “You don't want the owner-tenant relationship to be disrupted by a dispute, so if there is one during the course of that relationship, it really behooves the owner and the tenant to have a quick dispute resolution process,” he advises.

That's important in a case where a right for the owner to go into the tenant's space to make repairs is going to be included in the lease. A requirement to use expedited binding arbitration to settle repair disputes should cover two common types of disputes: whether the contested repairs are “necessary” and refusals by the tenant to make repairs at all.

Provision #4: Require tenant to make repairs, with conditions

If you decide that you want the tenant to make repairs, then include a satisfaction clause in the lease that requires the tenant to do any repairs to the “sole satisfaction of the owner.” However, when drafting this clause an owner should be aware that courts interpret “sole satisfaction” as “reasonable,” so that owners don't demand an unreasonable level of repairs. Also, the owner should still carve out the right to go onto the premises to repair damage if it chooses to and then charge the tenant for the cost of the repairs as additional rent.

Provision #5: Broad covenant

Sometimes there's a question of who caused the problem that needs to be repaired. Whether any particular condition falls within a repair covenant—such as wear and tear, weather-related damage, or vandalism—is lease-specific and varies widely from lease to lease. Try to negotiate a broad repair covenant that includes as many types of damage as possible.

Be Reasonable About Repairs

Lease provisions that are favorable to owners encourage tenants to maintain their space during the course of the lease. But owners need to be reasonable in approaching repair covenants with their tenants, says Gibbs.

“If it's really a serious problem, then exercise these rights, but if it's not, then value your tenant and rely on your tenant to eventually fix the problem, so long as they're paying rent and the problems aren't costing you as the owner,” he adds. “In this day and age especially, owners need to value tenants, so if the problem is fixable and you've got a creditworthy tenant, then defer to the tenant, and give it more leeway,” he says. “Don't go to court immediately to enforce your rights unless the damage looks like it's going to be there permanently or will worsen until the end of the lease,” he points out.

However, if a tenant abandons the premises, then the owner needs to become active and aggressive, including pursuing its lease rights or terminating the lease based upon the failure to comply with an ongoing repair covenant, Gibbs says. “That's when the owner's remedies come in to play so that it can try to recover its real damages resulting from the tenant's failure to comply with the repair covenants in the lease.”

Insider Source

Thomas E. Gibbs, Esq.: Partner, Allen Matkins, 1900 Main St., 5th Fl., Irvine, CA 92614-7321; (949) 553-1313; www.allenmatkins.com.

Sidebar

California Case Settles CRE Repair Covenant Question

Avalon Pacific-Santa ANA, L.P. v. HD Supply Repair and Remodel, LLC, et al. concerned a commercial real estate tenant's long-term lease of industrial property on which the tenant intended to make over $4 million in renovations and then open a construction supply store servicing contractors. After it commenced the renovations, which included the removal of interior office space, the tenant suspended construction due to the recession in the building industry. Thereafter, the property experienced vandalism and theft. The tenant restored the property to a cold shell, pending either resumption of the renovations if the market returned or a sublease for an alternative use.

Unhappy, the owner then sued the tenant and won, claiming that the tenant breached repair covenants in the lease and was liable for “waste” by failing to restore the premises to its preexisting condition.

The tenant won on appeal, however, after Allen Matkins argued, among other issues, that the cost of repairs are not recoverable for breach of repair covenants under an ongoing lease, and that to recover for waste, the owner had to show that the property damage was not repairable, but rather was permanent. The Court of Appeals accepted these arguments, setting new law in this area of commercial real estate. The court reversed the judgment and ordered the trial court to enter judgment in the tenant's favor. Recently, the California Supreme Court denied the owner's petition for review, making the decision final [Avalon Pacific-Santa ANA, L.P. v. HD Supply Repair and Remodel, LLC, et al., February 2011].

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