Rent rules

Most commercial leases provide that the tenant’s rent abates after a fire or other casualty, at least to the extent that the premises are not tenantable or are not usable by the tenant for the conduct of its business. Remember that in many jurisdictions, rent does not abate after such an event unless the lease says it does.

It is not uncommon for the lease form to provide that the rent abates only if the tenant did not cause the loss. On the face of it, this seems like a reasonable condition. Why should the tenant benefit from its wrongful act? On closer examination, however, that provision makes no sense for tenants, and can adversely affect landlords.

Tenant troubles
Most landlords insure their property against loss by fire and other casualty. Most also carry rent loss insurance (known as business income insurance) to cover their loss of income during the period that the property is being reconstructed. In fact, the landlord’s mortgage probably requires that insurance covering the loss of rents. And who pays for the insurance? The tenant does, of course, either in its base rent or in pass-throughs.

Assume that the tenant’s employee accidentally started a fire, or even that a disgruntled employee deliberately started the fire. In either case, the landlord will collect the proceeds of its business income insurance to the extent of the landlord’s loss of rents.

But wait, this tenant’s lease provided that its rent does not abate because it caused the fire, and it is responsible for the acts of its employees. This gives the insurance company a defense against the claim for lost rents because the landlord has not suffered a loss of rents. Thus, the landlord has not benefited from the language in the lease; its insurer has. But who paid for that insurance? The tenant, of course.

Landlord losses
Tenants often carry business interruption insurance, which is also known as business income insurance. That insurance will pay, in the event of an insured loss, the cost to the tenant of moving out of the damaged space, the cost of the rent in temporary premises, the cost of moving back to the original space and the tenant’s lost profits. If the tenant has such coverage, then the landlord of the damaged premises can collect its rent from the tenant and the landlord suffers no loss. If, however, the tenant is marginal and does not carry that insurance, it will have to pay those expenses out of its own pocket, and it will also be obligated to pay the rent in the damaged premises. If the tenant cannot afford to pay all those costs, which creditor will it not pay?

Of course it will not pay the landlord in the damaged building, especially if it has no real intention of moving back. Let the old landlord try to mitigate its damages. Granted, the party most generally damaged by the language in the lease is the tenant, but the landlord has some risk here, as well. Language which provides that a tenant that damages the building cannot take advantage of rent abatement is not really based on economics, because neither party to the lease benefits from the language and one, perhaps both, are injured by it. So what is its real effect? One word —retribution. The landlord wants to punish the tenant for its acts, or those of its employees. Consider that most tenants are not sole proprietorships, but are companies with employees. Those companies are legally responsible for the acts of their employees, but that does not necessarily mean that the company — the tenant — is actually being bad. So why punish the tenant when there is no economic benefit to the landlord?

Sidney G. Saltz is a partner in the Business, Tax & Real Estate Department of Barnes & Thornburg LLP’s Chicago office. He concentrates his practice in the area of commercial real estate. Reach him at (312) 214-8324 or [email protected].