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MISSING WORDS COST THE LANDLORD MILLIONS
by Jane M. Myers, Esq.
In a recent decision, New York State’s highest court gave a Manhattan landlord very bad news — the rent under a long-term lease would be half of what the landlord thought the lease said it should be.
The case involved a 20-year lease that included two 20-year option periods. The lease covered three small buildings containing 22 apartments and four retail stores on Second Avenue at 50th Street. The tenant elected to exercise the second option, for a final 20 years running from 2006 to 2026. The lease stated that the annual rent during the option period would be seven percent of the “value” of the leased premises. If the parties could not agree on the rent, they were each to hire an appraiser, which is what happened. The landlord’s appraiser estimated the value of the buildings and land at $7.1 million, which equated to a starting annual base rent of $497,000. The tenant’s appraiser put the value at $3.43 million, which yielded a starting annual base rent of $240,100.
The difference between the two values was due to the tenant’s appraiser taking the existence of the lease into consideration, while the landlord’s appraiser did not. Even though the property could have been put to a higher and better use, the tenant’s appraiser discounted the value to reflect that the premises was subject to a long-term lease for their current use – rent-regulated apartments and a few shops.
In light of the amount of money involved, the parties went to court, where both the trial judge and an appellate court sided with the landlord. However, the Court of Appeals ultimately ruled in the tenant’s favor. The Court’s reasoning was short and simple – when determining value there may be factored in the potential highest and best use of a property. However, “value” must also take into account all encumbrances on the property, including zoning restrictions, easements and existing leases.
Of cold comfort to the landlord, the Court stated that it would have been perfectly permissible for the landlord to charge a rent based on the value of the property without taking the lease into account – if that had been explicitly stated in the lease.
This last point is the larger lesson. When drafting a lease, or any document for that matter, it is critical that the document clearly reflects the understanding of the parties. It can be helpful to include an example to explain the concept, or, before the document is signed have someone outside the transaction read the language and provide their interpretation of what they think it means. That interpretation may be very different from what the person who drafted the document intended. As the case shows, a few clear sentences can be worth millions of dollars. (See 936 Second Avenue, L.P. v. Second Corporate Development Co., Inc., 861 N.Y.S.2d 256, 2008.)
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Please note that this article is intended only as a general discussion of issues pertaining to the preparation of a lease and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney in order to prepare a lease appropriate for your particular needs.