Loan-Related Damages in Lease Remedy Provisions

Robert C. Epstein
New York Law Journal
09-10-2004

Loans secured by real property typically require defaulting mortgagors to pay various sums in addition to the principal and interest owed the lender. These include default interest, late charges, collection costs, yield maintenance premiums (i.e., sums needed to purchase bonds that will generate payments sufficient to make the lender whole for lost interest due to a prepayment arising from a borrower default), and - often as the result of indemnity provisions - any other costs incurred by the lender due to the borrower's default.

This is especially true today, since many loans are securitized and a default under a securitized loan can have further repercussions, including additional costs incurred by the lender, such as the obligation for the originating lender to buy-back the securities.

A loan default may be caused by a tenant's failure to pay rent, especially when the tenant is the sole tenant or one of the larger tenants in a building. Not only may the failure to pay rent render the landlord unable to make its loan payments, it may also cause the landlord to default under its financial covenants to the lender, such as its obligation to maintain a certain debt service coverage ratio or minimum reserves. However, unless a lease expressly provides for a landlord to recover, as part of its damages from a defaulting tenant, the additional sums such landlord must pay its lender due to such default, the landlord may not be entitled to recover such sums. Accordingly, it is important for landlords to include in their leases, especially with larger tenants, a provision expressly permitting the landlord to recoup such sums.

Case Law

There are a number of cases to support the proposition that a remedies provision in a lease must include loan-related damages in order for a landlord to recover such amounts. See Chemical Bank v. Stahl, 255 AD 2d 126 (1998); 1009 Second Avenue Associates v. New York City Off-Track Betting Corp., 248 AD 2d 106 (1998); 437 Madison Avenue Assocs. v. A.T. Kearney, 127 Misc. 2d 37 (1985).

Since loan-related damages are considered consequential damages, they must be expressly listed in a lease to ensure that they are recoverable. Failure to expressly list such damages creates the risk that a court will find that the landlord's recovery of such damages was not contemplated by the parties at the time the lease was signed, and are therefore not recoverable.

For example, in Chemical Bank v. Stahl, the Appellate Division, First Department, held that: "Where a party fails to insert a provision permitting consequential damages into a lease agreement, the court will not supply it."

The case involved a landlord's claim against a tenant for lost rental income and financing costs incurred as a result of the tenant's failure to restore the premises to the agreed condition upon surrender of the space. Since the surrender agreement did not provide for these types of damages, the landlord was not permitted to recover them.

Likewise, in 1009 Second Avenue Associates v. New York City Off-Track Betting Corp., the First Department denied a landlord's claim for lost rent caused by the tenant's failure to timely vacate. As the court held:

The action before us seeks to impose liability upon OTB for consequential damages incurred by plaintiff because defendant held over beyond the lease term. Significantly, the lease contains an express provision imposing such liability, but only under circumstances in which plaintiff seeks to demolish the building and only upon three month's notice to OTB to remove from the premises. . . . [T]he inclusion of a provision for consequential damages reflects their 'unusual and extraordinary' nature, requiring them to be 'brought within the contemplation of the parties as the probable result of a breach at the time of or prior to contracting.' The provision reflects the parties' expectation that the 'usual and customary damages' - removal of the tenant, recovery of use and occupancy and incidental damages - is the measure of landlord's recovery.

Since the lease did not expressly provide that the tenant would be liable for lost rent if it held over, the landlord's recovery was limited to "usual and customary damages," meaning possession, recovery of use and occupancy, and incidental damages.

Sample Provision

To eliminate the risk that loan-related damages will not be recoverable from a tenant whose default has caused the loss, landlords should include appropriate protections in the remedies provisions of their leases.

One example is: "Tenant acknowledges that an Event of Default under this Lease may cause Landlord to incur damages under its mortgage and related financing documents, including the payment of increased rates of interest, legal fees, late charges, and sums necessary to maintain the mortgagee's yield on the loaned amounts. Accordingly, Tenant agrees that such damages should be included in the damages for which Tenant is responsible due to an Event of Default."

By inserting this type of language into its lease, a landlord will be in a better position to seek recovery of loan-related consequential damages from its defaulting tenants.

Robert C. Epstein is of counsel to Finkelstein Newman.