Interpreting the no-offsets and waiver of counterclaims clauses.

(The following is Part 1 of a 14-part series of columns prepared by our law firm examining the standard Real Estate Board of New York form commercial lease. The series will highlight particular clauses in the REBNY lease and how the courts have interpreted them.)

Before one gets to the numbered paragraphs of the standard form REBNY commercial lease, there are the introductory, unnumbered paragraphs, which refer to (i) the amount of annual rent (ii) the definition of the demised premises, and (iii) a no-offsets clause, i.e., that payment of rent shall be made "without any set off or deduction whatsoever."

From a landlord's perspective, these paragraphs are important and should not be ignored. In particular, there are a couple of recent cases expressly relying upon the no-offsets clause as a basis for granting summary judgment to a landlord on a claim for rent, notwithstanding the tenant's defenses and counterclaims asserting alleged breaches of the lease by a landlord.

The No-Offsets Clause

In Lincoln Plaza Tenants Corp. v. MDS Properties Development Corp., the Court held that the no-offsets covenant in a commercial lease barred all defenses or offsets based on any alleged breach by the landlord of the terms of the lease. Lincoln involved a summary non-payment eviction proceeding commenced by landlord as a result of continuous disputes with tenant concerning electrical, steam heat and sewage service hook-ups. The Court in Lincoln held that tenant's covenants to pay rent without setoff was enforceable notwithstanding the parties' ongoing dispute concerning utility services and hookups. The Trial Court dismissed tenant's defenses asserting breaches of the lease by landlord. The Appellate Division affirmed, stating: "In light of the provision of the commercial lease requiring payment of rent `without any set off or deduction whatsoever,' this Court does not disturb the dismissal of these claims as affirmative defenses."

Similarly, the Court in Kayser-Roth Corporation v. Heckler Manufacturing Group, Inc., held that "the independent covenant to pay rent in a sublease, without allowances for deduction, set off or abatement whatsoever, bars all defenses/counterclaims except the defense/counterclaim of constructive eviction (in the event of abandonment)."

In Kayser-Roth, sublandlord sued for rent, and subtenant asserted various defenses and counterclaims, claiming that overlandlord interfered with the subtenant by performing construction work in the premises and making the premises untenantable by, for example, depositing debris in the washrooms, drilling holes in the ceiling, and damaging the walls. The Court, on sublandlord's summary judgment motion, dismissed all of the sub-lessee's defenses and counterclaims, except for the defense/counterclaim of constructive eviction.

Lincoln and Kayser-Roth appear to be sound. They derive from the fundamental theory that the landlord's obligations under a lease are (unless otherwise specified) covenants independent of the tenant's obligation to pay rent as a consequence of tenant's leasehold estate interest in the premises.

Furthermore, a commercial tenant does not have an implied warranty of habitability to raise as a defense to negate its obligation to pay rent. The warranty of habitability created by statute is applicable only to residential properties and the Courts have refused to extend it to commercial property.

This theory of independent covenants in turn also explains the basis for the exception noted in Kayser-Roth, that the no-offsets clause does not preclude a defense of constructive eviction. If there is a complete failure of consideration so that the tenant is, in the eyes of the law, not obtaining the leasehold estate for which the rent is consideration because of the landlord's interference with the premises, then - and if, but only if, the tenant also vacates possession - the tenant's obligation to pay rent is suspended.

In brief, the requirements for a constructive eviction defense are as follows:

(i) A "grave and permanent" interference with tenant's beneficial enjoyment of the premises;

(ii) "In consequence of which" tenant was "justified" in vacating, and in fact did vacate the premises; and

(iii) That tenant has given notice to the landlord of the alleged eviction conditions, and a reasonable opportunity to cure.

Recently, the strictness of the constructive eviction doctrine has been eased in one respect: the Court has recognized a tenant defense of partial constructive eviction, where a discrete portion of the premises is rendered untenantable, and is vacated by tenant.

The foregoing suggests a practical question: is there something the landlord can add to the no-offsets clause in order to cut off (or subject to some condition precedent, such as by requiring specific advance notice) a defense of constructive eviction? In view of the theoretical basis of the constructive eviction doctrine, i.e. a legal failure of consideration that in effect sets aside the contract, it appears that no clause in the contract would be of much assistance to landlord. In short, as a practical matter, such a clause would probably not be enforceable and, as a business matter, is probably not an issue that landlord wishes to raise, with so little to gain.

Reliance on the no-offsets clause to strike defenses/counterclaims is similar to, but should be distinguished from, reliance on another lease provision - the waiver-of-counterclaims clause.

The Waiver of Counterclaims Clause

REBNY Lease form [paragraph] 26 states that: "It is further mutually agreed that in the event Owner commences any summary proceeding for possession of the premises, Tenant will not interpose any counterclaim of whatever nature or description in any such proceeding."

Note that this clause differs from the no-offsets clause in two ways: (i) it is limited to summary proceedings; but (ii) it applies to both holdover and non-payment summary proceedings.

Courts have held that this clause is not invalid, but have nevertheless often held that the tenant could assert its counterclaims, notwithstanding this clause.

State Court: Courts have held that they are not bound by the waiver-of-counter-claims clause and will disregard such waiver where the counterclaim appears "intertwined" with the landlord's claim. For example, in Amdar Co. v. Hahalis, a commercial non-payment proceeding, the tenant asserted counterclaims alleging that the elevator in the subject premises functioned improperly (and indeed at times not at all), preventing respondent from carrying on his business. The Civil Court held that the tenant's right to assert these counterclaims for loss of such essential services was not barred, notwithstanding the fact that the lease included the standard form waiver-of-counterclaims clause. The Court explained that "the claim of the tenant is so linked with the claim of the landlord, the facts are so closely connected that resolving them in one lawsuit instead of two will result in economizing judicial attorney time with a concomitant saving of legal costs." The Appellate Court apparently accepted the legal standard enunciated by the Civil Court, although it disagreed on the facts whether tenant's counterclaim was indeed so intertwined.

Federal Court: A recent Federal Court of Appeals decision held the waiver-of-counterclaims clause is not binding upon the federal court, where the tenant's counterclaims would be considered compulsory. In Sage Realty Corp. v. Insurance Company of North America, a commercial non-payment case, the landlord brought suit for payment of additional rent, and tenant asserted counterclaims in its answer. The district court dismissed the tenant's counterclaims pursuant to the standard form waiver-of-counterclaims provision contained in the lease. The tenant, on appeal, claimed that the waiver provision should not be enforceable in federal court. The Court of Appeals agreed. In federal court, unlike state court, certain counterclaims are deemed, under the applicable procedural rules, to be compulsory. According to Fed R. Civ. P. 13(a), any counterclaim that "arises out of the transaction or occurrence that is the subject matter of the opposing party's claim" must be asserted by defendant, or else it is deemed abandoned. In Sage, the Court held that "because [tenant's] counterclaims... are inextricably interwoven with [landlord's] claim for unpaid additional rent, and arise out of the same transaction and occurrence that is the subject matter of [landlord's] action... Rule 13(a) requires [tenant] to bring its counterclaims, if at all, in the instant case." The Second Circuit held, accordingly, that the waiver-of-counterclaims clause would not be enforced.

Again, the above decisions raise the practical issue whether there is anything better for landlord that can be drafted. It appears not. The basis of the Courts' decisions to ignore the waiver-of-counterclaims clause is that, when in conflict, the court's procedural rules favoring consolidation of issues in a single forum at a single time will triumph over the parties' lease clause. Accordingly, it does not appear that this clause can be improved upon.

Conclusion

The no off-sets clause is important and enforceable. A breach of a covenant in a lease by a landlord is not a valid excuse for the tenant to not pay rent. This principle is often supplemented by the clause contained in the standard form commercial leases prohibiting the tenant from interposing counterclaims in a summary proceeding. But, landlords should not forget the different scope and purpose of these two clauses. Even if a court does not, as a procedural matter, enforce the waiver-of-counterclaim clause, it should still, as a substantive matter, enforce the no-offsets clause, and give landlord a judgment requiring tenant to pay the rent, even if tenant is then permitted to continue litigating, whether in landlord-tenant or State Supreme Court, its counterclaims.

Thus, in reviewing a standard REBNY lease and drafting riders to such a lease, landlords should insure that the no-offsets clause and the waiver of counterclaims clause are present in the final form of the lease.