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Cost-effective enforcement when tenants default.

When a landlord considers a potential enforcement action against a defaulting tenant, it must determine how to maximize the benefits returned on each dollar spent in order to justify the action. By working closely with its attorney, a landlord can keep enforcement action simple and save both time and money throughout the entire process.

For starters, a landlord and its lawyer can simplify things by creating forms which use the "merge" feature in most current word processing programs to consolidate the many forms necessary in an enforcement action.

Managers can create a primary document--a basic form--and then insert the information that varies from case to case. When the "variable" information is typed into the corresponding fields of the secondary document, the primary and secondary document can be merged to create the completed form.

Asset investigation

The asset investigation is a critical step in any enforcement action. A judgment is a useless piece of paper unless the defaulting tenant or lease guarantor has the ability to pay the judgment. The landlord, therefore, should always identify assets subject to attachment or execution before filing a legal action.

The landlord can attach or execute only on the defaulting tenant or lease guarantor's equity in property, which generally is the amount of the forced sales value of the property in excess of the amount of the senior trust deeds/mortgages and other liens. In addition, each state exempts certain property, or a specific amount of certain property, from attachment or execution.

A landlord already may have a considerable amount of information about the defaulting tenant or lease guarantor's assets. Managers should carefully evaluate the financial information submitted with the lease proposal, plus any canceled checks, correspondence, and other materials.

Managers then should consult some generally available databases, which include the following information: corporate and limited partnership information filed with public agencies; real property owned by the defaulting tenant or lease guarantor; the owner of known addresses for the defaulting tenant or lease guarantor; fictitious business-name statements; litigation filed by or against, and judgments against, the defaulting tenant or guarantor; UCC-1 financing statements; and general credit and financial information from agencies like TRW or Dun & Bradstreet.

Unfortunately, information in these databases about real property may be outdated or incomplete. Thus, a manager should confirm, either through a report from a title insurance company or by inspecting records in the county recorder's office, the defaulting tenant's ownership of the property and the amount of any recorded trust deeds, mortgages, and liens. A manager also can retain an investigator specializing in locating people and assets.

Litigation management

The landlord can avoid significant expenses and billing disputes with its lawyer by addressing fees, costs, and invoices before retaining counsel.

The landlord and counsel should agree on the present hourly rates, and should discuss future increases in the hourly rates, a fixed amount for particular tasks, bonus payments and other result-oriented incentives, a retainer, discounts for prompt payment, and interest on overdue invoices.

In addition, they should discuss the items that are included in the fees for professional services, the items that will be billed as additional charges, limits on the amount of the charge for certain costs, and the payment of significant costs directly to the provider.

The landlord and counsel also should agree in advance on staffing and reporting procedures. In particular, they should discuss which attorney(s) and paralegal(s) will be used, the acceptable levels of seniority or experience required from these people, and the number of attorney(s) and paralegal(s) that should be engaged.

They also should agree on when the reports should be submitted, to whom they should be addressed, the format, the detail and length, and what documents the legal counsel should forward to the landlord.

It is important that the landlord find the best balance between the need to know what is being done on its case and the additional cost entailed in this reporting. Ideally, the landlord should request only what the person managing the litigation will read carefully and understand, and the person managing the litigation must be sure to carefully read and understand every report.

The litigation budget

The landlord should ask its counsel to prepare an estimate of litigation costs, and then the landlord and legal counsel should prepare an initial litigation budget. These documents will help the landlord and counsel develop appropriate litigation strategy, tactics, and objectives, and will establish a guideline for achieving the litigation objectives. Most importantly, they will make the landlord and the legal counsel more sensitive to cost effectiveness.

Few cases justify doing everything possible to maximize the chances for a judgment against the defaulting tenant or lease guarantor. The landlord and the attorney, therefore, must decide when an increase in the projected cost is justified and the landlord must be prepared to accept the risk of loss that is inherent in such cases.

A list of typical tasks/items for the estimate of litigation costs and initial litigation budget would include the following items: preliminary investigation, strategy and tactics, pleadings, provisional remedies, discovery, expert witnesses, investigation, pre-trial preparation, trial, post-trial motions, appeal(s), insurance coverage, administration, and settlement.

The landlord cannot treat the estimate of litigation costs and the litigation budget as a fixed-price contract. No one can accurately predict the opposing counsel's level of cooperation, or how aggressively or thoroughly the tenant or lease guarantor will pursue defenses or counter-claims.

And no one can accurately predict in advance the most appropriate level of one's own cooperation with opposing legal counsel, or how aggressively or thoroughly the landlord should pursue collection claims, oppose defenses, or defend counter-claims. When asked in advance, most attorneys--like most everyone else--will underestimate the amount of time needed to complete tasks and assignments.

The litigation budget must remain a flexible guideline for managing the litigation, and it must be revised as additional information becomes available. The landlord and counsel should decide how to monitor fees and costs as tasks are completed, so the litigation budget and/or litigation strategy can be appropriately revised.

Strategy and tactics

First, the landlord should calculate the projected claim before filing a suit.

The first item of damages is the amount of rent and other charges left unpaid when the tenant abandoned the premises. The second item is the projected loss of rent and other charges until the landlord should be able to find a reasonable replacement tenant, or until the end of the term of the breached lease, whichever would occur first.

In a declining market, the third item of damages is the difference between the rent due under the breached lease and the current fair market rental value, which is the estimated rent due under the new lease from the date the replacement tenant starts paying rent through the end of the term of the breached lease.

In an increasing market, the third item is the difference between the current fair market rental value and the rent due under the breached lease. This reduces, rather than increases, the landlord's damages.

The fourth item of damages is consequential damages, which includes broker's commissions; tenant improvement allowances; construction of any improvements for the replacement tenant; and either the removal of abandoned improvements or other property or the replacement of improperly removed improvements.

An aggressive pursuit of defaulting tenants generally discourages other tenant defaults. But failure to pursue a legitimate claim or an equivocal response to a tenuous claim might encourage other tenants to ignore their obligations under their respective leases or to pursue tenuous claims.

The landlord should anticipate affirmative defenses and counter-claims. Typical defenses and counter-claims include: fraudulent representations or concealment inducing the tenant to sign the lease; the mere existence, or mismanagement, of hazardous materials; negligent design, construction, repairs, or renovations; general mismanagement of the building; constructive eviction; trespass by the landlord or agent or agency under the landlord's control; creating or maintaining a nuisance; and, of course, breach of contract.

The landlord and its counsel should evaluate the potential for insurance coverage under the landlord's commercial general liability policy, keeping in mind the significance in the particular case of the separate duties to defend and to indemnify the landlord.

The basic coverages in a commercial general liability policy are bodily injury, property damage, personal injury, and advertising injury. The personal injury coverage includes coverage for wrongful entry, wrongful eviction, or other invasion of the right of private occupancy.

The landlord should carefully define the objective for each case and work closely with counsel to devise the most cost-effective case strategy and tactics. The initial litigation budget, and initial objectives and decisions about strategy and tactics, almost certainly will require revision as the case progresses.

When properly planned and executed, litigation with defaulting tenants need not be an empty exercise or a "black hole" of fees and costs. By employing cost-effective strategies, landlords can pursue defaulting tenants in a manner that best protects their own bottom line.

W.M. Lines is a partner with Cox, Castle & Nicholson, a Los Angeles-based law firm. He specializes in leasing and property management litigation.
COPYRIGHT 1993 National Association of Realtors
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Author:Lines, W.M.
Publication:Journal of Property Management
Date:Jan 1, 1993
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