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Landlords and Tenants Mediate Conflicts

Landlords and Tenants Mediate Conflicts

Source: Commercial Leasing Law & Strategy
Date: May 2010

Hon. David A. Garcia (Ret.)

Resolution Centers


By David Garcia Financial security has become a two-way street. Prudent landlords have always scru- tinized prospective tenants for financial se- curity. But in recent years, it has become equally commonplace for tenants to scru- tinize their landlords for financial security. Nevertheless, these are unusual economic times. The rise in loan delinquency rates has led to a wave of foreclosures. Tenants looking for commercial space are seeking to avoid leases with landlords that leave them at risk of losing that space, or that put at risk landlords’ ability to provide contracted services or complete promised improvements. Tenants recognizing that this may be impossible to accomplish in these volatile economic times may seek to protect themselves by negotiating appropriate lease provisions. More at risk are tenants who are operat- ing under lease provisions not negotiated in anticipation of unstable economic condi- tions. Some of those tenants are the benefi- ciaries of provident negotiations. Others are not, and related conflicts can often result in explosive litigation. Mediation offers an ef- ficient and cost-effective means to resolve disputes between parties including tenants, landlords, successor landlords or purchasers at foreclosure sales. F oreclosures in c ommercial r e a l t y s t r e s s l andlord - t e n a n t r elations Lenders and successor landlords, as well as landlords that are intent on forestalling foreclosure, all have significant incentive to avoid foreclosure and to maintain as stable a relationship with existing tenants, if it does occur, as economic circumstances require and permit. Consequently, lenders are defer- ring foreclosure, creating incentive for land- lords to seek to renegotiate lease obligations they are having difficulty fulfilling. More- over, when foreclosure occurs, foreclosing purchasers are motivated to negotiate new leases with existing tenants that will guaran- tee income flow. Whether or not tenants have protective lease provisions, conflicts frequently arise with landlords facing economic stresses, and more often arise with the successor land- lord, foreclosure purchaser. These conflicts threaten — and often result in — litigation. Before discussing how mediation can as- sist in the resolution of such disputes, a brief review of standard protective lease provi- sions and general legal principles related to foreclosures is useful. Protectiv e l e a s e Provisions Commercial property tenants often seek guarantees that their landlord will fulfill its obligations. For example, where the landlord is a thinly capitalized entity, or where there is otherwise concern about the landlord’s fi - nancial stability, or simply as a concession to the prudent tenant, tenants insist on land- lord guarantees to secure completion of the landlord’s construction or improvement ob- ligations, reimbursement of tenant construc- tion or improvement contributions, or other concessions the landlord has given as an in- ducement toward execution of the lease. The tenants protect themselves by requir- ing the landlord to put funds up front in an escrow account to ensure a source from which to satisfy the landlord’s obligations for lease concessions. Alternatively, tenants include a provision in the lease giving the tenant a right of offset for sums owed by the landlord (plus interest thereon) against sums owed by the tenant under the lease. Most commonly, to protect against fore- closure, tenants insist on appropriate “non- disturbance agreements” with third parties holding senior liens (e.g., a trust deed) on the property (thus ensuring that the tenant’s leasehold interest will not be affected by foreclosure or other adverse action against the landlord’s interest). Ordinarily, a successor in interest remains bound by all the terms and conditions in the lease. The sale or assignment ordinarily transfers all of the original landlord’s rights and remedies under the lease. This includes the right to sue for the recovery of post- transfer accruing rent and the right to ter- minate the lease or otherwise sue for breach of any other covenant in the lease. This ar- ticle will use California law to illustrate the discussion. See, e.g., California Civil Code Section 821. The tenant, in turn, becomes a tenant of the landlord’s successor, obligated to the successor under all of the tenant cov- enants in the lease. The tenant has the same rights and remedies to enforce the original landlord’s covenants against the successor, e.g., California Civil Code Section 823. n onjudicial F oreclosure d estro ys j unior i nterests A nonjudicial foreclosure (“trustee’s”) sale, however, conveys to the purchaser ab- solute title that “relates back” to the date on which the trust deed was recorded. All sub- ordinate liens and encumbrances, including junior leasehold interests (those created af- ter the deed of trust), are extinguished. See, e.g., California Civil Code sections 2924 et seq. Principal Mut. Life Ins. Co. v. Vars, Pave, McCord & Freedman (1998) 65 Cal.App.4th 1469, 1478, 77 Cal.Rptr.2d 479, 484. The same rule applies to subsequent amend- ments of preexisting (senior) leases. Subse- Landlords and Tenants Mediate Conflicts Hon. David A. Garcia (Ret.), who served 20 years on San Francisco’s municipal and supe- rior courts, is a mediator and arbitrator with JAMS in that city. In addition to civil, family law, and criminal matters, Judge Garcia pre- sided over numerous settlement hearings involving employment, real estate, business/ commercial, insurance contract, civil rights, landlord tenant, personal injury, product lia- bility, medical malpractice, and legal malprac- tice with the vast majority of cases settling. He can be reached at dgarcia@jamsadr.com Volume 22, Number 12 • May 2010 Commercial Leasing La w & Stra teg y ® In THe Spo TLIGHTquent amendments are subordinated to the prior lien of the deed of trust and are ex- tinguished by nonjudicial foreclosure. In re 240 North Brand Partners, Ltd. (9th Cir. BAP 1996) 200 B.R. 653, 660. Because the foreclosure sale effectively destroys subordinate leasehold interests, the foreclosure purchaser may treat the tenants as occupants without rights, subject to imme- diate eviction. California Code of Civil Proce- dure Section 1161a. Conversely, tenants have no further obligations under their leases and may vacate. If the tenant under a lease extin- guished by foreclosure continues in occupan- cy after the sale, paying monthly rent to the purchaser, a new month-to-month tenancy is created, terminable by either party giving 30- day notice. Dover Mobile Estates v. Fiber Form Products, Inc., supra, 220 Cal.App.3d at 1498- 1500, 270 Cal.Rptr. at 185-187. Moreover, a senior lease may be deemed subordinate to an otherwise junior trust deed through a subordination agreement. Some leases include “automatic subordination” pro- visions, under which the tenant agrees that its lease will become subordinate to any after- created liens or encumbrances on the land- lord’s property. Principal Mut. Life Ins. Co. v. Vars, Pave, McCord & Freedman, supra, 65 Cal.App.4th at 1479, 77 Cal.Rptr.2d at 484. n o n d i s t u r b a n c e a n d a t t o rn m e n t a greements To protect against the risk of losing their leases through foreclosure, subordinating tenants often negotiate with the landlord to obtain a nondisturbance agreement from fu- ture lenders; thereby, foreclosing senior lien- holders agree not to disturb the junior ten- ants’ possession so long as the tenants have not defaulted on their leases. Principal Mut. Life Ins. Co. v. Vars, Pave, McCord & Freed- man, supra, 65 Cal.App.4th at 1479, 77 Cal. Rptr.2d at 484. An attornment agreement also addresses the parties’ relationship and rights in a fore- closure situation. Under such a provision, the tenant agrees to recognize (“attorn to”) the landlord’s successor in interest (foreclos- ing purchaser) as its new landlord. Princi- pal Mut. Life Ins. Co. v. Vars, Pave, McCord & Freedman, supra, 65 Cal.App.4th at 1479, 1483, 77 Cal.Rptr.2d at 484-485, 487. When a lease obligates a tenant to “attorn to” a new landlord in the event of foreclosure by a se- nior encumbrancer, the terms of the attorn- ment provision govern how that will occur and its effect on the existing lease. Successor landlords are motivated to rec- ognize leases with tenants who have at- torned to the new landlord. Nevertheless, the current economic conditions motivate landlords to seek beneficial amendments and create conflict. j udicial F oreclosure s a l e s d o n ot a u t o m a t i c a l l y e xtinguish j unior l eases In contrast, a judicial foreclosure sale does not automatically extinguish junior leasehold encumbrances. Rather, the trust deed ben- eficiary has the opportunity to elect which junior leases it wishes to wipe out through foreclosure by naming those encumbranc- ers in the foreclosure lawsuit. Junior encum- brancers not named in the suit are not af- fected by the foreclosure decree. California Code of Civil Procedure Section 725a; Chu- mash Hill Properties, Inc. v. Peram (1995) 39 Cal.App.4th 1226, 1228-1230, 46 Cal.Rptr.2d 366, 367. m ediation a n d e a r l y n e u t r a l e v a l - uation r esolv e r esulting c on F licts Regardless of the efforts made to provide protections in a lease, often because of the existence of protective provisions, conflicts ensue. Tenants with nondisturbance agree- ments often face eviction (unlawful detainer actions) following a foreclosure sale after the landlord owner’s trust deed default. In the current economic times, landlord disputes commonly occur over maintenance and repair obligations, completion of ten- ant improvements, credits and offsets, and renegotiation of lease terms. Conflicts may include third parties, such as contractors and their subcontractors, the landlord, the ten- ant, and sometimes the lender or lenders. Whether litigation has occurred or is threat- ened, mediation provides an opportunity to resolve disputes effectively. Mediation is a confidential, non-binding process whereby a neutral third party assists the parties to reach a mutually beneficial res- olution of their dispute. Often it is voluntary, though it can be court ordered. Unlike litiga- tion, where a judge or jury imposes a deci- sion on the parties, the parties retain control of the resolution. They decide whether and on what terms they will settle. Parties own the settlement. The mediator assists the parties to reach agreement by helping the parties to identify all of their issues and interests, to explore the risks and consequences of not settling, and to understand the strengths and weak- nesses of their positions (legally and prag- matically). Mediation helps the parties to un- derstand the potential benefits from settling and encourages parties to reach accommo- dation where accommodation is in their best interest. Ultimately, mediation explores and encourages optimal, pragmatic, realistic, and economic resolution. The mediation may commence with pre- mediation telephonic conferences, usually a joint conference with counsel for all par- ties to discuss logistics, such as briefing, exchange of briefs, necessary attendees, whether to commence the formal mediation with a joint session. The joint telephonic conference may be followed up by private telephonic conferences where counsel can address sensitive issues. The formal mediation session may com- mence with a joint session, either a simple introduction or more formal presentation of positions, or with private caucuses between the mediator and each party. During the pri- vate caucuses the parties are encouraged to share information that the parties do not wish to share with the other sides. These cau- cuses provide an opportunity for the parties to assess pragmatic solutions. The caucuses continue until a settlement solution accept- able to all parties is reached. The parties then write and execute a mem- orandum reciting the terms of the agreement. Because of the complexity of commercial lease negotiations, a formal agreement and all necessary supplemental documents, in- cluding all of the required terms can be pre- pared later. The mediator may be appointed to resolve expeditiously disputes regarding documentation necessary to effectuate the settlement. But given the collaborative na- ture and the interest in continuing relation- ships, drafting the formal documents is gen- erally not problematic. Early neutral evaluation (a mini-trial) can also be used in conjunction with mediation. It is an effective method for resolving dis- putes when combined with mediation. The neutral receives briefs in advance of the hearing, and listens to the proffered case in- cluding informal statements by the parties with strict time limitations, then makes an assessment of the cases and defenses. Sometimes where the issues are exclusively legal and not factual, the parties can elect to submit the briefs for a non-binding evaluation as if the briefs were for summary judgment (without the formality). In advance of receiv- ing or following the evaluation, the parties can agree to go forward with mediation with the evaluating neutral or another neutral. The evaluation is non-binding and confidential as are all briefs and submissions. c onclusion Mediation should be considered to avoid litigation and work out solutions between tenants and landlords, successor landlords (including foreclosing lenders), or purchas- ers at foreclosure sales. This is a low-cost solution that is more pertinent than ever in lean economic times. LJN’s Commerical Leasing Law & Strategy May 2010 Reprinted with permission from the May 2010 edition of the La w JouRNaL NewsLetteRs. © 2010 aLM Media Properties, LLC. all rights reserved. Further duplication without permission is prohibited. For information, contact 877.257.3382 or reprints@ alm.com. #055081-06-10-07

Financial security has become a two-way
street. Prudent landlords have always scrutinized
prospective tenants for financial security.
But in recent years, it has become
equally commonplace for tenants to scrutinize
their landlords for financial security.
Nevertheless, these are unusual economic
times. The rise in loan delinquency rates has
led to a wave of foreclosures.
Tenants looking for commercial space are
seeking to avoid leases with landlords that
leave them at risk of losing that space, or
that put at risk landlords' ability to provide
contracted services or complete promised
improvements. Tenants recognizing that this
may be impossible to accomplish in these
volatile economic times may seek to protect
themselves by negotiating appropriate lease
provisions.
More at risk are tenants who are operating
under lease provisions not negotiated
in anticipation of unstable economic conditions.
Some of those tenants are the beneficiaries
of provident negotiations. Others are
not, and related conflicts can often result in
explosive litigation. Mediation offers an efficient
and cost-effective means to resolve
disputes between parties including tenants,
landlords, successor landlords or purchasers
at foreclosure sales.

Foreclosures in Commercial
Realty Stress Landlord-
Tenant Relations
Lenders and successor landlords, as well
as landlords that are intent on forestalling
foreclosure, all have significant incentive to
avoid foreclosure and to maintain as stable a
relationship with existing tenants, if it does
occur, as economic circumstances require
and permit. Consequently, lenders are deferring
foreclosure, creating incentive for landlords
to seek to renegotiate lease obligations
they are having difficulty fulfilling. Moreover,
when foreclosure occurs, foreclosing
purchasers are motivated to negotiate new
leases with existing tenants that will guarantee
income flow.
Whether or not tenants have protective
lease provisions, conflicts frequently arise
with landlords facing economic stresses, and
more often arise with the successor landlord,
foreclosure purchaser. These conflicts
threaten — and often result in — litigation.
Before discussing how mediation can assist
in the resolution of such disputes, a brief
review of standard protective lease provisions
and general legal principles related to
foreclosures is useful.
Protective Lease Provisions
Commercial property tenants often seek
guarantees that their landlord will fulfill its
obligations. For example, where the landlord
is a thinly capitalized entity, or where there
is otherwise concern about the landlord's financial
stability, or simply as a concession
to the prudent tenant, tenants insist on landlord
guarantees to secure completion of the
landlord's construction or improvement obligations,
reimbursement of tenant construction
or improvement contributions, or other
concessions the landlord has given as an inducement
toward execution of the lease.
The tenants protect themselves by requiring
the landlord to put funds up front in
an escrow account to ensure a source from
which to satisfy the landlord's obligations
for lease concessions. Alternatively, tenants
include a provision in the lease giving the
tenant a right of offset for sums owed by
the landlord (plus interest thereon) against
sums owed by the tenant under the lease.
Most commonly, to protect against foreclosure,
tenants insist on appropriate "nondisturbance
agreements" with third parties
holding senior liens (e.g., a trust deed) on
the property (thus ensuring that the tenant's
leasehold interest will not be affected by
foreclosure or other adverse action against
the landlord's interest).
Ordinarily, a successor in interest remains
bound by all the terms and conditions in
the lease. The sale or assignment ordinarily
transfers all of the original landlord's rights
and remedies under the lease. This includes
the right to sue for the recovery of posttransfer
accruing rent and the right to terminate
the lease or otherwise sue for breach
of any other covenant in the lease. This article
will use California law to illustrate the
discussion. See, e.g., California Civil Code
Section 821. The tenant, in turn, becomes a
tenant of the landlord's successor, obligated
to the successor under all of the tenant covenants
in the lease. The tenant has the same
rights and remedies to enforce the original
landlord's covenants against the successor,
e.g., California Civil Code Section 823.
Nonjudicial Foreclosure
Destroys Junior Interests
A nonjudicial foreclosure ("trustee's")
sale, however, conveys to the purchaser absolute
title that "relates back" to the date on
which the trust deed was recorded. All subordinate
liens and encumbrances, including
junior leasehold interests (those created after
the deed of trust), are extinguished. See,
e.g., California Civil Code sections 2924 et
seq. Principal Mut. Life Ins. Co. v. Vars, Pave,
McCord & Freedman (1998) 65 Cal.App.4th
1469, 1478, 77 Cal.Rptr.2d 479, 484. The
same rule applies to subsequent amendments
of preexisting (senior) leases. Subse-
quent amendments are subordinated to the
prior lien of the deed of trust and are extinguished
by nonjudicial foreclosure. In re
240 North Brand Partners, Ltd. (9th Cir. BAP
1996) 200 B.R. 653, 660.
Because the foreclosure sale effectively
destroys subordinate leasehold interests, the
foreclosure purchaser may treat the tenants
as occupants without rights, subject to immediate
eviction. California Code of Civil Procedure
Section 1161a. Conversely, tenants have
no further obligations under their leases and
may vacate. If the tenant under a lease extinguished
by foreclosure continues in occupancy
after the sale, paying monthly rent to the
purchaser, a new month-to-month tenancy is
created, terminable by either party giving 30-
day notice. Dover Mobile Estates v. Fiber Form
Products, Inc., supra, 220 Cal.App.3d at 1498-
1500, 270 Cal.Rptr. at 185-187.
Moreover, a senior lease may be deemed
subordinate to an otherwise junior trust deed
through a subordination agreement. Some
leases include "automatic subordination" provisions,
under which the tenant agrees that its
lease will become subordinate to any aftercreated
liens or encumbrances on the landlord's
property. Principal Mut. Life Ins. Co. v.
Vars, Pave, McCord & Freedman, supra, 65
Cal.App.4th at 1479, 77 Cal.Rptr.2d at 484.
Nondisturbance and
Attornment Agreements
To protect against the risk of losing their
leases through foreclosure, subordinating
tenants often negotiate with the landlord to
obtain a nondisturbance agreement from future
lenders; thereby, foreclosing senior lienholders
agree not to disturb the junior tenants'
possession so long as the tenants have
not defaulted on their leases. Principal Mut.
Life Ins. Co. v. Vars, Pave, McCord & Freedman,
supra, 65 Cal.App.4th at 1479, 77 Cal.
Rptr.2d at 484.
An attornment agreement also addresses
the parties' relationship and rights in a foreclosure
situation. Under such a provision,
the tenant agrees to recognize ("attorn to")
the landlord's successor in interest (foreclosing
purchaser) as its new landlord. Principal
Mut. Life Ins. Co. v. Vars, Pave, McCord
& Freedman, supra, 65 Cal.App.4th at 1479,
1483, 77 Cal.Rptr.2d at 484-485, 487. When a
lease obligates a tenant to "attorn to" a new
landlord in the event of foreclosure by a senior
encumbrancer, the terms of the attornment
provision govern how that will occur
and its effect on the existing lease.
Successor landlords are motivated to recognize
leases with tenants who have attorned
to the new landlord. Nevertheless,
the current economic conditions motivate
landlords to seek beneficial amendments
and create conflict.

Judicial Foreclosure Sales Do
Not Automatically Extinguish
Junior Leases
In contrast, a judicial foreclosure sale does
not automatically extinguish junior leasehold
encumbrances. Rather, the trust deed beneficiary
has the opportunity to elect which
junior leases it wishes to wipe out through
foreclosure by naming those encumbrancers
in the foreclosure lawsuit. Junior encumbrancers
not named in the suit are not affected
by the foreclosure decree. California
Code of Civil Procedure Section 725a; Chumash
Hill Properties, Inc. v. Peram (1995) 39
Cal.App.4th 1226, 1228-1230, 46 Cal.Rptr.2d
366, 367.
Mediation and Early Neutral Evaluation
Resolve Resulting Conflicts
Regardless of the efforts made to provide
protections in a lease, often because of the
existence of protective provisions, conflicts
ensue. Tenants with nondisturbance agreements
often face eviction (unlawful detainer
actions) following a foreclosure sale after
the landlord owner's trust deed default.
In the current economic times, landlord
disputes commonly occur over maintenance
and repair obligations, completion of tenant
improvements, credits and offsets, and
renegotiation of lease terms. Conflicts may
include third parties, such as contractors and
their subcontractors, the landlord, the tenant,
and sometimes the lender or lenders.
Whether litigation has occurred or is threatened,
mediation provides an opportunity to
resolve disputes effectively.
Mediation is a confidential, non-binding
process whereby a neutral third party assists
the parties to reach a mutually beneficial resolution
exchange of briefs, necessary attendees,
whether to commence the formal mediation
with a joint session. The joint telephonic
conference may be followed up by private
telephonic conferences where counsel can
address sensitive issues.
The formal mediation session may commence
with a joint session, either a simple
introduction or more formal presentation of
positions, or with private caucuses between
the mediator and each party. During the private
caucuses the parties are encouraged
to share information that the parties do not
wish to share with the other sides. These caucuses
provide an opportunity for the parties
to assess pragmatic solutions. The caucuses
continue until a settlement solution acceptable
to all parties is reached.
The parties then write and execute a memorandum
reciting the terms of the agreement.
Because of the complexity of commercial
lease negotiations, a formal agreement and
all necessary supplemental documents, including
all of the required terms can be prepared
later. The mediator may be appointed
to resolve expeditiously disputes regarding
documentation necessary to effectuate the
settlement. But given the collaborative nature
and the interest in continuing relationships,
drafting the formal documents is generally
not problematic.
Early neutral evaluation (a mini-trial) can
also be used in conjunction with mediation.
It is an effective method for resolving disputes
when combined with mediation. The
neutral receives briefs in advance of the
hearing, and listens to the proffered case including
informal statements by the parties
with strict time limitations, then makes an
assessment of the cases and defenses.
Sometimes where the issues are exclusively
legal and not factual, the parties can elect to
submit the briefs for a non-binding evaluation
as if the briefs were for summary judgment
(without the formality). In advance of receiving
or following the evaluation, the parties
can agree to go forward with mediation with
the evaluating neutral or another neutral. The
evaluation is non-binding and confidential as
are all briefs and submissions.
Conclusion
Mediation should be considered to avoid
litigation and work out solutions between
tenants and landlords, successor landlords
(including foreclosing lenders), or purchasers
at foreclosure sales. This is a low-cost
solution that is more pertinent than ever in
lean economic times.

Hon. David A. Garcia (Ret.), who served 20
years on San Francisco's municipal and superior
courts, is a mediator and arbitrator with
JAMS in that city. In addition to civil, family
law, and criminal matters, Judge Garcia presided
over numerous settlement hearings
involving employment, real estate, business/
commercial, insurance contract, civil rights,
landlord tenant, personal injury, product liability,
medical malpractice, and legal malpractice
with the vast majority of cases settling. He
can be reached at dgarcia@jamsadr.com