Building Better Leases Series – Damage & Destruction

Building Better Leases

“Premises Partial Damage”

Partial Damage refers to destruction to improvements that can be repaired within 6 months from the date they were damaged. These damages do not cost more than 6 months of Base Rent. In addition, they do not include the cost of repairing Lessee-Owned Alterations and Utility Installations or items that the Lessee is obligated to maintain. The Lessor is responsible for notifying the Lessee within 30 days as to whether the damage is Partial or Total.

“Insured Loss”

Insured Loss refers to the damage or destruction to the improvements caused by an event required to be covered by property insurance without regard to the amount of the deductive or the coverage limits. It does not include the cost of repairing Lessee-Owned Alterations and utility Installations and Trade Fixtures because these items were to be insured separately by the Lessee.

Partial Damage Insured Loss

If there is Partial Damage or Insured Loss, the Lessor is responsible for making repairs as soon as possible, while maintaining the Lease in full effect. The Lessor should make repairs at his cost (except for Lessee Owned Alterations, Utility Installations and Trade Fixtures). If the repairs cost less than $10,000 then the Lessor can require the Lessee to make the repairs which is why it’s imperative for the Lessee to have insurance. If for some reason insurance proceed are insufficient or not available, then the Insuring Party will make up the difference in order to affect the necessary repairs (except for the deductible which is the Lessee’s responsibility), unless the reason insurance proceed are unavailable is because of the unique nature of improvements. Partial Damage resulting from flood or earthquake is subject to paragraph 9.3 and any net proceeds will be made available for repairs.

In the event that damages are $10,000 or less, the Lessee has an obligation to manage the repairs to the Premises. While the amount is not a large sum, the process of managing the repairs could be time consuming. Furthermore, the Lessor is not obligated to restore an “unique” improvements.

Partial Damage Uninsured Loss

In the event Partial Damage occurs that is not covered by insurance (Uninsured Loss) and is not caused by negligence or willful misconduct, then the Lessor may either make the necessary repairs and keep the Lease in place or terminate the Lease with a 30 days written notice. If the Lessor chooses to terminate the Lease but the Lessee wants to continue renting, they have the right to pay for the repairs and require the Lessor to make them and keep the Lease in place.

The tenant has the ability to force the Lessor to make repairs to their own building. Therefore, it would be smart for the Lessor to consider any costs associated with potential damage. On the flip side, the Lessee should consider inserting a threshold regard the cost of repairs (for example, the Lessor cannot terminate the Lease unless the uninsured costs exceed $X) so that they do not lose a lease over a $10,000 Uninsured Loss.

“Premises Total Destruction”

Total Destruction refers to destruction to improvements that cannot be repaired within 6 months from the date they were damaged. They do not include the cost of or the time required to repair Lessee-Owned Alterations and Utility Installations and Trade Fixtures. The Lessor is responsible for notifying the Lessee within 30 days as to whether the damage is Partial or Total.

If there is total destruction of the building, the landlord will have the option of replacing the Premises within a certain period of time or terminating the Lease. Because the Lease may be terminated due to Total Destruction, it is important that all Parties are comfortable with the time frames and cost parameters set forth in this section. The Lessee is expected to file a claim with their insurance carrier in the event that their Alterations and utility Installations are lost; it is not the responsibility of the Lessor to cover these costs.

The Lease will terminate 60 days following Total Destruction. If the damage was caused by gross negligence or willful misconduct of the Lessee then the Lessor has the right to recover his damages from the Lessee, depending on the Waiver of Subrogation. This is one of the only sections of the Lease that allows for termination of the Lease without providing an alternative remedy.

“Replacement Cost”

Replacement Cost refers to the amount necessary to repair, replace or rebuild property on the same Premises, with comparable materials and quality, without deducting any amount for depreciation.

Often times, older buildings do not meet current building and safety codes. Typically, these buildings are associated with cities and other regulatory agencies so that they are not required to meet current codes. When modifications or improvements are made to a building, the city will sometimes require the entire building to be brought up to code. As a result, the cost of repairing or rebuilding the older building could end up being higher than the cost of the same repairs to a newer building.

“Hazardous substance condition”

Hazardous Substance Condition refers to the presence or contamination of a Hazardous Substance in, on or under the premises which requires restoration.

It’s important to note that “Under the Premises” can mean not only the soil under the Premises, but also the ground water. In other words, the source of the Hazardous Substance does not necessarily have to originate from a property where the Premises are located.

Damage Near End of Term

If there is damage within the last 6 months of the Term, the Lessor may terminate the Lease if the cost to repair the damages is great than one month’s Base Rent. As a result, the effective termination date would be 60 days after the damage occurred. The Lessor must give the Lessee written notice of his intent to terminate within 30 days from the date that the damage occurred.

If the Lessee has an extension or purchase option, then he can preserve the Lease by: a) exercising his option, and b) providing the Lessor with any shortage in insurance proceeds need to make the necessary repairs. The Lessee must exercise the option and provide the money within 10 days of receipt of notice that the Lessor intends to terminate the Lease.

The purpose of this section is to protect the Lessor from having to replace improvements that could be expensive, given the short term remaining on the Lease, while simultaneously giving the Lessee the ability to override the Lessor’s decision.