When a commercial tenant defaults on its lease, some strategic decisions need to be made by both the tenant and the landlord.
As with any lease that ends in default, emotions tend to run high. Commercial tenants often have feelings about how the landlord’s conduct, or the condition of the premises, led to the failure of the business. On the other hand, commercial landlords always suffer significant losses when a tenant defaults. So, very often, one or both sides are very upset.
The purpose of this article is to make both parties aware of the common considerations after default on a commercial lease.
When they can, commercial Tenants may just dissolve the company or file a commercial bankruptcy — that is, unless the tenant believes it has a strong case against the landlord. In this scenario, the landlord does not get paid, but the landlord gets the property back relatively quickly.
Nobody is happy in this scenario but, at least, everyone is able to move on.
Most commercial leases require the owner — i.e. a human being or an entity very unlikely to become assetless — to sign a personal guaranty. So, there are plenty of times when the tenant cannot simply cut and run. In that situation, the tenant has two basic choices:
Scenario #1 – make a deal quickly, or
Scenario #2 – try to win by attrition.
Of course, Scenario #1 makes the most sense to all concerned. If the landlord can get the property back quickly, the space can become a producing asset sooner and, thereby, minimize losses.
As for the tenant, the terms of the commercial lease agreement are almost certainly not favorable, so settling early prevents entry of a huge judgment. Nonetheless, a quick resolution often does not happen. Again, emotions can be a factor, but that is not the only problem.
Most of the time, after a default, Landlords will do their calculations and present the Tenant with a big bill. That is understandable enough. It may very well be that, under the terms of the lease agreement, the Landlord is entitled to every cent.
It is hard to blame a commercial landlord for insisting on payment of every dime owed, but that does make it nearly impossible to cut a deal quickly. So, very often, we end up with Scenario #2, which is protracted litigation.
Real Estate Litigation
Everyone will lawyer-up and things will start getting expensive. Generally, both parties have suffered losses, so the costs of litigation are pouring salt on the wound. If emotions were not running hot before this point, they definitely are now.
Commercial tenants should understand they are playing a very dangerous game in this scenario.
Once the lawsuit starts, it’s basically for “all the marbles” because the landlord will be entitled to ALL the costs and fees resulting from this lawsuit, along with unpaid rents and other damages.
With few exceptions, sooner or later, the landlord is going to get a judgment so, the longer the case goes on, the bigger the judgment will be. Therefore, unless the tenant has some exit strategy, the tenant has the Sword of Damocles over its head.
But, be aware, landlords. Sometimes the commercial tenant does have an exit strategy.
If there has been a genuine default on the commercial lease, the landlord is almost certainly going to get some kind of judgment at the end of the lawsuit. And, because the commercial lease — unless it was not prepared professionally — will definitely have a provision for recovery of costs and attorneys’ fees, the amount of the judgment is likely to be significant.
I realize that all sounds good from the landlord’s perspective. Just remember, though, getting a judgment is one thing. Collecting on the judgment can be quite another.
Executing on the Judgment
In light of the forgoing, if the tenant makes the decision to fight the landlord’s lawsuit — thereby incurring legal fees and running up the amount of the judgment — then you have to figure the tenant probably has a plan.
Like all defendants in a lawsuit, the tenant can try to make the judgment uncollectible. Because commercial leases generally require a guaranty, it may not be a simple task for the tenant to make the guarantor “judgment-proof.” It will almost certainly take time to plan and manuever.
The tenant may start transferring assets out of the landlord’s reach. If you start seeing the tenant’s attorney utilizing delay tactics in the lawsuit, it may be that the tenant needs time to get the asset-protection plan in place.
, when done skillfully, can be very effective. Often enough, a judgment-holder will decide to cut losses somewhere along the way, and the parties move on. Maybe a commercial tenant would consider that a “win.” Maybe . . .
But, asset-protection does itself involve some expense and a fair amount of hassle. More importantly, there is a mechanism in the law called “piercing the corporate veil
” that allows a judgment-holder, such as a landlord, enforce the judgment against any new entity(s) the tenant creates for asset-protection purposes.
There is no real morale to this article. I just want commercial landlords and tenants to be aware of the cat-and-mouse game that can follow a default. At some point it comes down to just how far each party is willing to go. And, I have seen these cases go very far indeed.
There are a few critical moments along the way where the two parties need to carefully consider their options. Hopefully, this overview puts you in a better position to make the best decisions.