In a landmark case, a New York State trial judge recently ruled that a tenant who remained in commercial space after its lease expired is liable not only to the property owner, but also to the incoming tenant.
The ruling, believed to be the first of its kind in New York and possibly in the nation, came in state Supreme Court, New York's trial level, where an incoming tenant sued a so-called “holdover” tenant over space in the W.R. Grace Building, at 41 W. 42nd Street. The ruling has the potential to dramatically change how all parties in commercial leasing — owners, outgoing tenants, incoming tenants, and brokers — conduct business.
Justice Walter B. Tolub ruled after a non-jury trial that by staying on 18 months beyond the end of its lease, the outgoing tenant — a prominent fashion designer — had trespassed and was liable to the tenant who had taken an option for the space. Justice Tolub will next hear a trial on damages, where he will decide how much the fashion designer owes the incoming tenant, a prominent New York City law firm. No date has been set for the trial on damages.
Justice Tolub's finding of trespass and liability puts a new spin on the obligations that holdover tenants face. It is well settled that holdover tenants owe the property owner a fair-market rent that is often higher than what it paid during the term of the lease. Now, it appears, tenants that are slow to depart will also owe damages to their successors.
Flurry of lawsuits likely
Though the New York ruling technically does not set precedent in other states, and the fashion designer has filed notice of its intent to appeal, the decision is virtually certain to trigger a spate of lawsuits — in New York and elsewhere — by incoming tenants against holdover tenants. And the damages are real. By staying put, the holdover tenant can create a domino effect that stymies the incoming tenant, which then must hold over in its space, blocking its successor, and so on.
The tenant that started the chain may be liable to all who suffered damages. The law in each state is different, but this remains an unsettled area. So, is it safe to assume that incoming tenants will try to use the New York decision to create favorable law in other states and craft arguments for recovery of damages?
More than simply spawning a slew of lawsuits, this case — which Pryor Cashman Sherman & Flynn LLP litigated on behalf of the incoming tenant — creates a cautionary tale for all parties in commercial leasing.
Advantage landlords
Property owners have a new weapon in the battle to evict recalcitrant tenants. Owners are generally motivated to see these tenants leave because the owners usually have an obligation to deliver possession to an incoming tenant. Furthermore, incoming tenants who have not yet signed leases can lose interest and go elsewhere. Now, instead of merely charging a holdover tenant higher rent — which historically has not deterred holding over — owners can remind them of the New York case and the likelihood of liability and damages.
Incoming tenants, meanwhile, have an avenue of redress when their legitimate attempts to take space are thwarted. Incoming tenants who cannot take occupancy because a prior tenant held over should keep meticulous records of the damages they suffered, including the cost of temporary space, higher rent that they paid as holdover tenants, inability to expand operations, inability to operate efficiently, and business they turned away for lack of space or staff.
Brokers can no longer tell their corporate clients to hold over without fear, as has been the norm. Many brokers have strong enough relationships with landlords to strike a deal on behalf of a corporate client, but will not be able to protect those corporate clients from lawsuits by incoming tenants.
Tenants whose leases are about to expire should be aware that the holdover rate in urban office markets, such as Manhattan, is relatively high. In many cases, the reasons for holding over are a function of the tight market: New space isn't ready on time; small businesses don't have personnel dedicated solely to facilities; and some tenants simply don't allow enough time for a move.
But in ruling that corporate users need the economic certainty of knowing where they will be at any given time, Justice Tolub made it clear that even benign reasons for holding over constitute trespassing and leave the holdover tenant liable for damages to its successor. The message is clear: plan early, plan well, and budget your time. The cost of failing to do so has risen sharply.
Todd E. Soloway is the head of the real estate litigation practice group at the New York City law firm of Pryor Cashman Sherman & Flynn LLP.