Recessions force awareness of distinctions

Commercial tenants and landlords have a far greater frequency of stress in their leasehold relationship during periods of declining economic conditions. This is a result of the economic two-step which comes into play: the tenant’s income is the landlord’s income.

When the tenant’s business income suffers from an economic downturn, as most do, the landlord’s income is soon to become affected as rental payments become problematic for the tenant.

To stay alert to details, the landlord and their leasing agents need a quick refresher course in the narrow sets of activities a landlord takes to preserve their contract right to enforce the collection of rents agreed to in the leasing agreement. Initially, they need to acknowledge that the lease agreement is a document which contains two separate legal purposes. One is to convey a right in real estate — the ownership of the leasehold interest granted to the tenant. The other is to establish contract rights — such as the right to collect agreed-to rent due from the tenant.

These two aspects of a landlord-tenant relationship are separate and distinct. They are unique concepts frequently conflated and misunderstood but do not need to be. Until the leasehold is declared forfeited by the landlord, the landlord may not act independent of the tenant’s right to possession and cannot re-rent the space. Until forfeited, the tenant retains ownership of the right to possession, not the landlord.

In contrast, the lease agreement provisions are enforced until the lease agreement has been canceled by either mutual agreement by the landlord and tenant, or by actions of the landlord inconsistent with the tenant’s right to possession when the landlord fails to first declare the tenant’s right to possession forfeited. A tenant cannot, however, unilaterally terminate their ownership of the right to possession.

It is the lease agreement conditions that are enforced to collect rent called for in the lease agreement. Thus, preservation of the lease agreement is the primary concern of a landlord and their leasing agent for enforcing the collection of rent from a tenant in default.

Read on to learn about the landlord’s proper handling of the tenant’s right to possession needed to preserve the landlord’s right to collect rents.

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Recession Watch

Lost ability to recover future rents

Before a commercial lease expires, consider a tenant who closes out their business operations and vacates the premises, paying no further rent. The landlord serves the tenant with a three-day notice to pay rent or quit. [See RPI Form 575]

The notice includes a clause declaring a forfeiture of the lease when the tenant fails to pay rent within three days following service of the notice.

The tenant responds to the notice with a letter, stating they elect not to pay future rent and accept the landlord’s offer to terminate the lease. The key to the premises is returned to the landlord with the letter.

The landlord responds with a letter stating:

  • neither the landlord nor the tenant owe each other any further obligations under the lease; and
  • the tenant is to pay all rent due up to the date the tenant returned the key to the landlord.

The landlord then attempts to relet the premises, but without success.

Later, the landlord makes a demand on the tenant for payment of rents called for in the lease agreement for the entire remaining term of the lease. The landlord claims the forfeiture of the lease in the three-day notice terminated the tenant’s right of possession — but did not cancel the lease agreement.

The tenant claims the landlord is not entitled to any future rents called for in the lease agreement since the landlord agreed that neither the tenant nor the landlord owed any further obligation under the lease agreement.

May the landlord recover future rents from the tenant based on the lease agreement, notices and letters?

No! The lease agreement was cancelled by the communications agreeing to terminate all obligations under the lease agreement in exchange for possession. Therefore, the lease agreement was no longer enforceable. [Desert Plaza Partnership v. Waddell (1986) 180 CA3d 805]

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Lease agreements and property management forms

Surrender

Continuing our previous example, the tenant’s letter “electing to pay no future rent” coupled with the return of the key to the landlord initiated a surrender. It signified an implied offer to cancel the lease agreement in addition to terminating the right to possession, the forfeiture.

The landlord’s affirmative written response to the tenant’s letter foregoing future rents released the tenant from further liability on the lease agreement. The landlord’s conduct constituted acceptance of the tenant’s offer to cancel the lease agreement obligations.

Editor’s note — A declaration of forfeiture relates to the right to possession and reserves the landlord’s right to collect future rents under the lease agreement from the tenant. However, the landlord later effectively cancelled the lease agreement by their conduct in agreeing to the tenant’s offer to pay no future rent on return of the keys. [Calif. Civil Code §1951.2]

A lease agreement breached and space vacated

Consider a tenant who breaches a commercial lease agreement before the lease expires and vacates the premises without the landlord’s service of a three-day notice to quit on the tenant.

The landlord may respond by taking possession in one of four ways:

  • terminate the tenant’s right of possession and cancel the lease agreement by a surrender, then take possession as the owner and relet the premises to others or occupy the premises [See RPI Form 587];
  • terminate the tenant’s right of possession using a three-day notice containing a declaration of forfeiture (or a notice of abandonment), take possession and relet the premises to mitigate losses before making a demand for payment of future rents [See RPI e-book Landlords, Tenants and Property Management, Chapter 18; see RPI Form 575 and 581];
  • take possession of the premises and relet it on the tenant’s behalf, then collect any monthly losses from the tenant; or
  • enforce any tenant-mitigation provision in the lease agreement, leaving possession with the tenant to relet the premises to mitigate the tenant’s losses. [See RPI e-book Landlords, Tenants and Property Management, Chapter 34]

Only ownership of a real estate interest, such as a leasehold interest, and personal property may be forfeited. However, a contract, such as a lease agreement, is not property. A contract is evidence of rights and obligations. Thus, it may be cancelled, but it cannot be the subject of a forfeiture.

A surrender occurs when:

  • a tenant breaches a lease or rental agreement and vacates or intends to vacate the premises; and
  • the landlord agrees to accept a return of possession from the tenant in exchange for cancelling the lease agreement.

The cancellation of the lease agreement in a surrender situation occurs by either:

  • mutual consent of the landlord and the tenant [CC §1933(2)]; or
  • operation of law, implied due to the conduct of the landlord.

Editor’s note — Avoiding an unintentional surrender is one of the many reasons why a landlord needs to understand the difference between terminating a right of possession (the forfeiture of possession aspect) and the separate act of terminating a lease agreement (the cancellation of the right to future rents). [See RPI e-book Landlords, Tenants and Property Management, Chapter 18]

Related article:

Rent collectible under a lease agreement

For a landlord to avoid adverse legal consequences when a tenant prematurely vacates, lease agreements contain a remedies provision stating a surrender occurs only when the tenant enters into a written cancellation and waiver agreement. [See RPI Form 552 §2.4]

Termination of Lease and Surrender Agreement

The Termination of Lease and Surrender Agreement by Realty Publications, Inc. (RPI) provides the writing used to mutually terminate a lease agreement and release the tenant and landlord from any further obligations and liability under the lease agreement. [See RPI Form 587]

Lease termination and surrender agreement provisions include:

  • the termination date on which the tenant is to quit and surrender possession of the premises to the landlord [See RPI Form 587 §2];
  • a release between the landlord and tenant from all claims and obligations, known or unknown, arising out of the lease agreement and possession [See RPI Form 587 §2.1];
  • any monetary consideration remaining to be paid by the tenant to the landlord [See RPI Form 587 §2.2];
  • a description of any conditions to be performed prior to cancellation, which may include any payment the landlord will make to the tenant, such as a return of deposit, prepaid rent or settlement money on a dispute [See RPI Form 587 §2.3]; and
  • conditions pertaining to a subtenant, if any, that needs to be arranged and agreed to. [See RPI Form 587 §2.4]

Surrender by mutual consent

Consider a tenant who makes a written offer to surrender the leased premises to the landlord.

The landlord believes a new tenant, who will pay more rent for the space than the current tenant, can be quickly and easily located.

Still, the landlord demands an early-termination fee equal to three months’ rent to cancel the lease agreement. The tenant pays the fee and delivers possession, and the acceptance by the landlord cancels the lease agreement. Here, a surrender has occurred. [See RPI Form 587 §2.2]

Editor’s note — Mid-term leases sometimes contain an early-termination provision for a surrender. The provision allows the tenant to cancel the lease agreement on payment of a fee. This termination fee usually is in the amount of two to six months’ unearned rent. This is a type of prepayment bonus or liability limitation provision seen in mortgages and purchase agreements. 

Under an early termination provision, a surrender functions like a deed-in-lieu of foreclosure that conveys the real estate to the lender (possession returned to the landlord) in exchange for the lender’s cancellation of the note obligations (cancellation of the lease agreement).

Surrender by operation of law

Now consider a tenant on a lease with a ten-year term. A few years after entering into the lease agreement, the tenant vacates the premises. The tenant removes all of their personal property and returns the key to the landlord. The tenant has no intention of returning and has breached the lease agreement by failing to pay rent.

Since a surrender cancels the landlord’s right to future rents due under the lease agreement, the landlord refuses to treat the tenant’s return of possession as a surrender.

To avoid a surrender, the landlord promptly informs the tenant they intend to enforce collection of future rent due by the terms of the lease agreement.

However, without prior notice to the tenant, the landlord retakes possession, refurbishes the vacated space and leases it to a replacement tenant. The new lease agreement with the replacement tenant is for a lower rent rate than the prior tenant paid under the breached lease. The landlord notifies the prior tenant they have leased the premises to mitigate their loss of rent.

The landlord makes a demand on the prior tenant for the payment of rent. The rent demanded is the difference between:

  • the total amount of rents remaining unpaid over the remaining unexpired term of the prior tenant’s lease; and
  • the amount of rent to be paid during the same period under the new lease by the replacement tenant.

Can the landlord recover the lost rent from the prior tenant who vacated the premises and returned possession to the landlord?

No! Before entering the space to prepare for reletting the premises, the landlord failed to:

  • terminate the tenancy by serving a three-day notice with a declaration of forfeiture (or a notice of abandonment); or
  • notify the tenant they were taking possession of the premises as an agent acting on the tenant’s behalf.

The conduct of the landlord at the time they unilaterally took possession to relet the premises violated the tenant’s unforfeited and continuing right of possession. Although the landlord did not intend to accept a surrender, they did so by taking possession without first forfeiting the tenant’s leasehold (or advising the tenant of the landlord’s intent to act on the tenant’s behalf to relet the premises).

Here, a surrender by operation of law occurred. The landlord took possession while the tenant still retained their possessory interest in the property as granted by the lease agreement.

Thus, the landlord’s interference with the tenant’s remaining right of possession constitutes an acceptance by the landlord of an implied offer to surrender initiated by the tenant’s vacating the premises.

The result is the tenancy is terminated and the lease agreement cancelled by surrender. This result is avoided when the landlord first serves notice terminating the tenant’s right of possession with a declaration of forfeiture provision. [Dorcich v. Time Oil Co. (1951) 103 CA2d 677]

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The Three-Day Notice to Pay Rent or Quit: a landlord’s remedy for a material breach

Repossession and re-renting on the tenant’s behalf

A landlord may not want to terminate the tenancy on evicting the tenant. The landlord might rather retake possession, acting as the tenant’s agent to relet the property on the tenant’s (rather than the landlord’s) behalf.

Here, the landlord omits the declaration of forfeiture from the three-day notice since the landlord intends to leave the tenant’s right of possession intact.

Although no longer physically occupying the property, the tenant still owns the leasehold interest in the property and the lease agreement remains enforceable as it has not been cancelled. However, the use and occupancy of the premises is now managed by the landlord on the tenant’s behalf.

The landlord who intends to take possession and relet the premises as the tenant’s agent notifies the tenant about their agency actions twice:

  • once before taking possession of the premises; and
  • again when the premises is relet.

Even when a tenant fails to pay rent, removes all of their personal property, vacates the leased premises and has no intention of returning, the tenant cannot unilaterally terminate their right to continued possession of the premises, much less escape the obligations to pay future rents called for in the lease agreement.

Until the tenant’s right of possession is terminated by a three-day notice containing a declaration of forfeiture provision (or abandonment) served on the tenant by the landlord, no person other than the tenant has the right to occupy the premises.

However, the landlord who does not forfeit the tenant’s right of possession may establish themselves as the agent of the tenant who has vacated.

This is done in an effort to preserve the landlord’s reversionary interest from waste.

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Form-of-the-Week: Forms 550 and 551 – Setting the terms of a fixed-term or month-to-month residential tenancy

Inconsistent behavior while reletting on tenant’s behalf

Consider a tenant who has breached their lease agreement and vacated the premises. The landlord notifies the tenant that the landlord will enter the premises, take possession and relet the premises as the tenant’s agent, not for the independent account of the landlord.

The landlord relets the premises for less rent than the tenant had agreed to pay under the existing lease agreement. However, the new tenancy is for a period extending beyond the expiration of the tenant’s lease term. The landlord notifies the tenant they have relet the premises on the tenant’s behalf.

The landlord then makes a demand on the tenant for the loss in rent resulting from the reletting of the premises at a reduced rent. The tenant refuses to pay since the terms of the lease granted to the new tenant by the landlord exceeded the term of the tenant’s remaining right of possession under the breached lease agreement.

Here, the tenant’s right of possession which remains unterminated runs only until the expiration of the period fixed by the lease agreement. Had the vacating tenant sought to sublet the premises, the term of the sublease may not extend beyond the expiration date of the tenant’s lease.

Thus, the landlord who acts to relet the premises as the tenant’s agent for a longer term than the unexpired term remaining on the lease:

  • is not renting the premises on behalf of the tenant; and
  • has effected a surrender which cancels the lease agreement due to conduct inconsistent with the vacating tenant’s unexpired and unterminated right of possession. [Welcome Hess (1891) 90 C 507]

Related article:

May a residential subtenant retain possession when the master tenant defaults on rent, a three-day notice to pay is served, the subtenant tenders the delinquent rent, and the tenant vacates?

Maintenance to prevent waste

Now consider a landlord who, on notice to a vacating tenant, takes possession on behalf of the tenant. The landlord maintains and cares for the vacated premises while attempting to relet the premises.

The tenant claims the landlord’s care and maintenance of the property constitutes a surrender since the landlord exercised independent control over the premises by their maintenance activity.

However, the landlord has not surrendered the property merely by maintaining it to prevent waste. Acting as the agent of the vacated tenant, the landlord undertakes an obligation to make a good faith effort to lease the premises, called loss mitigation. This duty requires the landlord to keep the premises properly maintained. Care and maintenance of the property is an activity consistent with the landlord’s agency duty owed the tenant when acting on the tenant’s behalf. [B.K.K. Company v. Schultz (1970) 7 CA3d 786]

To avoid adverse legal consequences when a tenant prematurely vacates, lease agreements contain a remedies provision stating a surrender can occur only when the tenant enters into a written cancellation and waiver agreement. [See RPI Form 552 §2.4]

However, the landlord’s conduct regarding possession in response to a tenant’s breach of the lease agreement and vacating of the premises can result in a cancellation of the lease by surrender.

A landlord’s inconsistent conduct renders the lease agreement provisions requiring a written agreement to cancel the lease ineffective. Landlord/tenant law controls the results of conduct, barring application of contract law principles that ignore the landlord’s inconsistent conduct.

Related Video: Word-of-the-Week: Waste

Click here for more information on how waste forfeits the lease.

Want to learn more about surrender, forfeiture and abandonment? Click the image below to download the RPI book cited in this article.