This article explains the benefits landlords receive by including and using a Tenant Estoppel Certificate clause in lease agreements.
Protection for buyers and lenders
A real estate broker representing a landlord who wants to sell or refinance his income-producing property customarily prepares an annual property operating data (APOD) form. The completed APOD will be handed to prospective buyers and lenders to induce them to enter into a transaction with the landlord. [See first tuesday Form 352]
A thoughtfully prepared APOD provides buyers and lenders with a summary of financial information on the operating income and expenses generated by a property, as well as loans encumbering the property.
Buyers and lenders who rely on APOD figures should confirm the income and other leasing arrangements by conditioning the closing on their receipt and further approval of a signed Tenant Estoppel Certificate (TEC) from each occupant of the property.
The TEC details the financial and possessory terms of the lease, and whether the landlord and tenant have fully performed their obligations.
However, before the landlord can require a TEC to be signed and returned by the tenants to confirm the leasing arrangements, the lease must contain a Tenant Estoppel Certificate clause.
Excerpt from first tuesday Form 552 — Nonresidential Lease Agreement
|18.||Tenant Estoppel Certificates:|
|18.1||Within 10 days after notice, the Tenant will execute a certificate stating the existing terms of the lease to be provided to prospective buyers or lenders.|
Failure to deliver the certificate shall be conclusive evidence the information contained in it is correct.
- sign and return a TEC within a specific period of time after its receipt; or
- waive his right to contest its contents should the tenant fail to sign and return the TEC submitted for his signature.
The objective of the TEC is to confirm the current status of:
- rent schedules;
- security deposits;
- possessory and acquisition rights; and
- the responsibility for maintenance and other operating or carrying costs.
Also, the TEC will reveal any option or first refusal rights held by the tenant to:
- extend or renew the lease;
- buy the property;
- lease other or additional space; or
- cancel the lease prematurely on payment of a fee.
Tenant response to a TEC
In addition to information regarding the rent schedule and the rights and responsibilities of the tenant, a TEC includes a statement indicating a lender or buyer will rely on the information provided by the TEC when making a decision to lend or purchase. [See Form 598 §10]
The tenant’s acknowledgment of the TEC contents by his signed response, or waiver of the right to contest the contents of the TEC by nonresponse, can be relied on by a lender or buyer as establishing the contents of the TEC as complete and correct statements on the condition of the lease. [Calif. Evidence Code §623]
Should a dispute arise between the buyer (or a lender) and the tenant regarding conditions covered in a TEC, the properly submitted TEC bars any later claims made by the tenant which are in conflict with the contents of the TEC.
A buyer or lender asserts his right to rely on and enforce the conditions stated in the TEC by presenting the tenant’s TEC as a defense to contrary claims made by the tenant, called estoppel.
The tenant would be estopped from denying the truth of the information in the TEC or claiming conflicting rights.
Security deposits confirmed
When leases are assigned to a buyer on closing a sale, the buyer requires the seller to account for any security deposits collected from the tenants and credit the amount of the remaining security deposits to the buyer, called adjustments.
With a TEC, the tenant confirms the correct accounting and amount of security remaining on deposit with the seller. Thus, the TEC avoids the transfer of insufficient security deposits on closing and establishes the buyer’s liability for refund amounts.
If the buyer does not require a TEC to confirm the current amount of the security deposits claimed to be held by the seller for transfer to the buyer, the buyer may find himself paying tenants more than the security deposit amounts transferred by the seller on closing. [Calif. Civil Code §1950.5(i)]
To recover any deficiency in the credit received by the buyer on closing for security deposits held by the seller, the buyer would be required to pursue the seller.
TEC confirms prior representation
Use of an APOD form to present a summary of the operating data on a property’s income and expenses confirms the income flow and operating expenses the buyer can immediately expect the property to generate.
To establish, prior to closing, the income and expenses the buyer can reasonably expect the tenants to pay, the buyer must:
- review all the leasing agreements the owner has with the tenants;
- compare the results of the lease examination to the figures in the APOD received before the offer was submitted; and
- confirm the rent schedules, rent adjustments and the expiration of the leases by serving TECs on the tenants and reviewing their responses.
Status of the lease
The TEC verifies the following:
- whether possession is held under a lease or rental agreement;
- the current monthly amount of rent and the basis for rent increases;
- the date rent is paid each month;
- the date to which rent has been paid;
- any incentives given to obtain the tenant;
- whether the tenant has prepaid any rents;
- the term of the lease and whether an early cancellation privilege exists;
- whether and in what manner the lease/rental agreement has been modified;
- whether the tenant holds any options to renew or extend, acquire additional or substitute space, or a right of first refusal to rent vacated space;
- whether the tenant holds any options to buy the real estate;
- the amount and status of any security deposit;
- any improvements the tenant must or can remove on vacating the premises;
- any landlord commitments to further improve the premises;
- whether the landlord or tenant is in breach of the lease or the rental agreement; and
- whether the tenant has assigned or sublet the premises, or liened his leasehold interest.
Close on receipt of TEC
When received from the tenant, the TEC statement reflects only what has occurred at the time the tenant signed and returned the TEC.
Consider a tenant who signs and returns a TEC which is reviewed and approved by the buyer. Before escrow closes, the seller breaches, modifies or enters into some other leasing arrangement with the tenant.
The seller’s activities will not be noted on the TEC, and will also be unknown to the buyer when escrow closes unless somehow brought to the buyer’s attention.
Thus, after receiving the TECs, a buyer or lender should review them and close the transaction as soon as possible.
Consequence of no TEC
A lender or buyer may be confronted at the time of closing with a tenant who has not signed and returned a TEC. Before closing, it is good practice to investigate whether differences actually exist between the owner’s representations and the tenant’s expectations under the lease agreement.
Even though the lender or buyer can legally rely on the contents of an unreturned TEC when the tenant’s lease contains a TEC clause, an inquiry by the buyer or his agent is practical as a measure of prevention against future surprises.
Consider an owner of income-producing real estate who needs to generate cash and will do so by borrowing funds using the equity in his property as security for repayment of the loan.
Tenants occupy the property under lease agreements which include options to renew at fixed rental rates. The lender does not condition the origination of the loan on the lender’s receipt and approval of TECs from each tenant.
The lender makes the loan based on the value of comparable properties without regard for a schedule of the tenants’ rent. [See first tuesday Form 380]
The owner defaults. The lender forecloses and is the successful bidder at the trustee’s sale.
As the new owner, the lender (or anyone else who purchases the property at the trustee’s sale) reviews the rent paid by the tenants.
The new owner decides to increase the rents to current market rates in order to bring the property’s market value up to prices recently received on the sale of comparable properties.
However, the tenants who occupied the premises before the recording of the lender’s trust deed claim their leases, which provide options to renew at old rental rates, are enforceable.
The lender claims his foreclosure sale establishes him as a new title holder with priority over the leases, and further, the leases are not recorded.
Can the tenants who occupied the property prior to the recording of the lender’s trust deed enforce their renewal options even though the leases are not recorded?
Yes! The lender originating the loan on income-producing property, which was foreclosed and created the new ownership-by-foreclosure, recorded the trust deed knowing the tenants were in possession of the property. Thus:
- the leases held by pre-existing tenants, recorded or not, retain priority over the trust deed lien; and
- the lender is bound by the rent schedules in the pre-existing leases and renewal/extension options because of the seniority of the leases. [CC §1214]
The tenants’ occupancy of the premises prior to originating the loan puts the lender on constructive notice, i.e., the lender is charged with knowledge of the lease agreements, renewal options and rent schedules. [Evans v. Faught (1965) 231 CA2d 698]
The requirement for lender approval of a TEC on each tenant would have informed the lender of the tenants’ right and obligation to occupy and pay rent under their leases.
Thus, to be assured the owner’s scheduled future income represents amounts the tenants expect to pay, every buyer or lender acquiring an interest in income-producing real estate should require tenant approval of TECs based on lease arrangements the owner/seller purports to hold with each tenant.
Signing an erroneous TEC
Consider a tenant who signs a tenant estoppel certificate (TEC) on the landlord’s sale of nonresidential property. The TEC is erroneously prepared, stating an expiration date earlier than the date for termination provided in the lease.
The buyer relies on the TEC and purchases the property. The tenant remains in possession of the premises after the expiration date stated in the TEC. The buyer seeks to enforce the expiration date in the TEC by filing an unlawful detainer (UD) action to evict the tenant.
The tenant claims the buyer cannot enforce the expiration date in the TEC by a UD action since the TEC was not a written agreement which modified the lease, binding him to a different expiration date than actually stated in the lease.
The buyer claims the tenant is barred from contradicting the expiration date stated in the TEC.
Here, the new landlord can enforce the expiration date in the TEC and evict the tenant by a UD action. The TEC was a statement signed by the tenant certifying facts with respect to the lease which were relied on by the lender. Thus, the tenant was barred from later using the lease provision to contradict the TEC, called estoppel. [Plaza Freeway Limited Partnership v. First Mountain Bank (2000) 81 CA4th 616]
The erroneous, unsigned TEC
Now consider a purchase agreement for nonresidential rental property which requires the seller to provide the buyer with TECs for the buyer’s further approval or cancellation of the purchase agreement.
One tenant’s lease does not state the rent amounts but gives a formula for calculating rent. The seller instructs the buyer on how to calculate the rent due from the tenant based on the provisions in the tenant’s lease.
The seller enters the rent amounts on the TEC based on the same calculations given to the buyer and sends it to the tenant to be signed and returned to the buyer. The tenant refuses to sign the TEC since the tenant is not obligated under his lease to provide a TEC.
The seller hands the buyer a copy of the tenant’s unsigned TEC to satisfy the purchase agreement condition, which the buyer accepts.
After escrow closes, the buyer discovers the tenant’s actual rent is significantly lower than the seller’s estimate.
The buyer makes a demand on the seller for the difference between the actual rent paid by the tenant under the lease and the rent amounts calculated by the seller as the rent to be paid by the tenant.
Is the seller liable for the difference in the rent?
Yes! The buyer recovers lost rent from the seller in the amount of the difference between the seller’s calculated estimate of rent and the actual amount owed by the tenant. The seller is obligated under the purchase agreement to provide the buyer with an accurate TEC, and the buyer based his decision to purchase the property on the information provided by the seller, not on the lease provisions for rent. [Linden Partners v. Wilshire Linden Associates (1998) 62 CA4th 508]
A seller avoids liability for errors in the TEC prepared and sent to tenants by including a TEC clause in the tenant’s lease, calling for the tenant to sign and return a TEC on request. The failure of the tenant to provide the TEC called for in the lease is conclusive evidence any information contained in the TEC is correct. [See Figure 1]
Thus, a tenant’s refusal to sign a TEC when a TEC clause exists in the lease agreement results in the tenant, not the seller, being liable for the erroneous rent amount stated in the TEC prepared by the seller.