|
Some Considerations of Condemnation
Clauses
By M. Robert Goldstein and Michael J. Goldstein
Most leases used today are form leases containing "boiler
plate" clauses. Although they are reviewed when attorneys
are involved, our observation, based upon the almost universal
nonchanges in standard condemnation clauses, is that they
generally are accepted as written. The inference must be that
they are either so expertly drawn that they anticipate all
situations or are so little understood that most do not know
what to do with them. Where, however, leases are drawn to
order, one can find a variety of condemnation clauses, some
done quite well, others less so. Some are drawn so inexpertly,
that we wonder if either party had enough basic knowledge
to know how to structure such clauses.
Drafting a Specialty
The condemnation clause is one that requires special knowledge
and understanding. In drafting such a clause, one must understand
why it is necessary, what it is supposed to accomplish and
how it impacts on a tenant's rights as against the landlord
in a condemnation proceeding.
A tenant with a leasehold estate has a grant of an interest
in the real estate, the extent of that estate being measured
by the leasehold instrument. In the usual lease, there is
a grant for a term of years (or a specific lifetime which
can be equated to a term of years based upon life expectancy
tables) in exchange for the payment of rent. There is a benefit
to a tenant when the value of his leasehold exceeds the amount
of rent that he is paying. Absent any contrary contractual
arrangement (the condemnation clause) the tenant is entitled
to have any benefit from that leasehold estate compensated
for if it is condemned. A tenant who has a five-year remaining
term to his lease under which he has a rent obligation of
$1,000 a year but which space is worth $2,000 a year has the
benefit of $1,000 per year for five years.
Under this example, the value of the space is measured by
the rental of $2,000 per year, of which the landlord receives
but $1,000 and the tenant the other $1,000. Each would be
entitled to compensation for his respective interest. As the
property may not be worth more than 100 percent of its value
and as the tenant has been granted an interest in that property,
any compensation the tenant receives is carved out of the
value of the property as a whole.
Ruling in A&P Cases
As was said in Great Atlantic & Pacific Tea Co. v.
State of N.Y., 22 N.Y. 2d 75, 84, 291 N.Y.S. 2d 299, 305
(1968):
"Generally speaking, where there are two or more interests
or estates in a condemned parcel, the proper mode of assessing
damages is to ascertain first the damage to the fee as if
it were unencumbered, and then to apportion that amount among
all of the estates and interest which are held in the property.
. . . . In computing the value of the leasehold, the court
must first ascertain the fair rental value of the premises
and then deduct therefrom the actual rent reserved for the
remaining period or term of the lease."
How this rent disparity comes about very often determines
the position of the parties as to whether the tenant should
be entitled to compensation for loss of the lease. Most landlords,
with cause, take the position of why should I give the tenant
any part of the compensation for my property if he did nothing
but be there when values increased, either from inflation,
an increase in neighborhood values or just a miscalculation
of values in making the lease?
However, the increase in rental value may come about by an
expenditure by the tenant for the improvement to the property.
This runs a gamut from the improvement of an "as is"
building to a substantial structural alterations or additions
to the erection of an entire structure under a ground lease.
Obviously, when this occurs, the tenant assumes he will receive
the benefits of those improvements, not only over the full
term of the lease but through his option periods as well.
Such expenditures not only increase the value of the property
but are deemed prepaid rent by the tenant. (In re Water
Street, 19 A.D. 2d 44, 24, 241 N.Y.S. 2d 44 (1963)).
One must be careful, however, in differentiation between
those tenant improvements which became part of the real estate
either under common law doctrines or the "alterations
and improvements" clause in standard leases which reflect
it and those installations which are tenants' trade fixtures
for which the tenant is entitled to additional and separate
compensation (Matter of City of N.Y. [Allen Street],
256 N.Y. 236 (1931)) and which do not add to the rental value
of the property, not becoming part of the landlord's
estate.
It is when the tenant has added to the value of his landlord's
estate by improvements, the enjoyment of which over the term
of the lease is cut off by condemnation, that he seriously
bargains for a share of that condemnation award. That share
may be determined in any way the parties may agree, and the
Courts, in apportioning a condemnation award, will be bound
by the terms of that agreement (Traendly v. State of N.Y.,
51 A.D. 2d 489, 382 N.Y.S. 2d 365 (1976)).
Many Approaches Used
Many approaches to such an agreement have been used. The
basic approach is to let the measure of compensation be the
difference between rent reserved and higher rental value over
the term of the lease, including tenant option periods, discounted
to present value based upon market rates of risk and return
for leaseholds. When this happens, there are in essence three
estates to be valued, making up 100 percent of the value:
the landlord's estate based upon the rent reserved in
the lease, the tenant's estate which is based upon the
additional rental value over the rent reserved for the term
of the lease and the landlord's reversionary interest
after the expiration of the lease. If properly valued, these
three together should equal 100 percent. Because the property
is most times valued by a capitalization of income and the
leasehold is valued in accordance with tables on the present
value of a future flow of income which mathematically do not
work out the same, there is often a disparity, which is particularly
egregious in longer term leases.
The drafter of a condemnation clause should be aware of the
problem and attempt to treat it in his lease clause. One suggestion
is to provide that in no circumstance may the owner of the
fee estate receive less than the value of the lease rent capitalized
plus the reversion with the tenant receiving the present worth
of his rent bonus as long as it does not reduce the landlord's
award below that figure.
Very often, where improvements are made to the real estate
which add to its value, the means chosen to compensate the
tenant is to separate real property from trade fixtures, specifically
enumerating them, and provide for an amortization of the cost
of the improvements over the term of the lease. The problem
is in differentiating between trade fixtures and improvements
and assuming that the real estate value is increased dollar
for dollar with the cost of the improvements. Probably, this
is the best compromise approach, considering the alternatives,
but it appears to us that the trade fixture award, if and
when made, should be factored into the computations.
Where there is a land lease, with the tenant constructing
the building, two approaches have been used, one the typical
common laws case approach and the other a provision that the
land value goes to the fee owner and the building to the tenant.
There are, however, practical problems.
An Example
As an example, take a building which, when built, conformed
to the maximum that could be built under the zoning regulations.
Subsequently, the zoning is changed to permit more intensive
use of the land resulting in an increase in value. If the
land were valued only consistent with what was built on it,
it has one value. If valued in accordance with its highest
and best use, i.e., what could now be build on it, it has
a higher value. But the property still produces income only
in accordance with how it is built and produces a value based
upon it. Yet the rule of law in condemnation proceedings provides
for a value in accordance with highest and best use. If one
first values the land based on highest and best use the building
value is decreased. If one takes either current building value
(assuming it could independently be fixed) or land value based
upon the building as built, the land value, in terms of its
value if freed from the lease, suffers. The problem has led
to protracted negotiations where the problem has been recognized.
It has been suggested that there are at least two answers
to the problem. First, increase in land value increases the
rental value which, in any event, will increase total value.
But, it does not handle the problem of an increase in value
by reason of a zoning change. The second answer is probably
the correct one. Buildings only have such value as they add
to the land. As the land becomes increasingly more valuable
and the building is less and less an adequate improvement,
for whatever the reason, it becomes more and more obsolete
until the land value, freed of the building, is in excess
of the land as improved with that building, at which time,
it would be demolished. Thus, it is the land which must first
be valued at its highest and best use with the residual value
between it and total value attributable to the building.
Whatever the answer, however the parties arrive at it, it
must be considered in terms of knowledge of the economics
of real property valuation and how the clause will work in
that context. Note that we have not begun to discuss partial
takings and the special problems inherent in them, in terms
of apportionment of rent, reconstruction, allocation of values,
etc. We reserve that for another column.
|
