The Commercial Landlord’s Obligations, or Lack Thereof, in North Carolina

I have been asked by clients many times about the responsibilities of a commercial landlord with respect to a security deposit to be held during a lease term as security for the Tenant’s performance of its responsibilities under a commercial lease. Are there only certain types of uses that the security deposit might be used for, and must the deposit be held in a certain type of account? It is my belief that the number of questions I receive about this issue is related to the fact that there are clearly spelled out North Carolina statutory requirements applicable to the holding of a tenant security deposit in a residential lease setting.

North Carolina has one single set of statutes that concern the rights and obligations of parties to a lease. That set of statutes is known as the Chapter 42 of the North Carolina General Statutes, entitled “Landlord and Tenant”. Basically, except as otherwise set forth in this Chapter 42, or as set forth in a case interpretation (and relatively speaking Landlord-Tenant case law is not an area of significant case law in North Carolina) the lease is a contract where the parties may define the agreement, with a generally wide latitude as to legal obligations between themselves.

Within Chapter 42, there is a specific set of statutes collectively known as the “Tenant Security Deposit Act” (which is Article 6 of Chapter 42). All of the statutes in that Act, either directly or by reference, only apply to “residential dwelling unit” leases. With respect to residential dwelling unit leases, because of this Act, there are clear requirements on the amount of a security deposit that may be required by a landlord, the manner in which the funds may be held, the types of uses for which the money may be used, and the procedure that must be followed in reconciling funds with the tenant once the lease has expired or been terminated.

To my knowledge, none of these specified statutes in Chapter 42 have been applied to the commercial lease situation. Apparently, the legislature, when drafting these laws, recognized the difference in overall bargaining position between a typical residential setting, and a typical commercial setting.
It is not uncommon for a commercial lease to have a provision similar to the following:

“20. SECURITY DEPOSIT. Tenant shall deposit with Landlord the sum of _________, which sum Landlord shall retain as security for the performance by Tenant of each of its obligations hereunder (the “Security Deposit”). The Security Deposit shall not bear interest. If, at any time, Tenant fails to perform its obligations, then Landlord may, at its option, apply the Security Deposit, or any portion thereof required to cure Tenant’s default; provided, however, if prior to the Expiration Date or any termination of this Lease, Landlord depletes the Security Deposit, in whole or in part, then immediately following such depletion, Tenant shall restore the amount so used by Landlord. Unless Landlord uses the Security Deposit to cure a default of Tenant, or to restore the Premises to the condition to which Tenant is required to leave the Premises upon the Expiration Date or any termination of the Lease, then Landlord shall, within thirty (30) days after the Expiration Date or any termination of this Lease, refund to Tenant any funds remaining in the Security Deposit. Tenant may not credit against or deduct the Security Deposit from any month’s Rent.”

This common provision could create some uncertainty as to statutory compliance in a North Carolina residential lease. However, unlike a residential security deposit, it would appear that in North Carolina, a commercial landlord is not required to hold a security deposit in any special type of account, is not limited as to the amount that might be required, can hold the security for any type of default of the tenant, and does not necessarily have to account or report in any set way, or in any set time frame, as would be required in the lease of a residential dwelling unit. Obviously, though there is no legal requirement, some of the practices mandated in the residential setting might in fact be good business practices in the commercial lease setting. Regardless, whether or not to hold a security deposit, and in what amount and under what terms, is therefore ultimately a business decision in North Carolina, subject to negotiation between the parties to the lease. Arguably that is exactly where the decision is best made in a commercial setting.

Thanks,

Tom Grella

Empty Boilerplate or Valuable Content?

One of the most common questions I get from my lease clients as to the form and substance of the standard commercial lease is the meaning and intent of what is known as the “Waiver of Subrogation” clause. Perhaps some of the other questions that my client may think are: 1) Is the provision really that important, and 2) Does my attorney really know what it means himself, or is it just one of those standard “boilerplate” provisions used to increase the size of the document and the size of his fee?

The reason that the Waiver of Subrogation provision is necessary in most cases of premises damage is quite simply that having such a provision is fair to all parties involved. In many instances both a Tenant and Landlord will have insurance on the leased property and premises, and in many or most instances there may be an overlap of coverage between the two policies. In other commercial lease situations, the Landlord may obtain the insurance, and pass the cost on to the Tenant, and Tenant may not have other overlapping coverage. In any event, in many commercial lease situations (and arguably in every commercial lease situation even if not specifically stated), the Tenant will actually be the party who has paid the premium of property and casualty insurance even if that policy is actually in the name of the Landlord; either directly by virtue of a pass-through of the premium, or indirectly as an increase to the rental rate. In the situation where both parties to a lease have obtained insurance, both of the policies (of both Landlord and Tenant) will normally allow the insurance company to be subrogated to any interest of the inured in the event that the insurance company is stuck paying a claim. In other words, if the insurance company is required to pay a claim, it naturally desires to step into the shoes of the insured party, and take action against the party responsible for the damage if its insured otherwise has the right to do so.

Practically speaking, if a Tenant has been negligent in some way and damage occurs on the premises, or if damage otherwise occurs and Tenant is responsible regardless of fault, the Tenant will normally have the responsibility of payment of the expense to repair or maintain the premises, assuming there were no insurance to pay for the damage sustained. If insurance in the name of the Landlord has been obtained, and that policy pays the claim, without a waiver of subrogation provision the insurance company may have the right to claim reimbursement from the Tenant, or Tenant’s insurer (in the event that Tenant has overlapping coverage). If Landlord has the right to subrogate, in the event where Tenant’s has overlapping coverage, Tenant can expect its future insurance premium to increase. In the event that no overlapping coverage exists, Tenant is likely to find itself paying for damage as a reimbursement to the insurer, even though Tenant has already paid for coverage though payment of the premium.

It is beyond the purpose of this short blog article to get into all of the various case interpretations of instances under which a tenant whose lease lacks a Waiver of Subrogation clause might make the case that it should not be subject to subrogation based on some legal theory (such as the parties intentions, or term end obligations). Suffice it to say that there are such theories out there. Instead of reliance upon a legal theory to create intention of agreement, the lease can instead contain a clear and unambiguous Waiver of Subrogation provision. Inclusion is a valid way to keep an insurance company from proceeding against a Tenant for reimbursement after a claim has been paid by the insurer pursuant to the terms of an insurance policy that Tenant has actually or effectively paid for.

Thanks,

Tom Grella

Downward Economy = Increase in Leasing Opportunity

As the economy took a downward turn last year, there were a few areas of legal representation that seemed to take an upward swing. One of these areas, seemingly on the increase in my most recent experience, is commercial leasing. The reasons for this upward turn could be many, however certainly it is at least in part due to the fact that purchase money is less available through commercial lenders. Many potential commercial operators simply do not have the ability to purchase, and as business closings increased, available sites also increased, and owners of commercial properties became more receptive to lease as an alternative to sale. Because of this increase in commercial leasing, I thought it would be good to review some of the provisions contained in typical commercial leases. The types of things that clients seem to always ask questions about. Over the next two or three weeks I will be posting to this blog five separate articles about leasing. I expect that the following five areas of leasing will be explained and discussed:

1. Subrogation
2. Tenant security deposits
3. Options to purchase and rights of first refusal
4. Assignment and sublease
5. Casualty and insurance

Feel free to let me know if you would like me to cover any other commercial leasing topics in this blog.

Thanks,

Tom Grella