District Court Explains Standard for Wear and Tear Exception in Commercial Real Estate Leases | Practical Law

District Court Explains Standard for Wear and Tear Exception in Commercial Real Estate Leases | Practical Law

A recent Minnesota District Court case demonstrates the importance of carefully negotiating repair and surrender clauses in long-term commercial real estate leases. The case also explains what types of wear and tear are excluded from a tenant's surrender obligations.

District Court Explains Standard for Wear and Tear Exception in Commercial Real Estate Leases

by Practical Law Real Estate
Published on 30 Mar 2017 • Minnesota
A recent Minnesota District Court case demonstrates the importance of carefully negotiating repair and surrender clauses in long-term commercial real estate leases. The case also explains what types of wear and tear are excluded from a tenant's surrender obligations.
On February 2, 2017, in H.F.S. Properties v. Foot Locker Specialty, Inc., a Minnesota District Court, in a case of first impression, explained the significance of the wear and tear exception commonly found in surrender clauses in commercial real estate leases ().

Background

Foot Locker was a tenant on land governed by two long-term leases. Foot Locker entered into a lease in 1949 and was assigned an interest in a lease from 1920 that governed the same land. Both leases expired on June 30, 2015.
Under the leases, Foot Locker was required to demolish an existing structure and construct a new building.
The 1920 lease contained no specific surrender clause, but it did have a repair clause obligating the tenant to keep the premises in good order and repair. The 1949 lease required Foot Locker to surrender the premises in good condition with wear and tear excepted.
The leases did not require a particular use of the premises, nor did they require the tenant to even occupy the building.
The building fell into disrepair and was abandoned from 1993 to 1998, when it was subleased to a construction company that structurally altered the building for office use.
HFS Properties owned an adjacent building and sought to purchase Foot Locker's building to create a parking lot. In 1999, HFS purchased the land subject to the leases and became Foot Locker's landlord.
The building was vacant again from 2001 until the lease termination date. The city revoked the building's certificate of occupancy and noted several building code violations that needed to be corrected before the building could be reoccupied.
In 2014, a ruptured pipe resulted in violations that needed to be fixed immediately on threat of criminal punishment. Foot Locker corrected those violations, but 110 building code violations existed when the premises was surrendered.
HFS knew the building was in disrepair and held Foot Locker in breach of the lease under the repair clause. In 2014, HFS demanded more than $11 million to repair the building code violations, including new elevators, stairwells, windows, plumbing, and sprinklers. Foot Locker claimed compliance with the lease would only cost $653,000 because it was not responsible to repair the building to the point that it complied with 2015 building codes.
Both parties filed for summary judgment and asked for a preliminary ruling on the scope of damages to expedite litigation. The parties' main disagreement was whether the appropriate measure of damages would be:
  • The cost of repairing the building to comply with the lease obligations, as HFS claimed was required according the repair clauses in the leases.
  • The difference in the value of the building on the date of surrender and the value it would have had if the repairs were made, which Foot Locker argued in favor of because that measure was used in analogous construction contract cases.

Outcome

Damages

The court held that the appropriate measure of damages was the cost of repairing the building to comply with the lease obligations because:
  • Minnesota law did not provide a basis for applying construction contract damages in a leasing matter.
  • Minnesota law supports the right of a landlord to recover the reasonable value of restoration when the tenant fails to surrender the property in its original condition in violation of a lease's surrender clause.

Wear and Tear Exception

The court found HFS was responsible for repairing those building code violations falling within the wear and tear exception.
In reading the repair clause (which stated Foot Locker had to keep the building in good condition) and the surrender clause (which excepted wear and tear) together, the court held that Foot Locker was required to surrender the building in good condition with wear and tear excepted.
The court reasoned that the newer 1949 lease contained a specific wear and tear exception, while the older 1920 lease only contained a general obligation to keep the building in good order and repair during the lease term. Without an implied wear and tear exception, long-term leases would essentially require the tenant to carry out a complete renovation before surrendering the premises. The court followed the principle that a contract's specific term controls over a general term.

Observance of Statutes and Ordinances

The court held that the lease's requirement that the tenant observe all statutes and ordinances did not require the tenant to pay for repairs for the building code violations that existed when the lease terminated. The lease did not require Foot Locker to surrender the building in compliance with 2015 building codes. Foot Locker complied with its statutory obligations by:
  • Registering the building as vacant and leaving it vacant when it was unoccupied.
  • Repairing violations that required immediate attention.

Practical Implications

This case is significant because it demonstrates the potential ramifications of not having specifically tailored surrender and repair clauses in a long-term commercial lease. Long-term leases require practitioners to use foresight to protect the future interests of landlords and tenants.
Although this case is unique because it involves different requirements in two applicable long-term leases, it highlights the analysis a court may follow when considering the application of a wear and tear exception in a surrender clause.