Most commercial office leases include a seemingly innocuous provision that requires the tenant to provide an estoppel certificate from time to time if requested by the landlord. The estoppel certificate may be relied upon by prospective purchasers or lenders and includes various tenant representations and warranties about the lease, the condition of the premises and the landlord’s compliance with the lease provisions. With the record setting pace of building sales in Center City Philadelphia the past year, many tenants have been receiving requests for these certificates from their landlords. While these certificates are important to the landlord and a necessary part of any purchaser’s or lenders due diligence, tenants should not take these lightly and need to be very careful about what they say and how they say it.
Because any rental property is only as good as the rent stream it throws off, prospective purchasers and lenders for the property need to conduct some basic due diligence about the leases (the underlying source of the rents) before proceeding with a transaction. If a property generated $3Million of net cash flow the prior calendar year, that doesn’t necessarily mean that it will do so next year or the year after. Certainly in any potential sale or loan transaction, the owner will provide financial statements and rent rolls to the buyer or lender, as well as certified copies of all of the leases. The owner will also provide these parties with comprehensive representations and warranties about the leases and the buildings. Why then is the tenant required to deliver an estoppel certificate which covers a lot of the same subject matter?
The answer is contained in the name of the document itself. Buyers and lenders rely on the factual statements contained in the lease documents as well as the numbers provided in the financial statements when underwriting the asset. If they can get the tenants to certify as to these facts and circumstances and they rely on the certificates in completing the purchase or loan, the tenant is thereafter estopped (i.e., prevented) from taking any contrary position after the sale or loan is concluded. Thus, even though the tenant has not benefitted from the sale or loan, by signing the estoppel certificate, it may forfeit future rights or leverage simply by signing the certificate.
Assume for example that a tenant has moved into new space which was recently built out by the landlord. Everything has been going smoothly for the first two months of the lease term and the tenant now receives an estoppel certificate from the landlord that it needs to fill out and return in 10 days. The certificate states, among other things, that the landlord has fully performed all of its construction obligations in accordance with the lease, the tenant has taken possession of the premises and is paying rent, and tenant has no claims or offsets against the landlord under the lease. It all looks pretty straightforward so the tenant executes the document and sends it back to the landlord. Everything is great except that three months later its July, the original landlord has sold the building and the air conditioning isn’t working. The tenant hires an HVAC specialist to determine what is going on and it turns out the contractor who installed the HVAC system didn’t do it correctly. It is going to cost $30,000 to fix.
The tenant calls up the new landlord and says “You didn’t construct the HVAC system as required in my construction drawings and now you need to correct it at your cost.” Unfortunately for the tenant, the new landlord has a different view of the world. It claims that the tenant has no valid claim now because it certified to the new owner three months ago that the landlord had constructed the improvements in accordance with the lease and the tenant had no claims with respect thereto. Because the new owner relied on these representations when it bought the building, the tenant may now be estopped from raising the claim against him.
Alternatively, assume that a tenant has been growing rapidly and is in need of additional space in the building. It has no expansion rights in its lease but, given its long and friendly relationship with the original landlord, they had an ongoing verbal agreement that if contiguous space became available in the building, the landlord would offer it to the tenant first before doing a deal with anybody else. This is how things had been done for 10 years with no problems. Again, the tenant receives the estoppel in anticipation of a sale and the tenant signs it. The estoppel includes a fairly standard statement that “Attached hereto as Exhibit A is a true, correct and complete copy of the Lease including all amendments thereto. There are other modifications or agreements, verbal or written, with respect to the Lease.” The new owner leases space contiguous to the tenant without coming to them first. The tenant calls up the new landlord and says “You violated my right of first refusal and cannot lease that space without coming to me first.” Unfortunately, because the tenant certified that there were no other agreements regarding the space except as set forth in the Lease document, it may be estopped from challenging the new lease.
Landlords need the ability to require tenants to verify the status of their leases and tenancies to prospective buyers and lenders. Without these certificates, it would be very difficult to sell or refinance these assets. However, in accommodating the landlord on transactions which provide no benefit to the tenant, the tenant should not put itself in a position where it unwittingly prejudices its rights. If and when a tenant is asked to provide an estoppel certificate, it should adhere to the following general guidelines:
- Avoid making absolute representations and warranties unless you are 100% sure about what you are stating and there is no chance of being wrong.
- Where appropriate, limit representations to “The best of Tenant’s knowledge” and, because the Tenant may often have little time to turn the certificate around, qualify the representation further by saying “To the best of Tenant’s knowledge without independent investigation.”
- Do not make representations about provisions in the Lease that speak for themselves. Thus, if there is a comprehensive provision in the Lease regarding Rights of First Refusal for expansion, do not make a representation or warranty about what that provision says. It speaks for itself and the parties can read it and interpret it themselves. Any statement you make now may prevent you from taking a contrary position in the future.
- When making representations about the condition of the Premises or building including that the Landlord has constructed the Tenant Improvements in accordance with the Lease, be sure to carve out any latent defects or matters which might not reasonably be apparent. Thus, in our first example regarding the HVAC system, if the Tenant had qualified its representation this way, it would have had a better claim later.
Finally, if you have been having a problem with the landlord or the building and are not satisfied with the way things have been handled to date, the Estoppel Certificate is a great opportunity to raise the issue again. By putting potential buyers and lenders on notice about ongoing disputes, breaches or disagreements, you not only preserve your claim going forward, but you may also have the necessary leverage at that point in time to effect change. The current owner doesn’t want to have unhappy tenants when the new buyer comes poking around and the new buyer may want to be perceived as the white knight that is going to come in and make everything better.
For more information contact Glenn Blumenfeld