In the spring of 1988, a raging fire swept through the First Interstate Bank building in downtown Los Angeles. That event galvanized the city into adopting a strict sprinkler retrofit ordinance. Its terms require building owners to install comprehensive fire-safety improvements within three years of receiving notice from the Fire Department of noncompliance with fire-safety standards.
This catastrophic fire, which received widespread national press coverage, also prompted other state and local authorities throughout the country to pass or consider adopting similar ordinances regarding sprinkler retrofits in commercial buildings.
Commercial owners, faced with the large capital expenditure needed to comply with these requirements, are asking whether all or part of this cost may be passed on to their tenants. Often the answer is no.
Unfortunately, if a lease does not specifically address the allocation of the cost of government-mandated capital improvements, the owner that seeks to pass the cost on to its tenants faces an uphill battle. This article explains why and offers drafting tips for dealing with the issue in new leases.
Allocation in existing leases
The question of who bears the cost of any government-mandated capital improvements has traditionally been overlooked in the negotiation of real estate office leases. Thus, to pass such costs through to tenants under existing leases, owners must look to general provisions such as the "operating expenses" and "compliance with laws" sections of the lease.
However, in most cases neither lease provision specifically addresses the allocation of the cost of government-mandated capital improvements such as sprinkler retrofitting. Consequently neither provision offers an owner more than a limited chance at success.
Compliance with laws. The typical "compliance with laws" provision obligates the tenant to abide by all existing or future laws, ordinances, orders, rules, regulations, or other governmental requirements. Although at first glance the provision may appear sufficient to enable owners to pass on the cost of government-mandated repairs to tenants, many courts have been reluctant to require tenants to bear the costs of such "substantial" alterations.
For example, in Gletin R. Sezvell Sheet Metal, Inc. v. Loverde, 70 Cal. 2d 566, 674, 75 Cal. Rptr. 889, 894 (Cal. 1969), the California Supreme Court concluded that a tenant's unqualified covenant to comply with laws and ordinances does not, standing alone, constitute an assumption by the tenant of the duty to comply with government-mandated alterations of a "substantial" nature.
Unless such costs are specifically allocated in the lease, courts apply general principles of contract interpretation to construe the parties' intent regarding such allocations at the time the lease was executed. To determine the parties' intent, courts have considered a variety of factors, such as:
* Whether the law or ordinance existed when the lease was executed. If a law is newly enacted, it is less likely to have been contemplated by the tenant on entering into the lease.
* Whether the alteration is required as a result of the tenant's particular use of the premises.
* Whether the cost of compliance is "substantial" in relation to the tenant's rental obligations.
* Whether the owner or the tenant will derive a greater benefit from the alteration.
* Whether the alteration is structural or nonstructural.
After weighing these factors, courts have been reluctant to permit an owner to pass through to its tenant liability for "substantial" government-mandated repairs which are unrelated to the tenant's specific use of the leased premises based upon the generic "compliance with laws" section of a commercial lease. See, e.g., Dennison v. Marlow, N.M. 1987 744 P. 2d 906 (holding that sprinkler retrofit costs could not be passed on to a commercial tenant). …