LEGAL ASPECTS
OF LEASE FINANCING
From a legal perspective, lease financing can be divided into three major categories:
(1) sale-leasebacks of real property (e.g., land and/or buildings or parts of buildings);
(2) chattel leases intended as security agreements (e.g., leases of
equipment, aircraft, computers),
(3) true leases or personal property. There is a fourth category of lease that involves the right to exploit real property through
mining, drilling for oil or gas, or recovery of other natural resources. Such leasesare beyond the scope of this book. This chapter will concentrate primarily onsale-leasebacks of real property.
Rights of ownership in real property are called estates and are classified to
indicate the quantity, nature, and extent of the rights. The two major categories
of estates are freehold estates (those existing for an indefinite time) and estates
that are less than freehold, (those that exist for a predetermined time).
Estates less than freehold, often called leasehold estates, are discussed in
general terms as follows.
A real property lease is both a contract and a grant of an estate in real
property. A lease is a contract by which the owner of the real property, the
landlord (lessor), grants to another, the tenant (lessee), an exclusive right to the
use and possession of the real property for a definite or ascertainable period of
time. The time of possession is called the lease term. The principal characteristics of the lease estate are that it continues for a definite or ascertainable term and that it carries with it the obligation on the part of the lessee to pay rent to the
lessor.
By law, in most states, leases for a term longer than a specified period or
time must be in writing. The period is fixed at 1 year in some states; in others,
it is 3 years. A copy of a lease contract appears at the end of this chapter.
Although the leasehold estate carries with it an implied obligation to pay
reasonable rent, the lease contract almost always contains an express promise
known as a covenant, by the lessee to pay rent in specified amounts at specified
times. There are several reasons for this. The most obvious is that, in the absence of such an express covenant providing the amount of rental and the times for payment, the rent is stipulated to be a reasonable amount and is payable only at the end of the term.
Aside from the economic advantage of setting the amount of the rent without
recourse to the courts and of obtaining payment in stated installments, the lessee's express covenant to pay rent serves other useful functions.
Most leases contain a provision to the effect that breach by the lessee of any
of his covenants in the lease will entitle the lessor to declare the lease at an end, and will give him the right to regain possession of the property. The lessee's express undertaking to pay rent thus becomes one of the covenants on which this provision can operate. Under the common law, if there were no Such pro-vision in the lease, the lessee's failure to pay rent when due would give the
lessor only the right to recover a judgment for the amount of such rent; it would
give him no night to evict the lessee from the premises or to regain the property.
This is a direct result of the common-law doctrine that the mutual covenants in
lease are independent of one another, unless the lease contains an express
provision to the contrary. If the lessee breaches his covenant to pay rent, or fails to perform any of the other covenants in the lease, the lessor is not relieved of his covenant to provide the lessee with quiet enjoyment of the property. Although the lessor could successfully sue the lessee for breach of contract, he could not treat that breach as an excuse for nonperformance by the lessor.
In many states today, the common-law rule has been changed by statute so
although there is no provision for this in the lease. However, such statutes give
that the lessor is given a right to dispossess the lessee for nonpayment of rent
the lessor a meaningful remedy only where the lease contains an express covenant to pay rent in stated installments or in advance. Rent that is not expressly made payable in advance or in stated installments becomes payable only at the end of
the term.
Termination of the Lessee's Obligation to Pay Rent
The implied obligation to pay reasonable rent, because it arises out of the ca hold, ceases when the leasehold is transferred by assignment. Thus when the lessee assigns a lease that does not contain an express agreement to pay the implied obligation to pay reasonable rent passes to the assignee. This is not
true where the lease contains an express agreement of the lessee to pay rent.
Under an express covenant to pay rent, the lessee remains liable despite the fact that he has assigned the leasehold to another lessee, unless the lessor releases him from the obligation. The assignee is also liable to the lessor tor the stipulated rent. The assignee or a lease that contains an express covenant to pay rent is liable for the stipulated rent-not tor the reasonable rent. This result is derived from the theory that certain covenants in the lease, of which the covenant to pay rent is one, run with the property. Such covenants pass to the assignee of the lease as if they were attached to the property covered by the lease. Covenants that have this quality of "running with the land are covenants that touch and concern the land and thus "run" with it: covenants to pay rent, covenants to pay taxes, Options to renew, options to purchase, covenants to repair and restore,and covenants to keep the premises insured.
under this doctrine, the covenant to pay rent passes to the assignee of the
lease as long as he remains in possession of the property. Although the assignee of the lease is thus bound to pay rent, the original lessee is not relieved of his contractual obligation to pay rent. Should the assignee tail to pay the stipulated rent, the original lessee will have to pay it. He will, of course, have a right to be reimbursed by the assignee.
without specific restrictions in the lease, leases are freely assignable. Many
leases, however, prohibit assignment without the lessor's written consent. If the
lessee assigns without written consent, the assignment is not void, but it may
be ignored by the lessor. In other words, the prohibition of assignment in a lease
IS only for the benefit of the lessor and cannot be relied on by the assignor to
terminate an otherwise valid assignment on the grounds that the lessor did not
consent. lf, however, the lessor accepts rent from the assignee, he will be held
to have waived the restriction. The restriction, once waived, cannot be revived
by the lessor on subsequent assignments.
A sublease differs from an assignment in that it involves the transfer, by one
lessee to another, of less than all the lessee s rights in the lease. For example,
Hero Manufacturing is a lessee under a lease that is to terminate on December
31, 1981. Hero enters into an agreement with Xenon Electronics that is called
Assignment of Lease. The agreement provides that Hero "hereby assigns all
its right, title, and interest in the above lease to Xenon Electronics, for a stated sum of money, and provides further that if Xenon Electronics does not pay the rent stipulated in the lease to Hero's lessor, "then and in that event Hero reserves the right to reenter the said premises." Most courts say that even though this agreement is labeled "Assignment off Lease," Hero has not, in fact, assigned the lease but has merely subleased. The reason is that hero has reserved a right of reentry, that is, it has in fact transferred less than its whole interest in the lease. Most subleases are easily recognizable as such. The typical sublease would arise in the foregoing example if Hero leased the premises to Xenon for a shorter
period than that covered by its own lease, for example, until December 30, 1980
at a stated rental payable to Hero rather than to Hero s landlord.
Thank you
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