First, check your lease. Check your lease to see what happens in the event of damage or destruction (look for headings like, “Casualty” or “Damage and Destruction”). Virtually all commercial leases address casualty because large amounts of money tend to be at stake. However, the way in which casualty is addressed varies widely among commercial leases due to many factors such as the leverage of the parties during lease negotiations, the size of the leased premises, the dollar value of the lease, the permitted use and whether the leased premises is a standalone building or a single suite in a shopping mall. The parties to a commercial lease have broad discretion to distribute risk and responsibility in the event of a casualty, and applicable law rarely comes into play.
Because California law is exceedingly tenant-friendly, most landlords insist on including an express waiver of any statute or regulation concerning damage or destruction in their commercial leases. In the unusual event that such waiver is not explicitly comprehensive or the casualty provision fails to fully address the fallout of damage or destruction to the property, California law could still possibly augment the terms and conditions stated in the lease.
Although it is most likely that your lease, and your lease alone, will control what happens if the building or property is destroyed, you should have your attorney confirm whether that is the case under your specific circumstances. Because California law rarely governs casualty when there is a written lease in place, this resource will focus primarily on the basic elements of a casualty provision, helpful questions to ask in the fallout of major property damage and ways landlords and tenants can take affirmative steps to protect their respective interests when unexpected events derail general business operations.
If you do not have a written lease, California law will apply. If your lease agreement is not in writing, or in the unlikely event your written lease is silent on the topic of damage and destruction, California law will dictate how to move forward in the aftermath of a casualty. The California Civil Code provides the framework for restoration of damaged property and equitable adjustments to the parties’ lease obligations.
Commercial Lease Considerations. Under a commercial lease, automatic termination in the event of a casualty, regardless of the extent of the damage, is exceedingly rare. The tenant should assume that the lease is in full force and effect unless and until the express terms and conditions for any abatement, termination or other relief are satisfied. Often the landlord and sometimes the tenant will have the option to terminate the lease, but only if certain criteria are met and only following notice to the other party. For example, the landlord may be permitted to terminate the lease if most of the property is rendered unusable and restoration would take longer than a certain amount of time (e.g., one year) or if the cost of restoring the property is greater than the insurance proceeds available to the landlord. The tenant’s right to terminate the lease, if any, is normally more narrow than the landlord’s right to terminate and activates later in time than the landlord’s. It is common for both parties to have a right to terminate if a significant casualty occurs in the last one to two years of the lease term.
Applicable Law. A lease automatically terminates when the leased premises is entirely destroyed. If the leased premises is not entirely destroyed, but is “substantially damaged” (no longer fit for the use for which originally leased), then the tenant has the option to terminate the lease with appropriate notice to the landlord. Whether the leased premises has been entirely destroyed or substantially damaged is a factual determination made on a case-by-case basis. If the landlord can repair damage to the leased premises in a reasonable period of time, then the leased premises is less likely to be considered substantially damaged, and it is unlikely that the tenant would be able to terminate the lease on the basis of such damage. Another factor in determining whether the leased premises is substantially damaged is an understanding of the permitted use under the lease. For example, if the leased premises is a retail store, damage that results in the leased premises being inaccessible to the public may render the leased premises substantially damaged even if the extent of damage is not that great.
Commercial Lease Considerations. Under a commercial lease, the parties are free to define partial and total damage however they want and attach whatever obligations they see fit to such standards. Most often, the definitions will hinge on how long repairs would reasonably take, the extent of the damage and the way the damage affects the usability of the property and/or leased premises.
Applicable Law. The answer depends on specific factual circumstances. To be considered “entirely destroyed” or “substantially damaged,” the leased premises must generally cease to be fit for the use for which they were leased. While major fire or flood damage will likely result in the leased premises being entirely destroyed or substantially damaged, limited damage and damage from smoke and light water intrusion may only result in the leased premises being considered “partially damaged.” It is important to consider also what constitutes the “leased premises.” For example, in the case of a ground lease in which the tenant leases the underlying land and is responsible for all improvements upon the land, the leased premises are the land itself, not the improvements constructed on the land. In that event, the destruction or damage to the improvements will generally not be considered destruction or damage to the leased premises, and the tenant will not have a right to terminate the lease. If the leased space is a suite within a building or a storefront within a shopping center, then the extent of damage will be determined based on the direct and indirect damage to the specific space and not the damage to the entire building or shopping center.
Commercial Lease Considerations. Under a commercial lease, the landlord is typically required to rebuild the building if neither party has elected to terminate. Sometimes the landlord is required to rebuild the leased premises, in which case the lease will likely require the tenant to assign all insurance proceeds from the casualty to the landlord. Often the landlord will be required to restore the building to a certain condition (e.g., substantially the same condition existing prior to the casualty) and within a reasonable time. Sometimes the landlord will be required to obtain an independent contractor to opine on matters such as the extent of the damage, the cost of restoration and the timeframe required for such restoration. Occasionally the tenant will have an affirmative obligation to notify the landlord of a casualty. It is critical that each of the landlord and the tenant review the lease carefully for and take note of all notice requirements and timeframes around their respective rights and responsibilities following a casualty.
Applicable Law. California law does not impose any obligation on the landlord to rebuild the building or the leased premises.
Commercial Lease Considerations. Under a commercial lease, the tenant is sometimes obligated to rebuild the leased premises. Most often the tenant would be required to restore the interior of the premises and its improvements and alterations, while the landlord would be responsible for the structural and exterior portions of the leased premises. Sometimes a lease will expressly require the tenant to restore the leased premises to the condition existing prior to the casualty, regardless of the amount of insurance proceeds the tenant receives. As noted above, it is critical that each of the landlord and the tenant review the lease carefully for and take note of all notice requirements and timeframes around their respective rights and responsibilities following a casualty. There are no legal restrictions on how the parties delegate the obligation to rebuild (e.g., the tenant could theoretically be responsible for rebuilding the building, although this would be very unusual).
Applicable Law. California law does not impose any obligation on the tenant to rebuild the building or the leased premises.
Commercial Lease Considerations. The time the landlord may take to rebuild is entirely dependent on what the lease says. Some commercial leases include specific periods of time, while others may use a less specific standard, such as “reasonably expeditious.” Often the lease will expressly excuse the landlord from delays related to insurance claims, labor troubles, and other causes beyond the landlord’s reasonable control. Even if the lease does not expressly excuse these types of delays, a court would likely find them reasonable.
Applicable Law. If the landlord is required or elects to rebuild, California law requires the landlord to perform and complete the work in a reasonable time. Reasonableness is decided on a case-by-case basis.
Commercial Lease Considerations. In this instance, California law trumps whatever the parties may agree to in the lease. Under California law, the landlord is not permitted to keep the security deposit due to a casualty event unless the casualty event is a result of the tenant defaulting under the lease and the landlord uses the security deposit to repair the resulting damage. Otherwise, the landlord must return the security deposit to the tenant within 30 days after the lease terminates and the landlord is back in possession of the leased premises (or such shorter period as may be agreed upon in the lease).
Applicable Law. Yes. Under California law, the security deposit must be returned as described above.
Commercial Lease Considerations. Often a commercial lease will allow for rent abatement in proportion to the percentage of the leased premises that the tenant is not able to use and does not use due to the casualty event and the landlord’s ensuing repairs. However, on occasion, a commercial lease will require the tenant to pay full rent in the event of a casualty and insist that the tenant be made whole through insurance (e.g., business interruption insurance). If the lease is terminated, however, the tenant’s obligation to pay rent may not extend past the effective date of termination.
Applicable Law. If the lease is terminated because the leased premises have been entirely destroyed or substantially damaged, the tenant is relieved of its obligation to pay rent after termination. Under California law, rent reductions for partial damage will be governed by the terms of the lease or, if the lease is silent, on a negotiated resolution with the landlord or through litigation.
Commercial Lease Considerations. The tenant may not withhold rent if the landlord fails to timely repair the leased premises unless the lease expressly allows the tenant to do so, which would be extremely rare. Under virtually all commercial leases, if the tenant does withhold rent absent express permission under the lease, the tenant would quickly be in major default and an array of severe remedies would then be available to the landlord.
Applicable Law. California law does not allow the tenant to withhold rent as a remedy for the landlord’s failure to timely repair the property, the building or the leased premises.
Commercial Lease Considerations. Not unless the lease includes this express and affirmative obligation. Commercial leases essentially never obligate landlord to assist the tenant with relocation in a casualty context.
Applicable Law. No.
Commercial Lease Considerations. No, the landlord cannot lease the premises to another party while the tenant’s lease is in place. The lease must be terminated before the landlord can grant a leasehold interest to anyone else. The tenant may assign or sublet its interest in the lease (usually subject to the landlord’s consent), and the landlord can sell its ownership interest in the property, but the landlord may not unilaterally alter the leasehold interest and the tenant may not alter the ownership interest.
Applicable Law. No.
Yes. Governmental agencies with jurisdiction over a building may condemn it if the building is not suitable for safe occupancy or for other public purpose reasons. Generally, FEMA, public health and safety agencies, and/or a local building inspection department have jurisdiction to determine that a building cannot safely be occupied. Whether a building is condemned is a government decision, so commercial leases do not address this issue.
When the government condemns property based on a finding that it is no longer habitable or safe for occupancy, the government is not responsible for paying for the loss of the property. Generally, the government is required to pay for condemned property only when the property is taken by the government for public use. Condemnation of property as unsafe is generally not a “taking” for public use. The landlord will generally rely on property owner’s insurance to recover the value (or at least part of the value) of the property. The landlord may also possibly obtain financial assistance from FEMA or other relief agencies. Whether a building is condemned is a government decision, so commercial leases do not address this issue.
