Property Rights Primer, Part 3: Issues to Consider When Negotiating a Condemnation Clause in a Lease

Of the many things that landlords and tenants are thinking about when entering into a new lease, the possibility that the property might be subjected to eminent domain proceedings is usually very low on the list. But condemnation cases do happen, and it is important for both the landlord and tenant to consider that possibility.

Understanding what rights a tenant has under common law principles, how and when those rights are valued, and how they can be modified by the terms of a condemnation clause in the lease is critical to addressing these things. It is challenging enough to face a taking by a governmental entity and the prospect of litigation that this entails. It is even more challenging to face a second set of litigation problems when the landlord and the tenant cannot agree about how their rights will be affected or who will be compensated. Having a clear and well-understood road map of what will happen if the government comes knocking on the door is the best way to avoid these problems.

This is the third in a three-part series addressing some of the common questions we hear in our eminent domain practice at Faegre Baker Daniels from our landlord and tenant clients about these issues.

The first article addressed how a tenant’s rights are usually treated under common law condemnation principles. The second article discussed how the parties to a lease may modify these common law principles by adding a “condemnation clause” to their agreement. This third article will provide a checklist of considerations when negotiating such a condemnation clause.

Are there specific things to think about when drafting condemnation clauses?

A well-drafted and comprehensive condemnation clause may eliminate the need for apportionment litigation between a landlord and tenant. Such a clause should address at least the following issues:

• How will compensation be divided in the event of a total taking? How will it be measured? Does the lease period considered in determining “bonus value” include options to renew?
• Who is entitled to compensation for trade fixtures? Who is entitled to compensation for tenant improvements? How will compensation be measured?
• Under what circumstances can either party terminate the lease? What is the trigger date for such termination — the date of notice? The date a case is filed? The date possession is granted? Or some other date?
• What happens in the event of a partial taking? Is the tenant entitled to damages to its leasehold estate and improvements? How will compensation be measured? Are damages limited to legally compensable items, or can the tenant receive compensation for damages even if not included in the award?
• What happens to the rent? Will it be reduced on a permanent or temporary basis if there is a partial taking? How will the amount of reduction be determined? How does any rent reduction relate to the right to share in the condemnation proceeds or the obligation to repair or restore the property?
• Who is obligated to rebuild or repair the premises in the event of a partial taking? How does that interact with the right to condemnation proceeds?
• Who will have the burden of proof in an apportionment proceeding? Will amounts be equitably divided based on the pro rata value of the landlord and tenant in relationship to the total award, or based upon the contractual allocation? How will those apportionment claims relate to other interests that may also make a claim by or through either party (mortgagees, other tenants, subtenants, easement holders, etc.)? Who has priority to the proceeds? What happens if there is a shortfall between the amount of the claims and the total award? Will contractual formulas for apportionment prevail over the evidence presented at a valuation trial based on the undivided fee?
• If the landlord owns more property in the area (such as in a shopping center complex, etc.) what property is relevant in determining the issues identified above — only the tenant’s leased premises, all of the landlord’s property, or different portions of the property based upon the relevant issue?
• Who will be entitled to present compensation claims or pursue settlement with the condemnor? Who will be entitled to fees and costs incurred in doing so? How do those fees and costs relate to the condemnation award (i.e., should those fees and costs be reimbursed first, before any apportionment of the award)?
• Can termination clauses or other lease provisions be exercised for the benefit of the condemning entity, or are they exclusively available to the landlord under the ordinary course of business?