By M. Rosie Rees

How can developers enter into leases for land they do not own? The answer is simple…most often, developers need to juggle many balls in order to complete the development of a shopping center such as locating, assembling and acquiring sufficient parcels of land; obtaining financing; identifying and negotiating leases or sales with potential anchors and outlot owners; leasing space to smaller tenants. Not infrequently, many of these activities have to happen concurrently, in order for them all to be completed on time. This can result in the developer entering leases for land it does not yet own. In such instances, both the landlord and the tenant must be careful to protect themselves against the possibility that the landlord will never obtain sufficient title to the property to pass a valid leasehold interest to the tenant.

Generally, the law in most states is that a lease for land not owned by the purported landlord at the time the lease was signed is enforceable as a conveyance of a leasehold interest by either the landlord or the tenant against the other after the landlord actually acquires a valid interest in the land, if the tenant was in possession of the leased property at the time the landlord acquired title, and if the tenant was not aware of the landlord’s lack of title at the time the lease was signed. If either of these conditions is not met, then the lease is just a contract to convey a leasehold interest, which a party can seek to enforce; but it does not actually convey any interest in the land. This general rule is instructive on how leases should be drafted to protect the parties’ interests.

For a landlord who wants to avoid being liable on the lease unless and until it actually has title, it is essential for the lease to state that the landlord does not have title to the leased property as of the date of the lease. This clearly puts the tenant on notice that the purported landlord does not have sufficient interest in the land to create a leasehold interest at the time of lease signing. The lease should also be conditioned upon the landlord acquiring title to the leased property, so that as long as the landlord has no valid interest in the leased property, there is no enforceable lease of a property interest. This condition should be accompanied by a termination right by the landlord, so that the contract to convey the land can be terminated at some point if the landlord is unable to obtain title.

On the other hand, landlord will want the lease to be enforceable once it acquires title, so the lease should make it clear that once title is acquired, tenant will automatically be deemed to have a valid and enforceable leasehold interest.

From the tenant’s perspective, it will want to know that landlord has the ability to obtain title to the property in the near future. Landlord should represent and warrant the state of its interest in the land. For instance, if the landlord has a contract to purchase the property, landlord should represent and warrant that fact. Tenant may want to see the actual contract of sale. Landlord should indemnify the tenant for any losses that tenant incurs due to a breach of this representation and warranty.

Landlord should also be required to agree to make an effort to complete the acquisition of title by a date certain. What level of effort will be a matter of negotiation. The tenant will want the landlord to use its best efforts; in other words, use whatever means possible, including the expenditure of whatever money needed, to acquire title. The landlord will want to limit its exposure to using commercially reasonable efforts, subject to unforeseen obstacles like condemnation or casualty. It will also not want to be forced to spend unreasonable sums nor waive reasonable contingencies it has imposed on the purchase, like environmental conditions or title encumbrances.

Tenant should have a right to terminate the lease if such efforts are not being made or if appropriate title is not acquired by such date. Also, if the landlord has a right to terminate because it failed to timely acquire title, as suggested above, tenant may want a right to re-instate the lease if landlord acquires title at a later date. If the landlord agrees, it should require an outside date by which this can occur.

Tenant should insist that the lease impose no duty on tenant to perform any obligations under the lease until the landlord has title, since it has no assurance of a leasehold interest until adequate and valid title is actually acquired. For instance, tenant should not have to incur costs to prepare plans for its work, nor accept delivery, until landlord can provide evidence of title. This can be accomplished by the requiring landlord to produce a title commitment establishing proper title as a condition to lease viability and the commencement of tenant’s obligations under the lease.

Since the tenant does not know when title will be passed to the landlord, the tenant should also insist that a memorandum of lease be recorded simultaneously with the recordation of the deed or other instrument granting the landlord appropriate title to the leased property. If needed, an escrow agent can be appointed to assure proper and timely recording of the memorandum of lease.

Additionally, the tenant will want to protect itself regarding future mortgages. The lease should be clear that it is not subordinate to any future mortgages unless the tenant is afforded a non-disturbance and recognition agreement from the mortgagee.

Each transaction will differ, of course. But each party should try to protect itself as much as possible when the landlord does not own the property it is leasing.

About the Author: M. Rosie Rees, Esq. is a partner with the Chicago office of Pircher, Nichols & Meeks, a national real estate law firm. Ms. Rees specializes in shopping center leasing on behalf of both landlords and tenants. She can be reached at 312-915-3112.