11.08 Leases

11.08.1

In General

A lease is a written or oral agreement, by which the owner of land, referred to as the landlord or lessor, transfers into another party, referred to as the tenant or lessee, the right to the exclusive possession and use of the real estate for a definite period of time.

A lease partakes of the elements of both a conveyance and a contract. It is a conveyance by the landlord to the tenant of the right to occupy the land for the specified time in the lease. It contains a contract by the tenant to pay rent to the landlord. In addition, it usually contains numerous other promises and undertakings by both landlord and tenant. The legal interest of the tenant in the land is called a leasehold estate and consists of the right to the exclusive use and occupancy of the estate.

To create a valid lease, the lessor must always retain a reversionary right to retake possession of the property after the term has expired.

Leasehold estates are generally classified as estates in personal property. However, some states provide for certain leasehold estates to be considered as real property while also retaining their characteristics as personal property.

Essential Elements of a Lease

There is ample diversity of opinion in the various jurisdictions as to what constitutes the essential elements of a lease. The following are the most common essential elements:

  • Date of the instrument:

    The date in which the lease is executed and not necessarily the date of its commencement.

  • Identity of the parties:

    The full names of the lessor and the lessee.

  • Capacity to contract:

    The lessor and the lessee must have legal capacity to enter into a contract.

  • Identification of the leased property:

    The leased subject property must be described with certainty although the legal description in the lease need not conform to standards necessary for other real estate instruments. However, for title insurance purposes, the lease must contain an insurable legal description in conformity with the proper local standards.

  • Term of duration:

    A leasehold is an estate for years; it must have a date of commencement and a date of termination. State law may regulate or limit the duration of a lease.

  • Mutual agreement of the parties to establish a lessor-lessee relationship supported by a valid consideration. Unless otherwise provided by statute, no particular words are required in order to create a lease. The intention of the parties is the test.

  • Rent: Its terms and form of payment.

  • Legal objective: The subject property must be leased for a legal purpose.

  • Written instrument: Statutes of Frauds usually provide that leases for more than one year or leases which will not be fully performed within one year from the making thereof must be in writing.

  • Signatures: The signature of the lessor is necessary to give effect to a lease. Nevertheless, it is the universal practice to obtain the lessee's signature because as a contract, the lease must be signed by both parties.

  • Seal, Witnesses, and Acknowledgment: In some jurisdictions, these are requirements in regard to either the validity of the lease or its recordation.

  • Recording: In some jurisdictions, any lease exceeding more than one year must be recorded in the same manner as a deed of conveyance in order to be valid against third parties without notice. Leases must be filed for record in the county in which the lease property is located. Some states allow the recording of a memorandum of lease instead of the original lease.

Most Common Provisions Contained In Leases:

  • Covenants and conditions.

  • Option to purchase.

  • Right of first refusal.

  • Extension or renewal provisions.

  • Restrictions on assignments or subleases.

  • Financing of improvements.

  • Ownership of improvements.

  • Restrictions on tenant's improvements.

  • Expenses and rental adjusters.

  • Repairs and maintenance.

  • Warranties and restrictions.

  • Insurance and condemnation.

  • Use restrictions, zoning, and waste.

  • Default.

Classifications of Leases

The most common classifications of leases are based upon:

  • The type of realty involved: Office leases, ground leases, proprietary leases, residential leases, commercial leases;

  • The term of the lease: short-term leases and long-term leases; or,

  • The method of rent payment: fixed-rental leases, graduated lease, percentage leases, gross leases, net leases.

Leasehold Mortgages

A leasehold mortgage is a mortgage executed by a tenant which affects solely the tenant's interest in a leasehold estate. In some states, leasehold mortgages are entirely statutory and compliance with the statute must be strictly accomplished. Generally speaking, the basic requirements for a valid leasehold mortgage do not differ much from the requirements for mortgages in general. Leases may require the prior approval or consent by the lessor in regard to any mortgage to be executed by the tenant on the leasehold estate.

11.08.2

Transfer Of Interests In Leases

Absent contrary provisions in a lease, or by statute, both the lessor and the lessee may transfer or alienate their respective interests under a lease.

However, most leases either prohibit transfers and encumbrances on the leasehold by the lessee or they require the consent of the lessor to such transfers and encumbrances.

Transfer by the lessor

  • Conveyance of the land (lessor's reversion) to a purchaser during the duration of the lease.

  • Conveyance or assignment of the lessor's right to receive rentals during the duration of the lease.

Transfer by the lessee

  • Assignment of the lease.

  • Sublease

  • Leasehold Mortgage (upon foreclosure).

Whether an instrument is an assignment or sublease does not depend upon the name given the instrument by the parties.

If the lessee transfers the entire unexpired remainder of the term created by the lease, and retains no reversionary interest, the instrument is an assignment.

If the lessee transfers less than the entire remainder of the term of the lease, and retains part of the term, however small the part may be, the instrument is a sublease.

The difference between assignment and sublease is important because it concerns liability. An assignee becomes liable to the original lessor for rent, whereas a sublessee is liable only to the sublessor, who is the lessee under the original lease. Whether the instrument is an assignment or a sublease, the lessee in the original lease continues to be liable for the payment of rent to the original lessor.

11.08.3

Option To Purchase Contained In A Lease

Lease is not being insured.

Both the lease and the option to purchase must be shown as exceptions in Schedule B.

Lease is being insured but the option is not being insured.

Special care must be exercised to avoid creating the impression or implication that the option is also being insured.

In describing the leasehold estate, terms such as "lease and option created" or "rights of the lessee under a certain agreement" should never be used.

It should be remembered that any simultaneously or subsequently issued owner's policy must contain a proper exception in regard to the option to purchase.

Lease is being insured and the option to purchase contained therein is also required to be insured.

Insurance of the option is accomplished exclusively by endorsement and it presents an extrahazardous risk to the Company.

Special consideration must be given in the event that the option to purchase is contained in a sale/leaseback transaction because, depending on its wording, the existence of the option may be evidence that the transaction was intended as a mortgage or a security device rather than as a true sale and lease.

11.08.4

Termination Of A Lease

In General

There are four basic ways by which a lease may be terminated:

  • By performance

  • By agreement

  • By breach

  • By operation of law

The termination may adopt any of the following forms:

  • Expiration of the term (unless there is a tenant holdover)

  • Cancellation

  • Rescission

  • Surrender

  • Abandonment

  • Forfeiture

  • Breach of a covenant or condition established by the lease

  • Violation of any other provision of the lease (if the lease so establishes)

  • Sale on execution (if judgment entered prior to the execution of the lease)

  • Foreclosure of mortgage (if mortgage executed prior to the execution of the lease)

  • Destruction of the subject property (in some cases)

  • Merger

The above forms of lease termination cannot be relied on for the purposes of deleting a lease exception from a title insurance policy.

Termination of the Lease by Merger

If the title to the leasehold estate and the title to the fee become vested in the same person, the estates may be said to have merged. But, while the courts of law apply the doctrine of merger when this situation occurs, courts of equity require that the intention of the parties to merge the two estates be demonstrated before the doctrine can be applied. In addition, the rights of third parties such as subtenants and lienholders of the leasehold interest remain unaffected by the merger. In regard to these rights, the leasehold is still in existence.

For this reason, when it appears that a merger has occurred, it is necessary to effect a complete examination of the leasehold estate in order to determine the existence of any outstanding rights of third parties. If any outstanding rights are found, they must be properly released or excepted in the title policy.

Specific evidence that both the lessor and the lessee intended a merger must also be made a matter of record.

In this connection, the following exception must be shown in Schedule B of the commitment:

If it is the intention of the owner(s) of the subject property to merge the aforesaid leasehold estate into the fee title to the land, a proper instrument should be executed by said owner(s) declaring that, by virtue of the conveyance recorded in Book _____ Page _____, said fee and leasehold interest have become merged, and that it is the intention of said owner(s) to terminate and cancel said lease and to declare the same terminated.

Said instrument, after proper execution is to be filed for record.

In this connection, this Company reserves the right to make any further requirement it may deem necessary.

Termination of the Lease by Mutual Agreement

If the termination of the lease is by mutual agreement between the lessor and the lessee, and unless there is recorded proof thereof, it becomes necessary to require that a formal "Declaration of Surrender" duly executed by the lessor and the lessee be made a matter of record.

Termination of the Lease by Default

From a title insurance point of view, any alleged termination of a lease by default must be supported by a proper judicial determination and coupled with proof of the physical surrender of the property. We do not accept the lessor's word that the lease is terminated.

11.08.5

Additional Matters To Consider In Regard To The Possible Termination Of A Lease

In connection with the possible termination of a lease, the following matters must be thoroughly ascertained:

  • That the tenant under the lease has surrendered possession of the subject property and has relinquished all possessory rights in the lease.

  • That the tenant has not become a holdover tenant.

  • That there is no unrecorded extension of the lease.

  • That the option to purchase contained in the lease, if any, has not been exercised.

  • That the option to renew contained in the lease, if any, has not been exercised.

  • That the lease did not create any other rights in favor of the lessee and affecting the fee estate.

  • That the tenant did not acquire any title or ownership to any improvement located on the land.

11.08.6

Sale And Leaseback Transactions

See Section 18.00 Sale-Leaseback Transactions.

11.08.7

Lease Provisions Which Require Specific Exceptions

In spite of the fact that a lease is specifically excepted in a title commitment or policy, it often becomes necessary to except certain rights or provisions contained in the lease due to their extraordinary importance in regard to the alienation or encumbrance of the property.

Those rights or provisions, which must be specifically excepted, may fall into any of the following categories:

  • Options to purchase.

  • Rights of first refusal.

  • Provisions prohibiting the act which is the subject of the title application, such as assignment, sublease, mortgage.