Appraisal Provisions in Leases Mean More Than You Think in New Jersey

It is a common belief that appraisal provisions in leases governing future renewal rents don’t really mean anything. The logic behind this conclusion is that regardless of what the lease says, if the tenant doesn’t receive a new rent number that justifies staying, it will leave. There is a lot of truth to this. However, a recent New Jersey Appellate Division decision, Cablevision of Oakland, LLC vs CK Bergen Holdings, LLC, App Div 27-2-3149 demonstrates neither a landlord nor a tenant can rely on conventional wisdom as a reason to forego doing the right job in the documents. If you are concerned about the methodology to be used in the appraisal process you had better make that clear in the lease. And if you want the Court to have the power to review an appraisal to determine whether there was compliance with the methodology mandated by the lease, you better make that clear in the lease, too.

In this case, Landlord and Tenant were at the point where the appraisal process was the determinant of renewal rent. How it got to that point is unclear. The provision had each of Landlord and Tenant appoint an appraiser and, absent agreement, a third appraiser would be appointed, whose sole opinion would be final. Tenant’s appraiser came in at $12 psf and Landlord’s appraiser came in at $25 psf – a massive differential resulting in a rent difference of approximately $750,000 per year, or, at a 6% “cap rate”, a valuation difference of $12,500,000. Given this differential, the third appraiser approach was utilized. He came in at $11 psf – $1 psf less than Tenant’s appraiser.

Landlord refused to sign an amendment memorializing this result. Tenant moved to compel Landlord to do so. Landlord’s defense essentially consisted of the argument that the third appraiser’s conclusion was flawed because the lease provisions which mandated how fair market rent was to be calculated, were not followed. The Court spent a few paragraphs disagreeing with Landlord’s specific arguments, including the following:

[Landlord] argues the [third appraiser’s appraisal] is flawed because it failed to take various features of the property into consideration as directed in the Lease. These features include improvements to the Premises paid for by Tenant; that the extension shall be on an “as is” basis; that no vacancy and no releasing expenses will be involved…[E]ven if these were not taken into consideration they all would further [Tenant’s] interest rather than [Landlord’s].[emphasis added]

The Court’s conclusion demonstrates the need for clarity in setting forth the appraisal procedures to be followed. Indeed the Court appeared skeptical of Landlord’s arguments focusing on clauses that would have benefited Tenant if included in the appraisal.

Perhaps more important is the Court’s ultimate conclusion – and why it is critical that the governing document should expressly provide for judicial review of the appraisal(s) and the methodology used therein, if, in fact, that is the desired result:

[The court] is unpersuaded by [Landlord’s] argument that the court was empowered to review the appraiser’s decision for an error of law, or a misrepresentation of the parties’ lease….[R]eview of a business valuation appraiser is afforded the same finality as an arbitrator’s decision. Thus, it is reviewed only for fraud, corruption, or similar wrongdoing [emphasis added].

In short, every once in a while the language governing the calculation of fair market rent on renewal will be determinative of what is paid and received. Absent language in the lease to the contrary, the appraiser’s conclusion will only be subject to very narrow review. So landlords and tenants would do well to get it right in the lease. And, if this is the desired result, expressly allow for judicial review of the substantive analysis used in the appraisals.

 

Shepard A. Federgreen is a Director in the Gibbons Real Property & Environmental Department.
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