Collecting Future Rent from Defaulting Tenant

I posted the following article in my regular blog, for guidance to Alabama landlords. It might also be relevant in other states. You should discuss this with your local attorney. The rules are fairly common, but SOME states might have different wrinkles. Certainly they will have different court decisions that spell out the rules. Citing the Alabama Supreme Court for "how the cow ate the cabbage" (as we say here in the South) is not going to be persuasive to a California judge.

In my classes around Alabama, many of you complain about District Judges and eviction lawsuits. You say the judges will not give you an award for rent accruing all the way until the expiration of the lease term, only rent up until you terminate the lease rights.

I am going to tell you why they do that and how you can avoid the problem.

Let's start with the basic rule. Basic rules are what courts will decide if the parties have not specifically agreed to something different in their leases.

The basic rule is this:

"[W]hen a tenant abandons leased premises the landlord has two options. First, the landlord may allow the premises to remain vacant and recover rent for the whole term of the lease, or the landlord may end the lease by accepting the abandoned property and re-entering the premises." Ex parte Kaschak, 681 So.2d 197, 200 (Ala. 1996)

In other words, if you terminate the tenant's rights under the lease, and attempt to re-rent the property, you cannot sue for rent due from that date until the end of the lease term. That is because you ended the lease. Technically, there are ways you can try to re-rent the property without terminating the lease, but we are not going to talk about those.

Suppose you just said, "Fine, I'll let the property stay vacant and won't try to re-rent it. That way I can sue for all of the rent." There are several problems with that:

1. A judgment against a residential tenant (and most small commercial tenants) is pretty much worthless. It is highly unlikely you will ever collect a dime. A judgment for $1,000 or for $12,000 is all the same. You might as well try to get a new tenant in there and start the cash flowing again. I'm not saying don't sue for the rent. That tenant might inherit money, hit the lottery, or try to buy a house in the future. They might have a good job with wages you can garnish. Your judgment ensures you'll have a shot at getting your money.
2. In the residential field, Ala. Code §35-9A-105 requires the landlord to mitigate its damages if the tenant defaults. In other words, the landlord MUST try to re-rent the premises, which provides a credit against the tenant's liability. That is what mitigation means. If the landlord has multiple similar vacant units, it can rent the other ones first, though. It does not have to rent the defaulting tenant's unit first.

How do you put all these things together, tie them up with a bow, and make them turn out the way you want?

You include a lease clause that says if the tenant defaults, then ALL of the rent for the remainder of the term is immediately due and payable. This is similar to your mortgages. The note says that if you default in making your monthly note payments, and remain in default for some period of time (usually 90 to 120 days) then the mortgage holder can accelerate and ALL of the principal balance will be immediately due and payable, plus interest. It is called an acceleration clause.

All landlords should have acceleration clauses in their leases. The Alabama Supreme Court case of HealthSouth Rehabilitation Corp. v Falcon Management Co, 799 So.2d 177 (Ala. 2001) sets out some guidance.

• The landlord must strictly comply with any notice provisions written into the lease regarding default, opportunity to cure, and acceleration. Of course, in the residential field, the requirements for notices regarding default and opportunity to cure are spelled out in the statutes. A lease can give a longer notice period, but not a shorter one. If the lease gives a longer one, that is what you must do. In the commercial field, it is whatever the lease says. Many commercial leases say that no notice at all is required.
• If the parties agree to rent acceleration, that is enforceable. When there is rent acceleration, then ALL of the rent is due BEFORE the landlord enters and re-takes possession of the premises. This is the critical distinction.
• If the landlord accelerates the rent, it must deduct any cost savings resulting from the tenant's departure. A simple example would be if the landlord paid for garbage pickup at a cost of $20 per month for a residential tenant or maybe $150 a month for a commercial tenant. If the tenant breaches and moves out, waste collection is no longer necessary. The landlord no longer has that expense. The tenant gets a credit against his rent liability for the landlord's savings.
• The landlord must reduce the future damages to present value. This could be a significant amount of money in a commercial context. The calculation must still be done in a residential rental, though. There is no guidance from the courts about a reasonable discount value. You probably need to present evidence about all of that.

Proper evidence might consist of the landlord's witness saying something along the lines of:

1. "Our lease with the tenant contained a rent acceleration clause. Here is a copy of our lease, with the relevant language highlighted in yellow." [If you do not bring this to the Court's attention through tesimony, the court is not obligated to figure it out. That is why many District Judges will not let you collect rent for the period after you terminate the lease, even though you might legally be entitled to do so, under your lease.]
2. "As required by the lease, we gave the following notices to the tenant, on the following dates _______________"
3. "After the date we accelerated the rent, we terminated the lease, entered and re-took possession, and attempted to lease the property to another tenant."
4. "We took the following steps to attempt re-renting the property___________" [This is your evidence that you attempted to mitigate your damages.}
5. "Those actions were unsuccessful."
   • (Or, "we signed a new tenant for a term beginning on _______. This results in a gross credit of $______ against the defendant's liability, but we also had re-renting expenses of $__________. As a result, we gave the defendant a credit in the net amount of $___________.")
6. "The defendant owes us $____________ in rent [same number as prior net figure] which would have been due over the course of _______ months."
7. "In the market place, a reasonable discount rate would be _____%." [Ask an appraiser. They can tell you this number.]
8. "Using that discount rate, the present value of the tenant's future rent liability is $___________. We are claiming that amount in damages." [In addition to any other damages for damage, past due rent, late fees, etc.]

How do you calculate present value of a series of future cash flows? Many websites will do the calculation for you. In Excel, you would enter the monthly rent in field A1, and the number of months you are claiming in A2, and the annual discount rate expressed as a decimal in A3. In A4, your formula should be:

=PV(A3/12,A2,-A1)

For a tenant who owes $500 a month in rent over a period of 48 months, the GROSS amount of rent due is 48 months x $500 per month = $24,000. Using a discount rate of 7% (as shown in the screenshot, above), the present value of that number is $20,880.10. You can claim damages for future rent in the amount of $20,880.10.

Landlord lawyers reading this blog, do you have anything to add?  People from other states besides Alabama?  Please share your thoughts.