Tuesday, May 6, 2014

Property Leasing Considerations
in the Maritime Industry

By Carrie A. Ivy

Many maritime businesses lease appropriately zoned land adjacent to or near waterways, and commercial leases in the maritime industry have special complexities and nuances. As compared to commercial lease agreements, maritime industry leases are often for a greater term and can include dry land, shoreline, and marine areas. It is crucial to consider limitations on shoreline development, access, use, and zoning, and there are special insurance considerations as well. There are also very often hazardous material risks or liabilities to be investigated in advance and which should be allocated in the lease document.

Permits for the use of state-owned aquatic lands and submerged lands are issued by the regulating local and state authorities, and vary among municipalities. Check with your local jurisdiction to confirm regulations for your area.

Due Diligence Property Investigation
Before negotiating the terms of the lease, it is wise to perform a due diligence investigation to confirm that the intended business activity is permissible under local zoning regulations, shoreline development restrictions, and other regulations. A maritime land use expert can be instrumental in this investigation.

The tenant most often is required to accept the property as-is, and should therefore build a feasibility and/or due diligence contingency into the lease negotiations to identify impediments and issues with the property before committing to the lease.

Tenants are often charged with the costs of upkeep, maintenance, and repair of the property and improvements. The feasibility contingency should provide the tenant the right to evaluate the suitability of the premises for its intended uses including everything from demographics, general site conditions and regulatory matters to the availability and condition of utilities, ingress and egress, and the availability and evaluation of financing. Many property owners will not allow soil testing or a Phase 2 environmental assessment survey due to the reporting requirements. If a Phase 2 assessment is allowed, the feasibility contingency should last long enough to complete soil testing with permits to determine whether any immediate hazardous materials remediation is required or whether the tenant may proceed with improvements.

Arriving at Fair Lease Terms
Rent is often calculated based upon a combination of square footage, moorage, parking, access, and other amenities. Some state-owned aquatic lands rents are calculated by statute. Increases to rent are most frequently calculated based upon the fair market rent, a set increase, or the Consumer Price Index. Leases of Port district property may require a bond for security of the payment of rent. Property taxes and building maintenance costs are frequently the tenant’s obligation.

Landlords and tenants should give strong consideration to operating, leasing, or owning the property through a business entity, such as a corporation or limited liability company, to limit personal liability for known and unknown liabilities. Assuming the owner and tenant are both entities, the entities are the proper parties to the lease, not the individuals. Some landlords request a personal guaranty of the lease obligations by the owner of the business entity/tenant.

The provisions of a maritime lease may differ from a typical commercial lease agreement. Because obtaining permits for new uses can be difficult and because regulations typically become more restrictive over time, lease terms may stretch ten to fifteen years or longer. A non-conforming use may be grandfathered into a more restrictive regulatory scheme, allowing the business to continue. A shorter lease term increases the risks of administrative red tape.

It may be challenging to accurately identify the leased premises area, especially when that includes shorelines and docks. The best solution may be to attach an accurate survey or drawing. Negotiate adequate protections for foreseeable contingencies, for example, a tenant’s right to rebuild a dock or pier that is damaged in a storm, deterioration, or other casualty.

Leases usually restrict the permissible business uses at the premises. A typical landlord will prefer to tailor the permitted uses closely to the tenant’s actual business operation. In contrast, it is often in a tenant’s best interest to state the permitted uses in more expansive language.

Tenants may request competitive exclusions in their leases, which limit the landlord’s right to lease nearby property to competing business. While it’s true that several businesses operating in the same industry in a close proximity can bring the desired business to the area and increase a tenant’s bottom line, direct competition with a nearby business can have an opposite effect.

HazMat Issues are Red Hot 
Allocation of hazardous materials liability between the property owner and business operator for cleanup, mitigation, and recovery is an important consideration in a maritime lease. Federal, State, and local statutes, regulations, and administrative agencies provide an extensive framework of liability, contribution requirements, fees, and fines. Liability for hazardous materials under Federal and State regulations is most often joint and several. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund) of 1980 and state counterparts impose liability on any past or present owner, tenant, contractor, or other responsible party. CERCLA’s strict joint and several liability effectively results in charging the entire costs of cleanup to each and every party responsible. The rub is that many parties may be long gone, out of business, or beyond the reach of the courts. If the government is able to identify just one party that contributed the polluting condition, that party can be liable for the entire cost of the cleanup. “Strict liability” is a legal standard that imposes liability without fault whatsoever. Formation of a legal business entity such as a corporation or limited liability company can help to protect the personal assets of the individual owner under some but not all circumstances.

Parties may allocate in the lease agreement liabilities for hazardous materials. A property owner may agree to indemnify and hold harmless a tenant for all pre-existing hazardous materials existing at the property at the commencement of the lease. Leases often impose liability on the tenant for all pollution caused by the tenant during the lease term and further require the tenant to indemnify and hold the owner harmless from fines and cleanup costs for those pollution events. An indemnification and hold harmless agreement only provides protection so long as the obligated party remains solvent and subject to suit. Problems of proof will exist and it may be difficult to prove the timing and source for pollution events. Bear in mind that these lease provisions are effectively a contract between owner and tenant and the statutory liabilities are imposed regardless of the lease provisions. It is wise to check with your insurance professional to determine what forms of coverage may be available. While a property owner typically requests a broad prohibition on the use and storage of hazardous materials, the tenant should consider a carve-out for hazardous substances used in its business.

Ownership of Property and Improvements
Lease agreements must reflect the ownership of the personal property and fixtures within the premises. Frequently, a landlord reserves the right, but not the obligation, to retain ownership of all property permanently affixed to the premises (‘fixtures’) at the end of the lease term. Tenants are often obligated to remove all fixtures and improvements at the end of the lease term and to repair any resulting damage. Some leases state that the owner reserves the option to retain all fixtures at the end of the lease. Tenants should carefully identify all trade fixtures and reserve ownership of the trade fixtures. It is crucial to negotiate these provisions before signing the lease.

Equipment, tools, and machinery used in the maritime sector are frequently financed. The landlord and tenant will usually be asked to sign agreements with the lender to assist in securing the lender’s loan. If the landlord refuses to sign, the loan may not happen, the tenant will be impaired in its ability to do business, and in turn, the tenant may default. Therefore, it may be in the best interests of all concerned for the loan to be approved.

Insurance Considerations
Casualty insurance covering the marine industry is unique with coverage unavailable in other industries. Most leases state the minimum insurance requirements for tenant and sometimes the owner. Business owners should not rely upon the lease requirements alone in selecting levels, amounts, and types of coverage. The insurance professional should review the lease agreement prior to the final negotiation stage to confirm the requirements are realistic and not cost-prohibitive for the tenant. Business owners should carefully consider their entire business operations and obtain appropriate additional insurance coverage.

For many maritime activities, coverage under the Longshore and Harbor Workers Act (LHWCA) will be required. Business owners should consider obtaining additional protection including ship builders risk hull insurance, port risk insurance, business interruption coverage and products completed operations coverage. Most policies have broad exclusions for hazardous materials liability. In turn, business owners should verify the existence of insurance by their ship owner customers such as hull & machinery, protection & indemnity (P&I), and LHWCA coverage.

Marine property owners are often very sophisticated and are willing to take all steps necessary to insulate themselves from current and future liabilities. This can be a challenge for small maritime industry business owners that have limited funds or negotiating leverage. Some business owners are more than willing to give up fair lease terms in exchange for access to the coveted property, but that trade may come at a high cost. Irrespective of whether a property owner is willing to negotiate fair and reasonable lease terms, the tenant should first focus on completing its due diligence to identify potential and actual issues affecting the business.

Take Away Points
We routinely recommend that property owners and tenants form a legal entity or entities through which to operate their business and for the protection of personal assets of the owner. Take care to analyze and obtain appropriate insurance coverage with sufficient limits. Before entering into a binding lease agreement, a tenant should perform its due diligence. Carefully review the lease with legal counsel. Be prepared to negotiate lease terms that are unacceptable. Armed with information obtained in the investigation, the parties are in a better position to negotiate fair lease terms. Most parties have at least some leeway in negotiating appropriate terms.

Carrie Ivy has worked as an attorney with Mullavey Prout Grenley & Foe LLP, an established law firm located in the Ballard neighborhood of Seattle, since 2004. Her practice focuses on real estate and maritime issues, including leasing transactions and commercial disputes. She can be reached at caivy@ballardlawyers.com.