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Memorandum of Lease Clause: No More Significant than the Gender Clause??

When you are negotiating a commercial lease for either a landlord or tenant, you will frequently encounter a “Memorandum of Lease,” or “Short Form Lease” provision. Often glossed over as quickly as the “gender” clause, in truth, this provision deserves as much focus as other critical provisions in your lease such as rent, lease term, renewal options or other key clauses. Because the filing of a Memorandum of Lease can have potentially significant consequences, both financial and legal, the decision to include such a provision in a lease should not be taken lightly.

What is a Memorandum of Lease?

A Memorandum of Lease or Short Form Lease (MOL) is usually a very short document (one to five pages in length, on average, depending on the complexity of the lease and the jurisdiction of the premises). The MOL typically contains only the most critical, but not confidential, provisions of a lease (e.g., a description of the premises; the term of the lease, including renewal rights; right[s] of first refusal; exclusive use clauses; etc.). A MOL is recorded wherever deeds are recorded, and the recording fees are typically paid either by the party designated in the lease, or, if not so designated, by the party requesting the MOL. Depending on the jurisdiction, the costs to record a MOL can be nominal or quite large.

What is the purpose of a Memorandum of Lease?

Documents are recorded to place “the world” on notice of their existence. A mortgage, for example, is recorded to notify third parties that a property owner has borrowed money, that the loan is secured by that property, and that a lien or any other interest in the property acquired after the date on which the mortgage is recorded will be subordinate to the lender’s lien. Whether or not a subsequent taker of an interest in the property has actual knowledge of another party’s validly and previously recorded interest relating to that property, the subsequent taker is bound by the prior party’s interest. This type of notice is referred to as “constructive” or “record” notice. A MOL, like any other document placed of record, is executed and recorded to put third parties on notice of the existence of the lease and, more particularly, of the critical terms that are typically recited (often verbatim or, at a minimum, summarized), in the MOL.

While some might argue that a MOL is unnecessary because third parties should be aware of a tenant’s possession and the possible rights that might attach to that tenant pursuant to its lease simply because they can “see” the tenant in possession of the property, this argument is weak. Knowledge that a tenant is in possession of a premises merely provides a prospective purchaser, lender or tenant with a “duty to investigate.” And, simple inquiry of a record owner is insufficient to apprise third parties of a tenant’s rights under a lease. It is only through recording of a MOL that a third party can be actually charged with having constructive notice of the most critical provisions in the lease. Through recording of a MOL a third party can be charged with constructive notice of the provisions of the lease. It should be noted, though, that a tenant’s obvious possession, even if inconsistent with the record title, can impart inquiry notice (which is not the same as constructive notice) to a subsequent taker.

“Constructive notice” or “constructive knowledge” and “inquiry notice” are confusing concepts. Constructive notice or knowledge is knowledge that a person is presumed to have simply because such notice would have been ascertained by proper inquiry and due diligence. The rationale is that a careless party should be assumed to know what that party would have learned had that party explored the sources of knowledge which are available for that party’s information. Therefore, the notion of constructive notice charges that party with whatever knowledge that party would have obtained by the performance of the duty to research the available sources. “Implied notice” is a presumption of fact relating to what someone could learn by reasonable inquiry; however, unlike constructive notice, implied notice arises from actual notice of certain circumstances which are of such a nature as to impose upon a person a duty to inquire which, if the inquiry were followed up with due diligence, would lead the inquirer to the knowledge at hand.

The need for a MOL is particularly important in situations where the tenant’s possession may not be ‘seen’ by a third party. For example, if a lease is signed, but the tenant does not open for business with the public for several months or even years, then, without a MOL, most third parties would have no knowledge of the lease. In such a situation, recording a MOL is necessary in order to protect the tenant’s rights as against third parties during the period after the lease is signed and before the tenant can actually be seen in the premises. Similarly, a MOL is important where a tenant moves out of its premises, continues to pay rent and the lease remains binding on both the landlord and the tenant. Under these circumstances, the tenant cannot physically be ‘seen’ in the premises; however the lease, together with any rights, restrictions, and concessions, remains in full force and effect. In fact, in such a situation, one could argue that a decision not to record a MOL as a decision to accept the risks that results from not filing the document.

Some states clearly afford protection without the need to record an MOL. In Maine and Massachusetts, for example, it was held that actual knowledge of a tenant’s possession gave rise to a third party’s duty to inquire as to the terms of that tenant’s lease as well as constructive notice of what would be found by such an inquiry. See Universal Container Corp. v Cambridge, 278 N.E.2d 727, 729 (Mass. 1972). In Cambridge, the petitioner was a tenant pursuant to a lease that provided for damages to the tenant’s leasehold in the event of a taking for public use. The respondent, the city, took a fee interest in by eminent domain and, in so doing, paid full value for the real estate to the fee owner. The petitioner, however, was not made a party to the transaction and never received any compensation for the taking of its leasehold interest. The Cambridge court held that a recorded notice of lease was sufficient to give the respondent constructive notice of the petitioner’s interest in the property.

While most jurisdictions do not actually require the recordation of a MOL, there are those that do require the recording of either a lease or a MOL under all or certain circumstances. In Louisiana, for example, a lease will be considered invalid as against claims by third parties if the lease (in its entirety or in a short form that, in Louisiana, is called a Notice of Lease) is not recorded. La. Rev. Stat. Ann. §44:104 and La. Civ. Code Art 3338. In Connecticut and Maine, a MOL (or the lease itself) must be recorded if the lease has a term of longer than one year (in Connecticut) [Connecticut General Statutes §§ 47-19 and 47-20] or two years (in Maine) [33 M.R.S.A §201]; otherwise, the lease is only binding on the parties to the lease and not on innocent third parties who would have otherwise benefited from the recording of such a document. As another example, in Alabama, a lease with a term of less than twenty (20) years [which includes the initial term and any option(s) to extend] does not need to be recorded in order to be enforceable against third parties; however, if the lease term is more than twenty (20) years, that portion of the lease which is longer than twenty (20) years is void unless the lease or a MOL is recorded within one (1) year after lease execution. Ala. Code §35-4-6 (1975). As a result of each state’s varying recording requirements, each state’s statutes and case law must be carefully examined whenever a party decides to record a lease or MOL..

Even in those jurisdictions that impose a duty on subsequent parties to inquire of a tenant in possession, it may be possible for an inquiring party to make an inquiry and receive incomplete information. Ultimately, the MOL is preferable because it avoids litigation that might arise to prove or disprove knowledge that was gained from the inquiry. Therefore, even if case law protects a tenant or other interested party if a MOL is not recorded, recording a MOL will always provide stronger protection, at least with respect to what is clearly and accurately stated in the MOL. Advice? Record a MOL, in every instance, unless the benefits of recording the MOL are substantially outweighed by the cost of doing so.

Why Record a Memorandum of Lease Rather Than the Lease Itself?

There are several reasons why recording the MOL is the preferred option.

First, as mentioned above, the cost of recording a MOL in certain jurisdictions can be quite high, often based on the number of pages that will be recorded. Nevertheless, as we all know, the majority of commercial leases contain many more pages than a MOL. Recording the actual lease, therefore, will increase the cost significantly.

Second, recording the lease itself would disclose to the world various terms and conditions that, presumably, one or more of the parties to the lease would prefer remain confidential (e.g., the amount of the rent, allowances, concessions, etc.). Disclosing such terms provides an easy way for prospective tenants to take advantage of confidential information and negotiate new leases to their advantage. Recording a MOL, where those terms can be referenced but not disclosed, would prevent third parties from utilizing such confidential information.

Does the MOL benefit both the Landlord and the Tenant?

It is commonly thought that a MOL generally benefits only the tenant. Tenants, especially those with a heavily negotiated lease (including concessions, exclusive use rights, construction restrictions, or restrictions as to the use of the rest of the overall property), want their lease recorded to ensure the viability of their business by making sure that the public knows of those protected rights. Additionally, a MOL is generally required by leasehold lenders or for a leasehold title insurance policy to establish lien priority. Landlords are often indifferent to the recording of a MOL, but will often agree to the record one to ensure that the lease itself will not be recorded, again for fear of disclosing sensitive information relating to concessions that it has granted to the tenant. In fairness, however, it must be said that some landlords prefer to avoid recording a lease due to the fact that, if the lease is terminated early, whether by surrender or by court proceedings (particularly in the lower courts where the court records may be unavailable), a landlord may have a difficult time proving that the lease is no longer effective and therefore in clearing its record title to the property. One way to protect a landlord from this problem is to provide a Discharge of Memorandum of Lease, in recordable form and fully executed by the tenant simultaneously with the tenant’s signing of the lease and the MOL, to be held in escrow by landlord’s attorney pending expiration or early termination of the lease in accordance with the terms of the lease.

What provisions should appear in the Memorandum of Lease?

At a minimum, the MOL should set forth the names of the parties, a description of the premises (almost always including a legal description of the entire property), the term of the lease (including, where known, the exact commencement and expiration dates), and lease options (including options to renew, purchase, rights of first refusal, restrictive covenants, etc.). Often, you will also see other critical provisions, such a tenant’s exclusive use rights or radius restrictions inserted into a MOL. Ideally, the MOL should accurately summarize (or, preferably, quote verbatim) those key provisions that could affect or be affected by outside parties. It should be noted that there is extensive debate among the states as to whether a third party is deemed to have notice of those items in a lease which are not included in a recorded MOL.

Should a Lease Address the Execution and Recording of a Memorandum of Lease?

The right to record a MOL is a valuable tool, and should be addressed in the lease. In general, and especially if there are important provisions in the lease that are important to a tenant or landlord which, if violated, could significantly harm the tenant’s or landlord’s business, the lease should include a provision addressing the right to record a MOL. A lease should typically state that the lease itself will not be recorded, but that a MOL will be recorded either simultaneously with the execution of the lease itself or at either party’s request. The lease should also set forth who will pay to record the MOL. This is especially important when the recording fees to record such documents are steep. In a heavily negotiated lease, the form of MOL to be signed and placed of record will also often be an exhibit to the lease. An example of lease language follows:

Simple language: “This instrument shall not be recorded by either party hereto. Each party agrees to execute, at the request of the other, a memorandum of this Lease to be recorded at the expense of the party requesting it.”

More detailed: “At the request of either party, Landlord and Tenant shall execute and deliver, in duplicate original counterparts, a recordable memorandum of this Lease identifying the Premises and stating the commencement and termination dates of the Term of this Lease.”

Very detailed (and tenant-favorable) for a retail lease: “A Memorandum of this Lease in the form attached hereto as Exhibit “A,” designating the parties in interest, the term, any exclusive use rights granted to Tenant, any extension rights granted to Tenant, any restrictions on alterations to the Premises imposed against Landlord, and describing the Premises, shall be signed and placed of record on the land records covering the site of the Premises; however, this Lease itself shall not be recorded. Landlord shall pay all transfer taxes, charges, and fees incurred in connection with recording the Memorandum of this Lease.”

What If The Lease Is Modified After The MOL Is Recorded?

In some states, such as New York, the statute provides that an agreement that modifies a lease that has already been recorded (either in full or via a MOL) is ineffective against a subsequent innocent purchaser for value, and therefore the tenant’s possession is insufficient to provide such innocent party with notice of such modification, unless the modification agreement (or a memorandum of same) is recorded. See N.Y. Real Property Law §291-cc(1). Therefore, as stated earlier, it is critical to be aware of your state’s laws before a tenant modifies its lease. If a tenant does not do so, it runs the risk of losing important rights that it just negotiated through the modification agreement against third parties who don’t know of such rights, and who can’t discover such rights even though diligent investigation.

Conclusion.

Commercial leases, at a minimum, should provide for the right to record a MOL. They should provide when and if a MOL will be recorded, a summary of what information will be included (or, even better, a form of MOL should be attached to the lease), and should provide who will pay the recording fees. In more complicated or heavily negotiated leases, attaching a form of MOL to the Lease is a wise decision (or, alternatively, negotiate the MOL simultaneously with the negotiation of the Lease, and have both documents signed simultaneously). In the end, both parties will be well served.


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