Why Not Just Blame The Landlord And The Mortgage Lender…? – Landlord & Tenant – Leases

The New York City Council has adopted a new law that imposes
penalties on landlords who knowingly lease premises to unlicensed
cannabis or tobacco sellers. The law imposes fines on landlords who
lease property to a tenant who they know will use the premises for
the unlicensed sale of cannabis or tobacco. The law imposes fines
on landlords who take no action after they are notified by a law
enforcement agency that an existing tenant sells cannabis without a
license. Although this blog refers to unlicensed cannabis sales,
the law applies not only to cannabis but also to the unlicensed
sale of cannabis products, tobacco, and e-cigarettes. Everything I
suggest below regarding cannabis also applies to the unlicensed
sale of cannabis products, cigarettes, and e-cigarettes.

The penalties for violating the law are severe,
with a fine of $5,000 for the first violation and $10,000 for
subsequent violations. Although not clear from the statute,
published reports suggest that each day that a violation continues
is a separate penalty. A landlord can defend against the violation
by showing that a proceeding to evict the unlicensed tenant has
been commenced.

The law defines owners to include not only people who own the
building but also mortgage lenders that take possession of the
property, contract purchasers who take possession before the deed
is transferred, tenants who sublease to the unlicensed seller,
parties that hold assignments of rents, managing agents, and anyone
else who directly or indirectly controls the premises. Since
virtually every commercial mortgage includes an assignment of
rents, a literal interpretation of the law imposes liability on
mortgage lenders who find out that a tenant is an unlicensed
cannabis seller, even if the lender does not have the authority to
evict the tenant.

To limit the risks, we recommend the following for different
groups of potentially liable parties.

Landlords:

Make sure that your leases expressly prohibit unlicensed sales.
The clause in the lease that describes permitted uses of the
premises should be drafted so that it cannot possibly be
interpreted to permit unlicensed cannabis sales. If you expect that
the tenant may be selling cannabis, require that the tenant provide
a copy of a duly issued license before commencing sales and a copy
of all renewals before the existing license expires. The lease
should authorize you to evict an unlicensed tenant by summary
proceedings and authorize you to obtain an injunction prohibiting
unlicensed sales. If the lease permits the retail sale of any
products, consider requiring the tenant to provide an annual
affidavit that no cannabis is being sold without a license. If the
lease permits subleasing, impose parallel obligations on both the
sublessor and sublessee as a condition of permitting the
sublease.

The lease should also include an indemnification provision for
any fines imposed upon the landlord for the wrongful acts of the
tenant. Indemnification against fines in some cases is considered
against public policy and thus unenforceable, but whether an
indemnification for these types of fines and related costs will be
enforced should be left to another day. For the moment, including
an indemnification clause is better than not having it. Make sure
that any contract you have with a managing agent requires that the
agent periodically verify the nature of
the occupancy and that the agent immediately commence
eviction proceedings if a tenant is engaged in the unlicensed sale
of cannabis.

Mortgage Lenders:

Commercial mortgages almost always include an assignment of
rent, so the new law seems to encompass all mortgage lenders. Other
statutes with similar language referencing assignments of rent have
been interpreted not to cover the standard assignment of rents in
which the lender has an assignment as additional collateral for the
loan unless the lender takes actual control of the rents. However,
no lender wants to be a test case. Therefore, the lender should
include a provision in its form of mortgage
expressly prohibiting the use of the premises for the unlicensed
sale of cannabis and obligating the borrower to commence eviction
proceedings immediately if there is any evidence of the unlicensed
sale.

The failure of the borrower to pursue eviction aggressively
should not only be a default under the mortgage, but the mortgage
should also include a provision giving the lender the right to
commence legal proceedings on behalf of the landlord if the
landlord fails to act promptly. If appropriate, based upon the
nature of the tenancy, the lender should obtain copies of all
licenses permitting the sale of tobacco or cannabis by the tenant
as part of its normal due diligence, and the tenant estoppel
certificate should obligate the tenant to provide copies of all
license renewals directly to the mortgage lender. If there is not
already an appropriate indemnification provision in the mortgage, a
provision should be added that expressly covers fines for
unlicensed cannabis sales. If the lender performs periodic property
inspections, as many bank mortgage lenders do, cannabis sales
should be included in the inspector’s checklist.

Managing Agents:

If a managing agent is authorized to negotiate and sign leases,
it should make sure that the lease provides all of the
protections that I suggest above for the landlord. If the
managing agent is only involved in ongoing management but not the
origination of a lease, the managing agent is still liable for
fines if it becomes aware of the unlicensed sale on any premises
that it manages. Therefore, I recommend that managing agents
conduct periodic inspections and also establish appropriate lines
of communication to make sure that a notice from a law enforcement
agency regarding unlicensed sales on the premises is not ignored.
Instead, the notice should be reported up the line so that the
landlord or the agent commences eviction proceedings
immediately.

And in conclusion, having appropriate
documentation in advance (such as leases, mortgages, loan policies,
and managing agent agreements), coupled with proper training of
your employees to know what to look for, is crucial to avoid
draconian penalties. We are here to help you because an ounce of
prevention is a lot less expensive than a pound of cure.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.