Though tax escalation clauses are standard in commercial leasing transactions, a trio of New York cases calls into question their enforceability when the tax escalation results from property improvements exclusively benefiting the landlord.
Beginning with Credit Exchange, Inc. v. 461 Eighth Avenue Associates in 1987, the Court of Appeals disregarded the plain text of the tax escalation clause at issue, instead discussing the general purpose of tax escalation clauses and whether that purpose is served by requiring tenants to pay tax increases due to property improvements.[1] In Credit Exchange, plaintiff leased the twentieth floor of a commercial building under a series of leases, the most recent executed in 1979.[2] Under the lease, plaintiff was obligated to pay 4.5% of the property tax increases beyond $203,342.50 annually.[3] Defendant purchased the property in 1981 and instituted improvements, including: security system installation, computerized elevator installation, window replacement, exterior resurfacing, and the addition of two floors.[4] Following these renovations, plaintiff’s tax bill more than doubled, from $20,648.59 in 1984/1985 to $46,658.36 in 1985/1986.[5] Plaintiff sought a declaratory judgment limiting its tax obligation, attributing the tax escalation solely to the construction of two additional floors from which plaintiff received no benefit.[6]
The Court of Appeals noted the general purpose of tax escalation clauses in commercial leases—to shift from landlord to tenant the proportionate share of real estate tax increases.[7] The court then determined that this purpose is not served by requiring tenants to pay real estate tax increases resulting from property improvements “redounding solely to the benefit of the landlord.”[8] Affirming the trial court’s denial of summary judgment, the Court of Appeals found triable issues of fact as to whether the improvements exclusively benefitted the landlord.[9] The court issued a brief opinion, declining to expand upon the types of improvements that exclusively benefit a landlord.
In 223 West Corp. v. B & D Leistner Properties, the First Department considered facts remarkably similar to Credit Exchange, and echoed the Court of Appeals’ decision without providing further illumination.[10] In 223 West Corp., tenant plaintiff moved for summary judgment declaring it not liable for an increased tax assessment, arguing the assessment increase resulted solely from property improvements.[11] In May 1996, Plaintiff leased the ground floor and basement of 223 West 19th Street in Manhattan.[12] At lease commencement, the building was a commercially utilized three-story structure.[13] Post lease commencement, mainly between 1998 and 2000, landlord defendant renovated the building to include residential floors, a roof-top terrace, and an upscale bar.[14] Additionally, the building was converted to a condominium.[15]
Pursuant to a tax escalation clause, plaintiff was obligated to pay 50% of the increase in property taxes over the base year.[16] For tax year 1998/1999, taxes were based on a building assessment of $236,430.[17] For tax year 2000/2001, the building’s improvements skyrocketed the assessment to $1,254,782.[18] Quoting Credit Exchange, the First Department affirmed the lower court’s grant of summary judgment in favor of plaintiff, declaring plaintiff not liable for tax escalation due to improvements “redounding solely to the benefit of the landlord.”[19]
The June 2015 decision by the First Department in Enchantments, Inc. v. 424 East 9th LLC, extends Credit Exchange to cover internal renovations that result in neither a horizontal nor vertical expansion of the premises.[20] In Enchantments, plaintiff sought summary judgment declaring it had no real estate tax liability for internal improvements solely benefiting the landlord—despite plaintiff’s lease containing a tax escalation clause obligating it to pay 40% of the increase in real estate taxes over the base year.[21] The Supreme Court, New York County, denied summary judgment, finding the Credit Exchange holding inapplicable to the case at bar.[22] The First Department reversed the Supreme Court’s order, finding the purpose of a tax escalation clause not served when tax increases result from any property improvements solely benefitting the landlord.[23] The First Department remanded the case to determine: (1) the extent to which the improvements caused the tax increases, and (2) whether the improvements solely benefitted the landlord.[24]
In light of Credit Exchange, 223 West Corp., and Enchantments, it is clear that courts will disregard the plain language of tax escalation clauses—clauses drafted by sophisticated contracting parties—to ensure tax increases due to property improvements solely benefitting the landlord are not passed on to the tenant. However, without further elucidation from the courts, the scope and nature of improvements “redounding solely to the benefit of the landlord” remains undefined.
[1] Credit Exch., Inc. v. 461 Eighth Ave. Assocs., 69 N.Y.2d 994, 997 (1987).
[2] Credit Exch., Inc. v. 461 Eighth Ave. Assocs., 506 N.Y.S.2d 168, 169 (1st Dep’t 1986), aff'd in part sub nom. Credit Exch., Inc. v. 461 Eighth Ave. Assocs., 69 N.Y.2d 994 (1987).
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] Credit Exch., 506 N.Y.S.2d at 997.
[8] Id.
[9] Id.
[10] See 223 W. Corp. v. B & D Leistner Props., 801 N.Y.S.2d 28 (1st Dep’t 2005).
[11] Id. at 28.
[12] 223 W. Corp v. B & D Leistner Props, 2004 WL 5487478 (Sup. Ct. Feb. 5, 2004), aff’d, 223 W. Corp. v. B & D Leistner Props., 801 N.Y.S.2d 28 (1st Dep’t 2005).
[13] Id.
[14] Id.
[15] Id.
[16] Id.
[17] Id.
[18] Id.
[19] 223 W. Corp., 801 N.Y.S.2d at 28.
[20] Enchantments, Inc. v. 424 E. 9th LLC, No. 650073/14 2015 WL 3849646, at *1 (1st Dep’t June 23, 2015).
[21] Id.
[22] Id.
[23] Id.
[24] Id.
PartnerTom represents owners, operators and developers in the acquisition, financing, development, ground leasing, and sale of significant properties. His experience includes office towers, commercial condominiums, industrial ...