Many lease agreements contain an “interim rent” provision enabling the lessor to charge for the use of the lease property for the time period between the actual acceptance date and the date on which the base term of the lease commences. Although interim rent is well established, it’s not specifically addressed in the UCC. Therefore, it’s valuable to have an understanding of how it’s used and how the courts enforce it.
The interim rent concept enables a lessor to set the lease commencement on a particular date, such as the first or 15th of the month. Moreover, interim rent provisions can provide the lessor with significant rent revenue in addition to the scheduled lease payments.
Interim rent is a well-established tool, but there are legal and practical parameters, which should be considered even though courts have routinely enforced such provisions. Knowledge of the relevant considerations and facts should maximize the probability that the interim rent provision will be enforced and minimize the number of dissatisfied lessee customers.
The Uniform Commercial Code
The Uniform Commercial Code (UCC) does not specifically address interim rent. (The commercial code citations herein are to Article 2A of the Uniform Commercial Code. As always, the reader is reminded to refer to the version of Article 2A adopted in his or her jurisdiction.) Thus, courts typically apply general commercial code and contract enforcement principles in analyzing interim rent provisions.
Generally, a lease contract is effective and enforceable according to its terms between the parties, according to UCC §2A-301. A lessee’s promises under the lease contract become irrevocable upon acceptance of the property, meaning that the provisions are not generally subject to cancellation, termination, excuse or substitution absent the consent of the lessor, states UCC §2A-407.
The commercial, arms length nature of most lease transactions further predisposes most courts toward enforcing the expressly stated agreements between the lessor and the lessee. The commercial nature of lease transactions, along with general Commercial Code and contract principles, provide a solid foundation for enforcement of conspicuously stated interim rent provisions.
Case Law Analysis
In addition to commercial law support, interim rent provisions have met with substantial success in reported federal and state opinions. Numerous courts have underscored the legitimate purposes that underlie interim rent provisions. In general, the courts have had little difficulty enforcing interim rent provisions despite the occasional estoppel and fraudulent inducement claims by the lessee.
For example, in Amplicon, Inc. v. Marshfield Clinic, 786 F. Supp. 1469 (WD Wis 1992), the Court expressly held that the interim rent provision was enforceable despite the lessee’s claim that it was fraudulently misled with respect to application of the interim rent provision. The Court found interim rent had never been discussed by the parties prior to execution of the lease. Regardless, the Court invoked the parole evidence rule and the integration provision in the lease to find the interim rent provision enforceable.
The Court’s opinion in In Re Edison Brothers Store, 207 B.R. 801 (BKDE 1997), analyzed, among other factors, the impact of an interim rent provision in determining whether a transaction was a true lease or a lease intended as security. The debtor argued that interim rent was merely an improper method of increasing yield. The Court unequivocally disagreed and held that the interim rent constituted “reasonable compensation” for the debtor lessee’s use of the equipment during the period prior to commencement of the base term. In so ruling, the Court noted:
“I disagree with Debtor’s characterization of the interim rent as additional consideration, implying that it was some type of additional up-front payment. The interim rent was, in fact, a reasonable rental payment to compensate [the lessor] for the Debtor’s use of the [Equipment] for a period from the date [the items of Equipment] were installed to the date each rental obligation commenced.”
In All-Luminum Products, Inc. v. Winthrop Resources Corporation, 28 Fed. App 611, 202 US App. Lexis 2657 (8th Cir. 2002), the Court affirmed entry of summary judgment despite the lessee’s claim that the interim rent was improperly calculated and that the provision was ambiguous. The Court held that the lessee’s argument relied on inadmissible parole evidence. Regardless, the Court noted that the interim rent was properly calculated based on the flat monthly fee of the base rental. However, the Court implied that it might have given more credence to the lessee’s claim had the lease actually been construed as a disguised loan.
Nearly every reported decision involving interim rent unequivocally holds that the provisions were enforceable. Significantly, each of the subject provisions appeared justifiable, reasonable, conspicuous and rationally related to the actual value of the lessee’s use of the equipment. It is where one or more of these factors is missing that the lessee has a potential argument challenging the interim rent provision.
Unfair Business Practices and Other Lessee Attacks
Lessee defenses based on fraud, estoppel and unjust enrichment have largely failed. In one case, however, a court gave some credence to a claim that an interim rent provision constituted an unfair fraudulent business practice.
In Underwriters Laboratories, Inc. v. Solarcom, LLC, 2002 US Dist. Lexis 18278 (ND Ill. 2002), the lessee alleged that the lessor should be estopped from charging interim rent because the lessor fraudulently induced the lessee into signing the contract and violated Illinois’ Consumer Fraud and Deceptive Practices Act. The lessor moved to dismiss the complaint arguing that the contract was a fully integrated statement of the parties’ intentions that could be contradicted by parole evidence.
The Underwriters court denied the lessor’s motion to dismiss, finding that many material factual disputes existed. However, Underwriters is distinguishable on its facts from most cases.
The subject transaction was not really a lease — the parties had borrowed from documents and, as the Court stated, trimmed a “square hole to accommodate a round peg.” The Court found that many of the provisions in the contract had no relevance whatsoever to the transaction. It appeared that the interim rent provision was somehow being used as some form of interest device. There was also ample evidence of false and misleading statements made by the lessor.
Under the unusual circumstances of the Underwriters opinion, the Court held that the lessee could state a claim for fraud and unfair business practices that was sufficient to survive a motion to dismiss. Notwithstanding, the case likely reflects the exception rather than the rule.
The use of interim rent provisions appears less justifiable in disguised loan transactions because the “additional rent” amounts to an increase in yield, which disturbs the implicit rate within a financing. Given that customers are more familiar with the concept of interest rates, any provisions that have the effect of varying the anticipated rate can be misleading and might cause concern to a court.
Some courts have expressed concern regarding interim rent provisions in non-true lease scenarios, especially when the rent exceeds interest accrual. Such concerns are not warranted in the true lease scenario because interest rates are not involved, and the lessee is receiving the value of the additional use of the equipment above and beyond the stated term of the lease.
The better view — as espoused by industry experts, courts and knowledgeable lawyers — is that no unfair business practice results from requiring a lessee to pay for the use of equipment for each day that it is in possession of the equipment. Nevertheless, it is conceivable that a court might invalidate an interim rent provision, which is wholly inconspicuous or represents a complete windfall to the lessor, which is unrelated to the actual value of the lessee’s use of the lease property.
Several Types of Interim Rent Provisions Exist
Several different forms of interim rent provisions exist, which are common in the industry. As highlighted by the court opinions, an important element of any interim rent provision is that it relates to the actual value of the lessee’s use during the stated time period. This relationship is usually accomplished by making the daily interim rent equal to 1/30 of the base rental amount.
Most interim rent provisions provide for base rental payments on the first, 15th or last day of a month. However, as long as the provision is clear and unambiguous and the lessee is obtaining the use of the equipment in exchange for the interim rent value provided, there is no inherent legal reason why the parties to a commercial lease should be prohibited from structuring the transaction to provide for a mid-month base rental payment date that is designed to maximize the number of interim rent days. However, whether such a provision is ethical depends on the particular facts of the transaction and the point of view of the lessor.
To further maximize interim rent, the lessor might want to consider adopting a quarterly commencement of base rental on the first day of April, July, October and January. By so doing, interim rent could be maximized beyond 30 days under such a provision and could be as long as 89 days.
Clearly, there are some in the leasing industry who view with disdain a practice of varying payment due dates in order to maximize interim rent revenue. Many lessees are unfamiliar with the interim rent concept and maximizing the amount, which the lessee must pay under such circumstances (unexpectedly to the lessee), strikes some as a very aggressive business practice.
However, as noted, such extended interim rent provisions enforceable so long as the lessee is charged interim rent only for the time during which it has possession of the equipment and so long as the amount of the interim rent is adequately set forth.
Some lessors choose to create headings that reference and highlight “interim rent” in order to make the provisions more conspicuous and less subject to attack as a result thereof. In some instances, lessors have left blanks for inclusion in the lease schedule (or have included in final funding letters) the exact dollar amount of the interim rent. Such specification highlights the separate nature of the interim rent charge and reduces the likelihood of any lessee confusion.
Interim rent provisions promote certainty by allowing lease commencement dates to start at defined, logical dates. Moreover, interim rent can be an important source of additional rent. Interim rent provisions are routinely enforced by the courts, especially where the provisions are conspicuous and not unduly overreaching.
In addition to the legalities, a lessor’s use of interim rent provisions also involves a number of business issues. For example, assuming a lessee refuses to pay the interim rent as agreed, the lessor must evaluate whether or not it is truly desirable to declare an event of default at the early stages of an otherwise performing lease. The issue is particularly thorny where the stream of rents has been assigned.
Moreover, a lessee that unexpectedly (in their mind) must pay a large, unanticipated interim rent invoice is unlikely to become a happy, repeat customer. Further, aggrieved customers are more likely to file bogus lawsuits and complaints with entities such as the Better Business Bureau. Legal fees and damaged goodwill are the inevitable result. However, the level of discontent might be lessened if the interim rent “stub” is only for a few days and is for the obviously commonsensical purpose of making the base rental payment due on the first of the month.
Regardless, knowledge of the relevant considerations and prudent application of the lessor’s well-established rights should enable lessors to obtain the full benefit of the interim rent tool without adversely impacting the lessee relationship.
Mark M. Scott is a shareholder of Buchalter Nemer in Orange County, CA. He can be reached at 949-760-1121 or via e-mail at email@example.com.
Vice President, Syndication,
Ray Ellingsen, Vice President of Syndication and Operations at Corcentric, details steps to take in the transformation from paper mess to paperless amid a rapidly digitalizing, post-COVID-19 environment.