Real Estate Tax Apportionment in Leases

December 2010Newsletters In the Zone

In SPJ, Inc. v. W2005/Fargo Hotels (Pool C) Realty, L.P., 2010 WL 4237371 (N.J. Super. A.D.), a landlord and tenant litigated over the proper apportionment of real estate taxes. There are lessons to be learned from this case.

The landlord owned a single parcel of land upon which a hotel and parking lot were located. In addition, that same parcel of land contained an unimproved area that the landlord leased to the tenant pursuant to a long-term ground lease, upon which the tenant constructed a restaurant.

The ground lease provided that the tenant would pay “lessee’s proportionate share” of real estate taxes and that “lessee’s proportionate share” was determined by dividing the total square footage of the restaurant to be constructed on the ground lease land by the total square footage of all of the buildings on the parcel, which turned out to be 33 percent of the taxes.

In addition, the ground lease provided an alternative procedure (at Section VI (C) of the lease) for the allocation of taxes, by granting the tenant an option to seek a separate assessment for the leased land. However, this alternative did not provide a procedure for how to separately assess the leased land.

Shortly after the restaurant was completed, the tenant complained to the landlord that the assessment relating to the new building was too high, as the cost to build the restaurant improvements was $732,000 but the increase in the assessment for all of the buildings at the tax parcel was $1,583,000. The tenant requested the landlord appeal the tax assessment and also have the taxes separately assessed.

Several years passed without the landlord taking any action.

Four years later, the tenant informed the landlord that it would seek a separate assessment as provided for under Section VI (C) of the lease.

Around that same time, the tax assessor informed the tenant that if it wanted a separate tax bill for its leased land, it would have to effect a subdivision of the leased land from the balance of the parcel. Thus, if the leased land were subdivided from the balance of the parcel, there could be separate tax assessments for each of them.

However, neither the landlord nor the tenant proceeded with a subdivision application.

A few months later, the tenant obtained an appraisal from a private firm that concluded the tenant’s improvements were overassessed by the tax assessor, and the tenant asserted to the landlord that, in light of this appraisal, the tenant’s share of the real estate taxes should be reduced.

The landlord responded by stating the real estate tax allocation provision of the lease spoke for itself, providing for the tenant to pay 33 percent of the taxes, and the appraisal obtained by the tenant was irrelevant for purposes of the lease.

Within a year, the tenant brought a declaratory judgment complaint, asking the court to declare that the appraisal was controlling so that the 33 percent allocation would be adjusted downward.

Although the trial court elected to reform the tax allocation provisions of the lease as requested by the tenant, the Appellate Division reversed the trial court and refused to reform the lease in the manner requested by the tenant.

The court held that the allocation provision of the lease was clear and unambiguous. There were two choices: (1) the tenant could pay 33 percent of the real estate taxes or (2) the tenant could request a separate tax assessment pursuant to Section VI (C) of the lease, which, according to the tax assessor, would require subdivision.

Since the lease did not authorize the use of an appraiser to take the place of the tax assessor, the tenant’s argument that the appraisal should be used was rejected by the court.

Although the court did not reach the question of the landlord’s required cooperation in connection with a subdivision application, the court stated that since, in New Jersey, each contract contains an implied covenant of good faith and fair dealing, it is possible that the lower court on remand could find the landlord was obligated to pursue a subdivision in order to give effect to Section VI (C).

The court analogized the situation to a party having to pursue its administrative remedies before seeking redress with the courts. In this case, the court held the tenant was required to pursue its contractual remedies (i.e., a subdivision) before it could seek a reformation of the lease by a court.

A lesson to be drawn from this case is that real estate tax apportionment provisions need to be carefully written. If the tenant in this case wanted the value of its restaurant improvements to be factored into the equation for its share of real estate taxes, it should have so provided, instead of providing for the apportionment to be based purely on square footage.

At a minimum, the clause in question could have been drafted to provide that Section VI (C) of the lease require a subdivision application that would have to allocate who would pay the cost of the subdivision. Further, a landlord would have to determine whether a subdivision would be acceptable to it prior to agreeing to such a clause. For example, a subdivision may be impractical if it would result in violation of zoning requirements, such as lot coverage.

Although a property may not be able to be subdivided, thus permitting a separate assessment, it is possible that an apportionment clause could provide that the tax apportionment be based on the value of the improvements based on specific assessment information made available by the municipal assessor relating to the respective improvements. If the assessor is not willing to give such information, the value of the improvements could be based on the amount by which the total improvements increase in value, assuming there is a record of the prior assessed values for each of the respective improvements already on the property.

In any event, the tenant could have saved itself a good deal of time and money by more carefully dealing with this issue at the time it entered into the lease.

For more information, please contact Melvyn J. Tarnopol at 609.572.2212 or [email protected].