Who Pays for Blackouts?

While there are many different costs to consider--base rent; increased operating expenses, including extra security costs, overtime costs relating to start-up of buildings once power comes back on-line and possible future costs relating to energy system upgrades and redundancies; employee overtime and absent employee coverage; spoiled product; lost revenue; and other consequential damages--for the most part, the tenant and not the owner pays. Although there are exceptions to every rule, the tenant will generally bear the burden here. With respect to base or fixed rent, even the biggest corporate behemoths are unable to negotiate a rent abatement clause that would kick in on day one for a cause beyond the owner's control. The best tenant-negotiated leases with the most favorable rent abatement clauses for non-access to or use of the premises almost always allow a several-day deductible for an event such as a blackout. Thus, the owner should have no real exposure in terms of base rent.

As for operating expenses, virtually all expenses, whether for existing line items or categories, or for new categories or line items related to security or power enhancements, would continue to be charged back to tenants. In general, the areas where a building owner might not recover his costs is where a tenant is paying a fixed or base rent that includes operating expenses or where a tenant is in a base year of a lease and the owner assumes the base-year operating costs; where the owner does not have a fully occupied building and gross-up provisions have been negotiated by a tenant; where bigger tenants have negotiated for an operating expense budget or for a cap on operating expense increases, and the expenses at issue blow the budget; and, of course, where an owner has a defaulting or bankrupt tenant that does not pay its bills. Going forward, owners negotiating new leases might want to consider carving out the costs from blackouts and other emergencies.

Most of the time, especially with the big service and financial firms that occupy much of Manhattan's business districts, the base and related rent charges are the least of the tenant's expenses and, as to individual tenants, not a significant building owner concern. The greater costs to the tenant relate to loss of productivity, lost revenue and increased expenses and various consequential damages including spoiled or pilfered products, computer and data back-up and recovery efforts and personal-injury lawsuits. These, of course, could become the owner's largest concern if the tenant attempts to look to him for reimbursement, perhaps on attenuated theories of negligence. Although it is unlikely tenants will have much success trying to make such a claim given the nature of the Blackout of 2003, it can still become a nuisance if it is dragged into unnecessary litigation. Owners whose leases have broad clauses requiring tenants to reimburse the owner for legal fees will have greater luck avoiding such litigation.

For these larger expenses, a tenant would generally have to look to his insurance or, in certain limited circumstances, the government, and the owner should be safely out of the picture. (If it turns out that any of the electric energy producers, suppliers or distributors were extremely negligent, then recourse may be pursued against them). However, with the exception of credible personal injures that may be ultimately covered by some parties' insurance (owner, tenant, energy supplier or public authority), these expenses for the most part will not be recoverable by a tenant in the case of a relatively short blackout, and owners should have no real concern as to exposure.

Where, as with the most recent crisis, the blackout is of a relatively short duration, unless the costs faced by a specific tenant are significant enough to reach an insurance threshold, or unless the specific type of event or the type of loss was specifically insured against, the tenant will likely not recover. Even with business-interruption coverage, there are various forms of deductibles and maximum amounts of coverage based upon policy limits. Should a tenant suffer business-interruption losses of the magnitude that would exceed the deductible and be within the bounds of the policy's coverage, then the tenant would in fact likely be able to recover. In any event, this would be between the tenant and its insurer, and given the circumstances of the blackout, absent specific egregious facts, the building owner should not have exposure.

The good news for most of us is that the blackout commenced in daylight, during the summer and was short in duration. Also public authorities responded promptly and relatively efficiently; terrorism was apparently not the cause; public reaction was orderly and understanding; and at a relatively small regional and national price, those authorities may have learned a valuable lesson and decide to act promptly on correcting and upgrading the country's electric grid system.

The lesson: Building owners should recommend that tenants obtain business-interruption insurance with a low deductible and first day kick-in if the cost makes sense and, in all cases, should require tenants to maintain some level of business interruption and rental insurance to reduce unwarranted owner exposure.

Attorney Mark S. Levenson specializes in real estate project development and finance for the Newark, NJ-based law firm of Sills Cummis Radin Tischman Epstein & Gross.