Take a Memo! Why a Memorandum of Lease is Important
Have you ever encountered a reference, often at the end of a long commercial lease document, to a “Memorandum of Lease” and wondered, “What is the point?” Most memoranda of lease are not deeply technical nor particularly long, especially as compared to their corresponding leases. While not the most technical or detailed aspect of any lease, the memorandum of lease clause (“MOL”) is important for the tenant to include and for the landlord to understand its ramifications. This article explains what a Memorandum of Lease is and why it is important.
A memorandum of lease is a recordable instrument that is used to alert third parties—such as lenders, other tenants of the property, and prospective buyers—that there is a leasehold interest encumbering a piece of real property. Not only does an MOL alert the world that the tenant holds a leasehold interest in the property for the length of the term of the lease, but an MOL also can act as a covenant running with the land to protect the tenant’s interests under the lease that the tenant may have as to third parties, such as an option to purchase or right of first refusal.
Tenant to be Seen
At its core, a memorandum of lease is recorded in the property’s chain of title to provide “constructive notice” of the tenant’s rights and interests in the leased property. It is the recordation of the document with the local records office that makes it public to third parties. The recordation of the MOL is particularly important in situations where the tenant’s possession is difficult to be ‘seen’ by a third party. As an example, if a lease is signed, but the tenant does not open for business or take possession for several months or years, then, without a recorded MOL, third parties would have no knowledge of the lease. In such a situation, recording an MOL is necessary in order to protect the tenant’s rights as against third parties during the period after the lease is signed but before the tenant can actually be seen in the premises. Likewise, an MOL is important where a tenant moves out of its premises, continues to pay rent, and the lease remains binding on both the landlord and the tenant. Under these circumstances, the tenant cannot physically be seen in the premises, but the lease, together with any rights, restrictions, and concessions, remains in full force and effect. In situations such as these, the decision not to record an MOL is a decision to accept the risks that result from not filing the document. In Illinois, as with most states, an MOL does not need to be recorded for the lease to be enforceable; however, there are other reasons for the MOL beyond the tenant declaring its lease of the property.
Memorandum of Lease as Covenant Running with the Land
If the tenant is granted rights under the lease that are enforceable against third parties (and not just the landlord), or for which third parties should be aware, a recorded memorandum of the lease describing those rights should be recorded to best protect the tenant as to those rights. The most common example is situations that grant the tenant an option to purchase the real estate or a right of first offer or refusal to purchase the real estate.
Moreover, for those retail tenants who were granted exclusive rights under their leases to exclusively sell such things as coffee or sporting goods, an additional means to enforce the exclusive rights covenant is by arguing that the covenant is not just a contract right under the lease, but a covenant running with the land. In order to enforce a covenant that runs with the land, the party seeking to enforce the covenant often must prove notice of the covenant to those against whom enforcement is sought. The convenient way for a retail tenant to ensure that its exclusive use rights under its lease are a covenant running with the land is to include those rights in the MOL. Many states recognize that leases contain covenants of the land and the MOL should be the tenant’s tool to ensure those covenants are enforceable against third parties.
Landlord Concerns for MOLs
As a recorded MOL clouds the landlord’s title, it is vital that the landlord protects its own rights and interests in the real property when negotiating and drafting an MOL. Including a unilateral termination right in the memorandum of lease protects the landlord in instances of a tenant default and saves the landlord from having to deal with a title company or court to clear the MOL from title. With a unilateral termination right in the memorandum of lease, landlord is able to terminate the MOL without tenant’s signature after the lease term has ended. In addition, if a landlord is considering refinancing with a mortgage loan, a landlord should remember that for every recorded MOL, there will likely need to be a corresponding recorded SNDA for the title company to ensure the lender’s mortgage lien.
Speaking of title companies, if a tenant seeks a leasehold title insurance policy, most title companies in Illinois require that an MOL be recorded in order to issue a leasehold title insurance policy. For any ground leases, a title company will require an MOL (and it is just good practice for a tenant under a ground lease to record the MOL) for any ground lease title insurance. Finally, title companies will be hesitant to insure a tenant’s leasehold mortgage, with the leasehold interest as collateral, without an MOL first recorded.
Not for Everyone
A five –year, 5,000 square foot office lease likely does not require an MOL—and a landlord may look sideways at a tenant who demands one. However, Illinois tenants with long-term leases, rights of first offer or refusal, options to purchase and/or exclusive use provisions included in their lease agreements should consider drafting and recording a memorandum of lease to protect their rights and interests. As the document, by its nature, is public, both landlord and tenant should agree on its contents in conjunction with the negotiation of the lease, even if the document or MOL clause is relegated to the end of the lease.
Christa-Gaye L. Kerr is a real estate associate in the Chicago office of Honigman LLP and Larry N. Woodard is a real estate partner and Co-Leader of the Construction Planning Practice Group in the Chicago office of Honigman LLP.