Federal Real Estate In A Turbulent Market, Part II - Landlord & Tenant - Leases - Real Estate and Construction (2024)

This is the second of a two-part series addressing specialconsiderations for government lessors in the current commercialreal estate market. Part I addressed the risks posed by governmentdownsizing and early lease terminations. Part II discussesdistressed assets and the unique challenges posed by distressedassets in two contexts: 1) lease expirations and governmentholdovers and 2) assignment of lessors' rights in the event ofa change of ownership or assignment of claims.

As explained in detail below, distressed assets present a numberof pitfalls and opportunities for lessors (and their lenders) withgovernment tenants. The primary takeaway for all of the scenariosoutlined below is that better outcomes will result from early,effective engagement and a sophisticated understanding of both thelegal rules and the government's standard practices andpolicies.

Holdovers and Short-Term Extensions

Since the easing of the COVID-19 pandemic and the beginning ofthe government's return to office, there have been a number ofacknowledgements from the White House, U.S. Office of Managementand Budget (OMB)¹ and U.S. General ServicesAdministration (GSA) that agencies should pause and reflect upontheir space needs moving forward. The practical result of thesepolicies has been that agencies have, for the past few years, beenrevisiting and reconsidering their long-term space needs, and thishas resulted in a slowdown or, in some instances a pause, inprocurements for new space.

The government's decision to pause its long-term leaseprocurements could not have come at a more inopportune time forgovernment lessors. As noted in Part I of this series, commercialoffice vacancy rates in some markets are the highest they have beenin decades, and many commercial real estate loans are coming due in2024 and 2025. Against this backdrop of difficulties in thecommercial real estate market, uncertainty with respect togovernment tenants' intentions at lease expiration has lessorsseeking to understand their rights and remedies. In particular,once a government tenant goes into holdover, it becomes even moredifficult to market or refinance a distressed asset. And it makesit nearly impossible to plan for a follow on tenant or – asis common with distressed assets – a completeredevelopment.

What, then, are the landlord's remedies for governmenttenants in holdover? First, note that the government cannot beevicted, even in the event that it stays past the expiration of thelease term. Though there is an implied duty to vacate inherent inevery lease,² a breach of this duty entitles the lessoronly to monetary damages; eviction is unavailable as a remedybecause it would constitute an order of specific performance of acontract obligation, and neither the U.S. Court of Federal Claimsnor the Boards of Contract Appeals have jurisdiction to entertainsuch a request under the Contract Disputes Act. See Podlucky v.United States, 2021 WL 2627130, at *2 (Fed. Cl. June 21, 2021)("Plaintiff is, essentially, asking the court to orderdefendant to specifically perform its obligations under thecontract. But a request for specific performance is equitable innature, and falls outside this court's jurisdiction."),aff'd, 2022 WL 1791065, at *1 (Fed. Cir. June 2,2022); Harmonia Holdings Group, LLC v. United States, 157Fed. Cl. 292, 301–02 (2021) ("[Plaintiff] cannot co-optthe Court's bid protest jurisdiction simply by reframing itsclaims as alleged violations of procurement law and requestinginjunctive relief (which is not available under the CDA)."(emphasis added)); Tenaska Washington Partners II, L.P. v.United States, 34 Fed. Cl. 434, 443–44 (1995)("[S]pecific performance is not a remedy available against theUnited States, because sovereign immunity has not been waived forsuch relief[.]"); Pellegrini v. United States, 103Fed. Cl. 47, 55 (2012) ("Equitable relief is not available toenjoin an alleged taking of private property for public use, dulyauthorized by law, when a suit for compensation can be broughtagainst the sovereign subsequent to the taking." (quotingRuckelshaus v. Monsanto Co., 467 U.S. 986, 1016 (1984)(citation omitted)).

However, landlords do have some small amount leverage innegotiating the terms of extensions and standstill agreements.First, in the event of a holdover, the lessor "is entitled tothe fair market value of the premises for the holdover period lesswhat GSA has paid appellant during the holdoverperiod."³ See Cafritz Co. v. GSA, GSBCANo. 13525-REM, 98-2 BCA ¶ 29,936 (Aug. 3, 1998) (citingRupert v. GSA, GSBCA No. 10523, 93-1 B.C.A. (CCH) ¶25243 (June 30, 1992)) (emphasis added). Similarly, "[t]herent in the lease is evidence of rental value, but a landlord mayestablish a rental value greater than [current contract]rent." See Rupert v. GSA, GSBCA No. 10,523, 93-1 BCA25,243 (June 30, 1992). So, if the fair market value rent issignificantly higher than the rent provided in the lease, thenlandlords have some leverage to negotiate favorable terms andconditions of any lease amendments that extend the term and keepthe government out of holdover.

Next, there are internal policies and incentives in place at theGSA to encourage contracting officers to avoid holdovers. Followingthe release of a 2015 U.S. Government Accountability Office (GAO)Report on the prevalence of short-term extensions and holdoversin GSA leasing, GSA committed to implement a program of settinggoals for reductions in holdovers and, as part of that program, GSAmaintains a "Key Performance Indicator" database thattracks holdovers and credits contracting officers who keep theirleases out of holdover. This also provides the lessor with someamount of leverage to negotiate favorable extension terms.

So, while short-term lease extensions and holdovers are becomingmore and more common, there is an opportunity for lessors to takeadvantage of the – admittedly limited – leverage thesesituations provide to negotiate rental increases and otherconcessions.⁴ The best practice in this scenario is toidentify expiring leases early, consider under what terms leaseextensions might be acceptable and engage with government tenantsand the contracting officer long before lease expiration. Lessorsseeking to re-let the premises to other tenants or redevelop theproperty should ensure the government is aware of these plans andthat any lease extension memorializes the potential impact aholdover would have. This may provide some entitlement toconsequential damages in the event of a subsequent holdover.

Lessors should also be aware that the government's timelinefor developing new lease requirements for succeeding leases beginsthree years out from lease expiration. This process involves anumber of stakeholders – to include the tenant agency and itsreal estate and finance teams, as well as GSA – and typicallyincludes a cost-benefit analysis to determine whether a succeedinglease would yield cost savings over a competitive procurement. See48 C.F.R. § 570.402-6. Early in this period, engagement withthe government can effectively shape the evaluation of succeedingleases versus competitive procurements.

Assigning Government Leases in Distressed Assets

Unlike traditional commercial leases, leases with the federalgovernment cannot be assigned, either through sales contracts orthrough operation of law, in the event of a foreclosure or areceivership. A group of statutes, collectively referred to as theAnti-Assignment Acts, have been enacted to ensure the governmentdoesn't run into a bait-and-switch scenario in which thegovernment contracts with one entity, only to have it assign thecontract to another. The statutes expressly prohibit any suchassignment:

The party to whom the Federal Government gives a contract ororder may not transfer the contract or order, or any interest inthe contract or order, to another party. A purported transfer inviolation of this subsection annuls the contract or order so far asthe Federal Government is concerned, except that all rights ofaction for breach of contract are reserved to the FederalGovernment.⁵

What this means as a practical matter is that unlike traditionalcommercial leases, the tenant – in this case, the federalgovernment – has the authority to refuse to acknowledge asuccessor in interest to a landlord who no longer has title orcontrol of the leased asset.

But while there is a blanket prohibition on the assignment ofgovernment contracts and leases, the law and the lease languageprovide three mechanisms for ultimate recognition of a new owner– or at least payment of rent – whether that ownerobtains title through sale, foreclosure or some other operation oflaw: Novation, Assignment of Claims and Attornment.

Each of these three pathways for assignment of interest in agovernment lease has its benefits and drawbacks, and for each ofthese pathways to assignment, the status of a distressed asset canimpact the cost-benefit analysis. For example, the question ofwhether the owner of a distressed asset remains solvent or haswound down its operations may impact whether and how the new owneror receiver seeks to execute a novation agreement – whichtypically must be executed by both parties to the transfer –or seeks another route.

Below, we describe each of these pathways and theirrequirements.

Novation

In light of the prohibition on unilateral assignment ofgovernment contracts and leases described above, the government hasimplemented a process to allow for assignment once both parties tothe asset transfer and the government have all agreed on the termsof the transfer: novation.⁶

The purpose of the novation process is to protect thegovernment's interests. The Federal Acquisition Regulation(FAR) explicitly acknowledges this purpose at 48 C.F.R. §42.1204(a), which gives the government the right to recognize athird party as the successor in interest to a government contractwhen it is in the government's interest to do so. Conversely,the government may exercise its discretion not to approve transferof a lease or contract. Specifically, 48 C.F.R. § 42.1204(c)indicates that when it isn't in the government's interestto approve a transfer, the original party to the contract (whichseeks to transfer the contract or lease) shall remain undercontractual obligation to the government, and the contract or leasemay be terminated should the original lessor or contract party notperform.

In practice, particularly in real estate, the government onlyvery rarely refuses to recognize a successor in interest followingthe purchase and sale of real property that is leased to agovernment tenant once the prospective lessor has offered someevidence of the purchase and its ability to perform under the termsof the lease. But the process requires three parties to activelyparticipate: the original lessor, the new lessor and thegovernment.

For distressed assets, this process can become problematic. Theoriginal lessor may not be a willing participant in any assignmentand, in some cases, the original lessor may no longer exist.Alternatively, the property may be managed by a receiver or aspecial servicer with legal authority to maximize the value of thedistressed asset.

These situations will require deviation from the standardnovation practices laid out in FAR Part 42.12.⁷ First,the standard novation language may need to be amended fromthree-party form into a two-party form. Additionally, many of therequired document submittals outlined in the lease and the FAR(parts 42.1204(e) and (f)) may not be available.⁸Finally, purchasers or lenders foreclosing on a borrower shouldconsider whether they are willing or able to accept liability forall of the previous owner's acts and omissions, as the standardnovation language requires.

The best way to approach the novation in the event of a sale ofa distressed asset is to address these concerns early in theprocess. Novations often take several months to complete and, ifthere are any deviations from the standard language or deliverablesbased upon the distressed nature of the asset, the novation processcan take even longer. Additionally, it is a best practice to engageearly in obtaining a System for Award Management (SAM.gov)registration, as this can take several weeks (or longer) and isoften the reason for delayed novation approvals; contractingofficers cannot and will not recognize new lessors until they havecompleted this registration.

Assignment of Claims

Though assignment of government contracts is prohibited, thesame statute that prohibits such assignments – 41 U.S.C.§ 6305 – expressly allows for the assignment of rentsdue under a federal contract or lease. Specifically, this statuteallows for the assignment of all rents due to "a bank, trustcompany, Federal lending agency, or other financinginstitution." Id.

The FAR⁹ clause that implements this statute –48 C.F.R. § 52.232-23 – provides as follows:

The Contractor, under the Assignment of Claims Act, as amended,31 U.S.C. 3727, 41 U.S.C. 6305 (hereafter referred to as "theAct"), may assign its rights to be paid amounts due or tobecome due as a result of the performance of this contract to abank, trust company, or other financing institution, including anyFederal lending agency. The assignee under such an assignment maythereafter further assign or reassign its right under the originalassignment to any type of financing institution described in thepreceding sentence.

This right is permissive, meaning the lessor has the right toassign its rents at its discretion, provided such assignment is acomplete assignment and is to a "bank, trust company, or otherfinancing institution." Notably, the government does not havethe right to refuse such a request, provided the assignee meets thecriteria outlined in the clause. The statute provides that "anassignment under this subsection is a valid assignment for allpurposes." 41 U.S.C. § 6305(b)(7).

GSA publishes a Leasing Desk Guide (LDG) that "containsauthorities, policies, technical and procedural guides, andadministrative limitations governing the acquisition by lease ofreal property" and that "appl[ies] to all PBS personnelengaged in the acquisition and administration of leasecontracts." Id. The LDG also "applies toagencies leasing space under delegated authority from the GeneralServices Administration (GSA)." This guide provides as followswith respect to the mechanics of assigning claims under GSAleases:

Note that the lease should not designate a differentpayee, except under rare circ*mstances where the lessor hasdesignated a different payee through an Assignment ofClaims. In such an instance, a Lease Amendment isnecessary to process a change in payee. Such a change must bedocumented through a Lease Amendment, along with the executedAssignment of Clams.¹⁰

In its LDG, GSA also provides a proposed subordination,nondisturbance and attornment (SNDA) agreement that addressesassignments of claims and rental payments, and this templateconfirms that the government will not recognize the lender as thepayee until and unless the lessor and the government execute alease amendment memorializing the assignment:

In accordance with Paragraph __ of the General Clauses of theLease, Assignment of Claims, (48 C.F.R. 52.232-23) the Lessor mayassign its rights to be paid to the Lender. Following suchassignment, to be made in accordance with the Assignment of ClaimsAct, as amended, 31 USC 3727, and following the execution of aSupplemental Lease Agreement changing the named Payee in the Lease,the Lessee shall pay all rent and all additional rent to theLender. Such assignment shall not be deemed to (a) cause the Lenderto succeed to or to assume any obligations or responsibilities asthe landlord under the Lease, all of which shall continue to beperformed and discharged solely by the Landlord, or (b) relieveLandlord of any obligations under the Lease.¹¹

Finally, note that an assignment of claims does not allow thelandlord and lender to avoid one of the more onerous obligationsfor government landlords: the SAM.gov registration. The FAR clausegoverning SAM registrations – 48 C.F.R. § 52.204-13,which is included in the General Clauses of GSA leases –provides that "Assignees [of claims] shall be separatelyregistered in the SAM." Just as with more traditionalnovations, as a best practice, lenders anticipating either anassignment of claims or attornment (or both) should begin their SAMregistrations sooner than later, as these can take several weeks tocomplete.

For distressed assets, there are a number of additionalconsiderations that lessors and lenders should take into account.First, establishing the correct assignee may be difficult forassets in foreclosure, governed by receivership or under a specialservicer arrangement; understanding the relationship and the orderof precedence of the various stakeholders is key. Second, a lessorthat is in default or has ceased functioning as a viable businessmay not be a willing participant in an assignment, in which caselenders should consider their rights to attornment, laid outbelow.

Attornment

For lenders seeking to foreclose or to obtain a deed in lieu offoreclosure, there is a third option for recognition as thelandlord: attornment. However, while government leases typicallyinclude a provision governing attornment (explained below),it's extremely rare to see the government take advantage ofthis option and treat lenders as the landlord without furtheraction. Accordingly, lessors and lenders should not expect a simpleattornment process and should instead plan on a traditionalnovation, albeit with some tailoring to address the uniquecirc*mstances surrounding the change in title.

First, most government leases¹² include a provisiongoverning SNDAs¹³ that provides as follows:

In the event of any sale of the premises or any portion thereofby foreclosure of the lien of any such mortgage, deed of trust orother security instrument, or the giving of a deed in lieu offoreclosure, the Government will be deemed to have attorned to anypurchaser, purchasers, transferee or transferees of the premises orany portion thereof and its or their successors and assigns, andany such purchasers and transferees will be deemed to have assumedall obligations of the Lessor under this lease, so as to establishdirect privity of estate and contract between Government and suchpurchasers or transferees, with the same force, effect and relativepriority in time and right as if the lease had initially beenentered into between such purchasers or transferees and theGovernment; provided, further, that the Contracting Officer andsuch purchasers or transferees shall, with reasonable promptnessfollowing any such sale or deed delivery in lieu of foreclosure,execute all such revisions to this lease, or other writings, asshall be necessary to document the foregoing relationship.

As a practical matter, the requirement that "transfereesshall ... execute all such revisions to this lease, or otherwritings, as shall be necessary to document the foregoingrelationship" typically means that lenders seeking attornmentor purchasers at a foreclosure sale will have to go through thenovation process outlined above.

GSA's LDG confirms that the government will likely seek toeffectuate a novation as part of the attornment process. In Chapter17, it provides a draft SNDA agreement that states:

If the Lender forecloses the Loan or acquires title to the RealProperty by deed in lieu of foreclosure, or in any other mannersucceeds to the interest of the Lessor under the Lease, or if theLender shall take possession of the Leased Premises, the Lesseeshall attorn to the Lender as its Landlord under all of the terms,covenants, and conditions of the Lease for the balance of the termthereof remaining and any extensions thereof which may be effectedin accordance with any option therefore as set forth in the Lease,with the same force and effect as if the Lender were the Lessorunder the Lease. Such attornment shall be effective andself-operative immediately upon the Lender's succeeding to theinterest of the Lessor, whereupon the Lessee shall recognize theLender, or any person claiming by through or under the Lender(immediate or remote), as the lessor under the Lease without theexecution of any further instruments on the part of any of theparties hereto. The Lease shall at all times continue in full forceand effect, and the respective rights and obligations of the Lesseeand the Lender upon such attornment shall be governed by the Lease.However, the Lessee agrees to execute, acknowledge, and or deliverto Lender any certificate or other instrument that Lenderreasonably requests to confirm such attornment. Likewise,the Lender agrees to execute a Novation Agreement in theform required by FAR Part 42.12.

LDG, Ch. 17, Attachment 4 (emphasis added)

For distressed assets, the process can become more complicated.Specifically, nonfunctioning or defaulting lessors may be unable orunwilling to participate in the novation process or to execute thenovation agreement, which typically requires commitments from boththe current owner and prospective owner. Effective outreach to GSAcontracting officers and counsel is vital in these cases, becauseit involves deviating from regulatory requirements and leaseprovisions.

Conclusion and Takeaways

The first and most important takeaway for exercising rights inconnection with a distressed asset under a GSA lease is tounderstand those rights and the obligations that come with them.While these rights differ dramatically from typical commercialleases, there are nonetheless a number of powerful protectionsavailable for lessors and lenders.

Next, early and effective engagement with GSA will typicallyyield better outcomes. Once the parties identify a need for anassignment or an attornment, they should consider an immediateoutreach to the contracting officer and – when appropriate– regional counsel.

Distressed assets present a number of unique challenges, butultimately, those challenges have no impact upon the lessor'sand lender's rights under the terms of GSA leases.

Footnotes

1. OMB Agency-Wide Capital Planning Memorandum No.M-22-14.

2. "The general rule is that 'an implied duty tovacate is an inherent part of every fixed term lease agreementunless the parties explicitly express an intention to thecontrary.'" Allenfield Assocs. v. United States,40 Fed. Cl. 471, 486 (1998) (quoting Prudential Ins. Co. of Am.v. United States, 801 F.2d. 1295, 1298-99 (Fed. Cir. 1986)cert. denied, 107 S.Ct. 1289 (1987)). For such a breach,the landlord's damages are calculated as the fair market rentalvalue minus the rent actually paid. Cafritz Co. v. GSA,GSBCA No. 13525-REM, 98-2 BCA ¶ 29,936 (Aug. 3, 1998). Inorder to bring a suit against the government to recover thesedamages, lessors must adhere to the requirements of the ContractDisputes Act, discussed in Part I.

3. For many lessors, this remedy will not provideadequate redress, particularly in situations where the lessor seeksto either empty the building and redevelop the property or has afollow-on tenant waiting for the government to vacate the premises.Damages stemming from the lost opportunity for follow-on leases orredevelopment are called "consequential" damages, and itis difficult to recover these damages under applicable U.S. Courtof Appeals for the Federal Circuit precedent.

4. One concession lessors should consider is a one-timeescalation of operating costs. Government leases typically escalatethe operating costs portion of the rent using a Consumer PriceIndex (CPI) multiplier from the U.S. Department of Labor'sBureau of Labor Statistics. This multiplier has not kept up withthe pace of inflation of operating costs in the years following theCOVID-19 pandemic. Specifically, energy costs in many markets haverisen at a rate that exceeded the historical CPI multiplier, oftendramatically. In light of this, the government may agree to anescalation in these costs, which will benefit lessors due to thecontinuing annual escalation of these costs.

5. 41 U.S.C. § 6305.

6. For previous discussed the novation process in detailin partnership with LexisNexis, see Holland & Knight's previous guidance.

7. The standard GSA lease form L100 incorporates thisportion of the FAR by reference.

8. While the standard GSA Lease form L100 expresslyincorporates FAR Part 42.1204 in the "Change ofOwnership" section, in practice GSA has adopted a NovationChecklist with an abbreviated set of deliverables that is moretailored to real estate transactions.

9. The FAR does not generally apply to leaseholdacquisition (see 48 C.F.R. § 570.101(d)), but governmentleases will often expressly incorporate FAR clauses that implementapplicable statutory mandates, such as this one.

10. LDG, Ch. 17 at 17-25 (emphasis in original). The LDGalso notes that "Regional counsel must be consulted prior toprocessing an Assignment of Claims." Id.

11. Id. at Attachment 4. This is not a lease orstatutory requirement, but rather an internal GSA policy. As notedabove, the statute expressly provides that "an assignmentunder this subsection is a valid assignment for all purposes"provided it meets the statutory requirements in 41 U.S.C. §6305(b)(6)).

12. The language cited herein governing SNDAs comes fromthe GSA Form 3517B – General Clauses. TheGSA serves as the procuring agency for most of the federalgovernment's commercial office space leasing needs, as itpossesses the statutory authority to enter into leases with termsof up to 20 years, while most other government agencies may onlyenter lease subject to annual appropriations, which has thepractical effect of forcing other agencies into one-year leaseterms with multiple one-year renewal options. Compare 40 U.S.C. § 585(b) (providing that the GSAadministrator may enter into leases of up to 20 years) with 31 U.S.C. § 1341 (limiting the obligationof funds to existing (annual) appropriations).

13. The General Clause language governing SNDAs alsoprovides that "[i]t is the intention of the parties that thisprovision shall be self-operative and that no further instrumentshall be required to effect the present or subsequent subordinationof this lease." However, the government also commits toexecuting other "reasonable" instruments upon request bythe lessor and lender:

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.