Real property leases often include provisions requiring the lessee (tenant) to rebuild if the building is destroyed for any reason. In most cases, the tenant will take out insurance to cover any potential losses. But what happens when a property is destroyed through the negligence or intentional act of a third party? Is the negligent party liable to the lessee for the cost of replacing the entire building?
Under New York law, “the proper measure of damages for permanent injury to real property is the lesser of the decline in market value and the cost of restoration.” In other words, when property is damaged, the owner is entitled to compensation for the loss of value. The tortfeasor is only required to pay damages sufficient to compensate for that loss in market value. In some cases, that may be less than the full cost to restore or rebuild the property.
Continuing Litigation Over the September 11 Attacks
A federal appeals court recently addressed perhaps the most famous (and tragic) case of property loss in New York history—the destruction of the World Trade Center in the September 11 terrorist attacks. Five months before the attacks, the Port Authority of New York and New Jersey, the World Trade Center's owner, signed a 99-year lease for 1, 2, 4, and 5 World Trade Center with World Trade Center Properties, LLC (WTCP). Another company, 7WTCo., held a 99-year lease for 7 World Trade Center which was signed in 1987. All five buildings were completely destroyed in the attack.
Both leaseholders were required to “rebuild, restore, repair, and replace” any buildings destroyed at their expense. Consequently, as the U.S. Second Circuit Court of Appeals observed, “The September 11th attacks were a financial catastrophe” for the leaseholders. Not only were they liable for rebuilding the entire World Trade Center site, they incurred additional costs in “pursuing insurance claims, replacing tenant improvements, retenanting the buildings, and paying mortgage carrying costs.”
The buildings, of course, were insured, and after several years of litigation, WTCP recovered just over $4 billion from its insurers, while 7WTCo recovered $829 million. These amounts were designed to compensate the leaseholders for all of their claims, not just costs incurred in rebuilding the World Trade Center site.
Meanwhile, in 2004, the two leaseholders sued a number of airlines and airport security contractors, claiming their “negligent maintenance of airport security checkpoints” were a proximate cause of the September 11 attacks. Although the lawsuit was brought under federal law, the courts applied the “substantive” tort law of New York. The leaseholders argued they were entitled to compensation for the full replacement cost of the World Trade Center buildings.
The defendants counter-argued they could only be held liable under New York law for the “diminution in the fair market value” of the plaintiff's leases. In the case of WTCP, they said that was only about $2.8 billion, or the amount of rent it owed to the Port Authority. Since WTCP already received far more than $2.8 billion from its insurer, the defendants said they would not owe any damages even if they were held responsible for the September 11 attacks.
The courts sided with the defendants on this issue. In a September 17opinion, the Second Circuit noted the fact the leaseholders incurred higher costs due to their contractual obligation to rebuild the World Trade Center site “do not alter the measure of their potential tort recoveries.” Nor was the court persuaded by the leaseholders' argument they were entitled to the full replacement cost due to the “unique public benefit” provided by the World Trade Center. The appeals court left it to a trial judge to perform a revised calculation of the leaseholders’ loss of value to ascertain whether the defendants may still be liable for any damages beyond what insurance covered.
Need Help With a Lease?If you are involved in any type of lease negotiations, it is important to understand the potential impact a catastrophic event may have on your rights and obligations to the other party. An experienced New York real estate attorney can advise you on this and other lease-related matters. Contact the offices of Waldhauser & Nisar, LLP, today if you would like to speak with someone right away.