Estoppel Certificates Explained
What are Estoppel Certificates?
An estoppel certificate is a device that is used by landlords and by lenders in order to get some certainty as to what their situation is on a property. The lease agreement also should provide for estoppel certificates. It’s one of those terms that nobody understands what it is and people sign it and figure, “Eh, it’s probably not important.”
If you’re a landlord, it’s really important that you include some provision for getting estoppel certificates from your tenants. And that needs to be in your lease. Because as a landlord, there’s a couple of things that you may want to do with that property. You may want to sell a property, you may want to refinance the property, in either case, you are going to be introducing a new party to that property and that party does not know what’s gone on in the premises before they arrived.
Let’s say that you own a strip mall shopping center. You have several tenants in the shopping center and they’re paying the rent and it’s a good investment property. Cash flows. But, for whatever reason, you want to sell it. The buyer is going to come in and the thing that’s going to be attractive to them about your shopping center is its profitability. The way it throws off cash. You’ve got all these tenants that are doing great, paying their rents on time, the rents are nice and high, and it’s really attractive.
However, they’re just taking your word for it. Because they know you, they don’t know those tenants, and they don’t know what’s gone on between you and those tenants. They want some assurance that if they buy the shopping center, that they’re not going to turn around and be faced with a giant lawsuit from the restaurant that’s your anchor tenant in the premises, saying, “Hey, you breached this agreement that we had years ago to put this really expensive, fancy fountain in the parking lot and we were really counting on that because that was going to be a major draw. There was going to be a lot of traffic that would come in as a result of that and we thought some of those people might want to stop by and eat at our restaurant. You promised, you didn’t do it, and now we’re suing you.”
Well, that’s a huge problem for somebody that just came in and bought the property because they didn’t know anything about that promise to build a fountain and they have in fact, succeeded to the obligations of the previous landlord. They now stand in that previous landlord’s shoes. They don’t want to be surprised in that way. They want something from the tenants that says, “We don’t have any secret claims that we’re going to assert against you.”
The landlord can go to his tenants and say, “Hey look, check out our lease. There on page 25 of the lease, that one section you didn’t understand, you just signed it and didn’t get what it meant. It says that you have to give me an estoppel certificate on demand.” The estoppel certificate says, “I’m the tenant and basically, I don’t have any claims against you. Or if I do have any claims, here’s what they are.”
Getting that estoppel certificate allows the landlord to sell the shopping center. He can take that to perspective buyers and say, “Here’s my lease roles, this is how much money I’m making on this building, none of these people have any claims against me, here’s their estoppel certificates, here’s all their lease agreements. As you can see, everybody’s committed for a long period of time, this is a great piece of property for you.” And it’s got a reliable landlord to sell the property. Without that, the landlord may not be able to sell the property at all, or if they are able to sell the property, there’s going to be some risk to the buyer that they’re not going to be able to mitigate against. They’re not going to be able to get as much in terms of a purchase price for the sale of that property. It’s tremendous advantage to the landlord to have a provision that allows the landlord to receive an estoppel certificates from commercial tenants.
The landlord may also want to refinance its loan on the property. Perhaps the property was acquired at a time where interest rates were very high, so the landlord is paying 7% interest on this property. But now the landlord can refinance his property for 4 1/2 and that’s a huge difference to the landlord in terms of their profitability in this investment. But the bank is not going to, just like the buyer of the property, the bank doesn’t want to have its security on the property, the shopping center, potentially subject to claims by disgruntled tenants who’ve got secret claims. Estoppel certificates are very valuable for landlords that are interested in refinancing their property or in selling their property.