Establishing Fair Market Rent Through Arbitration

By Scott R. Lippert, Esq.

In the commercial lease context, it can be difficult to reach an agreement concerning the methodology for arriving at the amount of base rent for any extensions of the term.  There are several different approaches:  there can be a stated, fixed amount; an amount derived by formula (e.g. CPI increases); or an amount derived by an appraisal process, frequently referred to as “fair rental value”.  In the first two instances, the drafting should be pretty straight-forward.  It is in the last instance where the parties have room to disagree about the process for resolving conflicting appraisals.

Frequently, the language in the lease will require either that the landlord propose the new base rent during the extended term, or that the landlord obtain an appraisal report from a qualified appraiser, stating the proposed rent.  The tenant would then be given the opportunity to dispute the landlord’s position with the tenant’s own appraisal.  The point of contention then becomes how to resolve the difference, if any, between the respective positions of landlord and tenant.

Some clauses provide for an averaging of the two positions if they are within a certain range, say within 5% or 10% of each other.  If not within that range, or if the parties prefer not to provide for averaging, generally a third appraisal is then required, which will be binding upon the parties.  The third appraiser may or may not be aware of the other appraisals. 

There is another approach, one which has been around for a while, which in my experience has recently come into vogue.  It is called “Baseball Arbitration”.  Baseball Arbitration requires each party to submit its number to a neutral, and the neutral’s charge is to pick one number or the other.  The neutral either comes up with his own figure without knowing the figures of the parties and the figure closer to the neutral’s figure will prevail (“night baseball arbitration”) or the neutral is made aware of each party’s figure and picks one or the other.  No averaging, nothing in between.  The theory is that, out of fear that the other side’s number will be chosen, the parties will each submit a reasonable number, within the midrange of possible outcomes.  There’s no point in submitting an outlier, since it is not likely to prevail, or at least so the thinking goes.

This, I believe, is risky business and it surprises me that business people are proponents of this device.  It is unlikely that the three appraiser process will lead to a result that is not within the range of reasonable outcomes.  In contrast, with baseball arbitration, one of the parties could really get hurt.  Chances are the parties will have done some negotiating before reaching an impasse and seeking arbitration.  If the parties are wildly far apart, baseball arbitration seems very risky, as they will likely be more entrenched at that point, in their respective positions.  To reduce the likelihood of a disastrous result, my advice is to stay away from baseball arbitration when establishing fair rental value.

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