Negotiate Use of One Experienced Arbitrator for Extension Option Disputes
“Alternative dispute resolution” (ADR) methods, including arbitration, are often used by commercial real estate owners to resolve differences with tenants out of court. Arbitration is a great solution for parties who are in disagreement about a single, clear-cut issue. Common, but potentially costly, issues like renewals and extensions are well suited to arbitration.
That’s why many leases provide that if the parties can’t agree on a renewal or extension rent, then that rent is to be determined by three arbitrators. The process works by each side picking one arbitrator, and the two arbitrators picking a third.
But a three-arbitrator arrangement to settle a dispute can be detrimental to owners. Avoid this scenario by carving out the right to use a single arbitrator for renewal or extension rent disputes.
ADR Expense Cautionary Tale
The main reason why you should negotiate to scale back to one arbitrator, rather than a three-person panel, is cost. Using three arbitrators for a dispute is just too expensive—and unnecessary. Take a 1,500 square foot space, for example. Let’s say the tenant is paying $18 per square foot per year, and the owner has indicated that it wants $25 per square foot per year during the renewal/extension term. If the parties don’t agree and under the lease three arbitrators are required, costs could spiral out of control. Here’s the cost of choosing three arbitrators, assuming that each arbitrator is at the rate of $500 per hour and that the arbitration will be for one day, comprising approximately eight hours: The cost for the three arbitrators for that one day arbitration is $12,000 ($500 x 8 = $4,000 x 3 = $12,000).
In addition to this cost, you and the tenant would then generally designate your own counsel, and assuming that counsel’s hourly rate is also approximately $500 per hour, the counsel’s cost for that one-day arbitration would be $8,000 ($500 x 8 = $4,000 x 2 = $8,000).
But the expense of arbitration doesn’t stop there. Each side also has to pick a designated appraiser for the property to determine the fair market rent during the renewal/extension term, and assuming the appraiser’s cost is also $500 per hour, its cost for the day would be $8,000 ($500 x 8 = $4,000 x 2 = $8,000).
In that scenario, the cost for the arbitration for that single day would total $28,000. Even when that amount is divided by two—as the owner and tenant would each pay 50 percent of the arbitration cost—the cost is enormous: $14,000 for each party for that single day of arbitration.
How to Keep Costs Low
When deciding whether to negotiate provisions requiring three arbitrators, consider the possibility that the arbitration could take more than just one day, as many do, reaching into the tens of thousands of dollars. An exception to an unwillingness to spend this kind of money on arbitration would be a scenario where the money involved in the dispute is extremely high.
Instead of spending a fortune on arbitration, lobby to have you and the tenant agree on a single experienced, qualified commercial arbitrator, which will cut down the costs substantially. Ask your attorney to adapt for your situation our Model Lease Clause: Specify Use of Only One Arbitrator to Keep Costs Under Control. And negotiate that both parties pick a single appraiser, who both agree is fair, experienced, and knowledgeable in real estate, which will also cut down the cost of the arbitration even further.
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