Y2K CRISIS? NOT IF THE TENANT AND LANDLORD ARE PREPARED

By Ted Simpson

Everyone is talking about what will happen when January 1, 2000, comes, and you happen to be on the 47th floor of a high-rise building. However, if proper precautions are taken, these fears should not be an issue.

Y2K Office Building Basics

Office buildings provide some of the most dreadful Y2K forecasts, because almost all of an office building's operations rely upon date-sensitive data. In particular, equipment with embedded chips presents an enigma, because the software is contained within the hardware and typically cannot be reprogrammed. Additionally, the Y2K problem is compounded because of the significant interdependence that office buildings have on third-party suppliers and service providers. Imagine the following:

* The building's air conditioning system drops the temperature to 40 degrees.

* The elevators stall between floors.

* Card keys are gobbled up like stolen ATM cards.

* Janitorial service is shutdown.

* Access to computer-locked telephone/computer closets is denied.

* Bills are generated for 95 years of back rent.

* The computer concludes that the lease is nonexistent.

What a Tenant Should Do

Most likely, if your company leases space in Class A office towers, you won't be sitting in your office on January 1, 2000, with the lights off. However, there are certain steps tenants should take to ensure that landlords take the proper Y2K precautions.

1) Obtain a copy of the landlord's plan to minimize or eliminate the effects of Y2K issues. Generally, it is the landlord's obligation to maintain the building. Thus, the landlord is responsible for the building's Y2K compliance.

If you are negotiating a new lease or re-negotiating an old one, you should request the landlord to represent that it has taken or will take the following steps before a specific date:

* Designate a Y2K manager for the building.

* Inventory all embedded systems.

* Contact the suppliers of the embedded systems to ensure their viability.

* Identify solutions for handling any malfunctions.

* Test the building during after-hours to determine the functionality of the system in a test Y2K setting.

* Determine the landlord's insurance coverage for a Y2K shut-down.

2) Identify which systems are your responsibility. Equipment that was purchased or installed by the tenant, or that is under the tenant's control, generally is considered to be the tenant's responsibility. You, the tenant, should review these systems to determine to what extent they use embedded chips and whether they are likely to shut down on January 1, 2000. If you have such concerns, contact your supplier and try to identify solutions for the potential failure of these systems.

3) Know who is responsible for Y2K building compliance costs. The majority of leases are silent as to whether Y2K preparatory costs and remedial costs will be included or excluded as an operating expense pass-through. In new leases, this issue is negotiable, and the outcome will depend upon the leverage of each party. With respect to existing leases, the ability of landlords to pass through these costs will most likely be decided in post-Y2K litigation.

4) Know who covers losses resulting from Y2K problems. A very important question to be researched in existing leases and carefully drafted in new leases is the remedy for the tenant in the case of an interruption in building services. If an investment banking tenant is locked out of its suite because of Y2K failures and loses a multi-million dollar trading opportunity, how are costs allocable?

This question is best addressed with an in-depth review of the business interruption clauses in the parties' insurance policies. It is important to pay particular attention to coverage of Y2K losses and the Force Majeure provisions of such policies. Insurance carriers in forty-six states have been granted permission to deny claims for business losses related to Y2K problems. It is important that the landlord contacts its insurance carrier to determine its stance on Y2K costs.

In new leases, a tenant should require its landlord to indemnify it from losses associated with Y2K, including consequential damages. Also, the tenant should demand rent abatement and termination rights in the Interruption of Services clause.

The Year 2000 Information and Readiness Disclosure Act (Public Law 105-271) protects office building owners' good-faith disclosure of Y2K plans and activities to tenants. This law says that a tenant may not sue the owner for a good-faith statement regarding the compliance of a building system that turns out to be false. Should the landlord fail to provide sufficient evidence of a plan, you should inform the landlord of the increased liability it may face and request immediate action.

The act does not protect owners from lawsuits based on violations of lease terms that require a landlord to provide uninterrupted services for the tenant.

5) Find out if suppliers and vendors are Y2K compliant. Many landlords depend upon third-party providers for security, janitorial, and other similar services. The landlord should ascertain what their suppliers and vendors are doing to avoid potential Y2K problems and, if possible, obtain warranties from them with respect to their Y2K compliance.

6) Regulated tenants must get a landlord's Y2K compliance certificate. Tenants should request this certification of their landlord as soon as the regulatory body requests it. Not all buildings will be compliant, and therefore some negotiating and mediation between your landlord and the regulators may be necessary. The negotiations may be lengthy, so plan accordingly.

Over the past decade, real estate professionals have successfully navigated a range of challenges (The Americans with Disabilities Act, the phaseout of chlorofluorocabons, and the deregulation of the telecommunications industry). The Y2K problem is no bigger an issue than these and can be managed with a well-defined action plan. However, it might take a motivated, well-informed tenant to push its landlord into properly handling the millennium bug. *

Ted Simpson is a member of the Special Projects Team at Cushman Realty Corporation (CRC) in Los Angeles, specializing in corporate representation. Established in 1978, CRC is a privately-held commercial real estate brokerage company operating in 11 offices nationwide.

Editor:
James L. Craig, Jr., CPA
The CPA Journal

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