Legal Issues in Leasing Transactions for Landowners and Farmers

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1 Legal Issues in Leasing Transactions for Landowners and Farmers 1 There are many legal issues that may arise when a landowner leases land to a farmer. Farmland leasing is unique from any other type of leasing. When leasing farmland, both parties must have an understanding of the characteristics of the land, the activities that have occurred there in the past, the activities currently occurring there, and the activities that the new farmer intends to perform when he or she takes over the land. There are basic contract clauses that are almost always included in a lease. In addition, there are other clauses that each party may consider including. The parties, landowner and farmer, are able to decide which terms are in the lease and how much detail the lease will contain about each term. The lease is a legally binding contract that governs the relationship between the parties and can be used in the event that a dispute arises. All parties must be sure that they understand and are comfortable with all of the terms in the lease. The terms of a lease are all of the clauses that record the agreements that have been made. The following list of frequently asked questions and answers is intended to introduce you to legal leasing issues, provide general information, and help prepare you to discuss them with an attorney. Only your attorney can advise you about your specific concerns and issues regarding your leasing transaction. The following research and FAQ was provided by Christine Arena, Rachel Rivers and Ross Pifer, all of the Rural Economic Development Council, The Dickinson School of Law, Pennsylvania State University. It was created expressly for PASA (Pennsylvania Association for Sustainable Agriculture) in What is a lease? Frequently Asked Questions and Answers General Lease Questions A lease is a legally binding contract between two or more parties. A party is someone who signs the lease. In a lease for farmland, the parties are generally the landowner(s) and the farmer/tenant(s). A lease is used when a landowner contracts to allow a tenant to use the land, but the landowner does not transfer ownership of the land. A lease is not used for a sale of land. Does the lease need to be in writing? Depending on state law, a lease of a year or more may be required to be in writing. Even when a written lease is not required there are many advantages to having it in writing. Why should I have a written lease? A written lease offers many protections for the parties. It records the obligations and rights of each party, which is helpful if a dispute later arises. For example, it may be beneficial for the landowner to include in the lease if he bears the burden of maintaining the water source. That way, if an issue arises, he knows he is responsible to make the repairs. The same applies conversely; if the lease states that the tenant/farmer is responsible for maintaining the water source, the landowner knows the tenant/farmer is responsible to act should a maintenance issue arise, and will breach the lease

2 2 otherwise. If such a term were only made orally, it may be hard to determine who is responsible, which can be time consuming and troublesome. Additionally, a written lease will be more persuasive in court. Who should sign the lease? Those who will be bound by the lease should sign it. Those who sign assume obligations and rights under the lease. If a husband and wife jointly own the land both should sign the lease. If the land is owned by just one person then only that person needs to sign the lease. For the farmer/tenant, if a couple is leasing the land, both parties may sign the lease, or just one. Even if one spouse does not jointly own the land or intend to work the land, it is advisable that both spouses sign. It is important to realize that each person who signs is obligated under the lease. What should be included in the lease? The lease should include clear descriptions of all real and personal property that is being leased. Real property is land and structures that are permanently affixed to the land, such as buildings with foundations and fixtures. Personal property is property which is not permanent to the land, such as machinery, equipment, and tools. Examples of personal property that should be included in the lease if the tenant/farmer is allowed to use them are tractors, combines, and other farming equipment. Anything on or near the property that the tenant is not free to use should be explicitly excluded from the lease. The water source also should be included in the lease, as it is important to determine who is responsible for providing and maintaining it. What if the farmer and the landowner disagree about what to include in the lease? As with any agreement, bargaining is required when drafting the lease, and therefore, some desired arrangements might have to be sacrificed for others. This is all part of negotiating the terms that work best for both parties. For example, the farmer/tenant may want to use a shed located on the property, but the landowner may not want the farmer/tenant to use it. If the use of the shed was very important to the farmer/tenant, and maybe even a "make or break" term for him, the landowner may choose to compromise. It is important to speak with your attorney about which terms you are willing to negotiate on and which are "make or break" for you. If the parties cannot agree on a specific issue, avoiding the issue is not the best way to handle it. Failing to address the issue in the lease can lead to more ambiguity. The lease should be as clear as possible about what the terms are, including what is prohibited. Who are the parties to a lease? Questions about Lease Clauses The parties to a lease are those people who will be bound by the terms of the lease. All parties must sign the lease. Those who sign assume obligations and rights under the lease. What is a description of the leased property? The description of the leased property should include the exact location of the land, the acreage of the land, and all buildings, machinery, and water sources that are included in the lease. The

3 3 description of the leased property clause is the place to list everything that the lease includes. It may also be a good place to list everything that is explicitly excluded from the lease. For instance, if there is a barn on the property that the landowner intends to retain control of and does not want the tenant to use, it would be wise to explicitly state this restriction in the description of the land. If the exclusions are many, consider making a separate section in the lease to record them. The description of the land should reference any official documents referencing the property that are recorded, such as a deed, land survey, etc. What is a fixture? A fixture is something permanently affixed to the land or to any permanent structures on the land. For instance, a furnace or hot water heater may be fixtures because they cannot easily be removed but are affixed to the land or to a permanent structure on the land, such as a home. Generally, the tenant will be allowed use of all fixtures. If it is unclear whether something is a fixture, it should be addressed in the lease whether it is included in the lease. What does it mean for something to "run with the land"? When something runs with the land it is permanently part of the title (ownership) to real property. The land may be subject to restrictions, such as for utility lines or access roads. You may consider running a title search or speaking with an attorney to check for such easements that "run with the land" because they may have an impact on you. What is a payment term? A payment term describes how much compensation (rent) the tenant will pay to the landowner, when payment must be made, including how often, what form the payment should take, i.e. cash or check, and what happens if it is not paid or not paid on time. What details should I consider including about a payment term? You should consider including the date by which payment is due, amount due at that time, where and to whom payment should be made, the proper form of payment (cash, check, etc.), and any penalties for late payment. Why are payment terms important? It is important to describe the payment terms so that all parties clearly understand how much rent is to be paid, when it is to be paid, how it is to be paid and what happens if it is not paid. If an issue involving any of these agreements arises, the parties can turn to the lease to clarify any discrepancies. What options are there for the duration of the lease? A lease can be for a term of years or for a periodic tenancy. A term of years (also know as a fixedterm tenancy) lasts for a specific period of time, such as a year or five years. A periodic tenancy is a month-to-month or a year-to-year lease that automatically continuously renews. With a periodic tenancy, the lease is terminated when either party provides written notification of termination within the notice period that the parties previously agreed upon. For example, if the lease is a year-to-year periodic tenancy, it will automatically renew for another year unless one party gives written notice that

4 he intends for the lease to be terminated. If the parties agree upon a periodic tenancy it is important to determine how and when notice should be given to end the lease. 4 I am a farmer/tenant. Why is the duration of the lease important to me? The farmer/tenant will invest a lot of resources, including money and energy into the land. In order to protect his investment, the farmer must ensure he will have adequate access to the land. It is important the farmer know what crops will be planted and harvested before entering the lease so he can better determine for how long he will need to lease the land and the duration of possible investments he intends to make in the land. This determination will enable the farmer to establish a timeline for his investment and better ensure that he does not under or over-commit in the duration of the lease. The landowner should seek to find a balance between over-committing to leasing the land and leasing the land for enough time to see the value of any improvements and investments made in the land. I am a landowner. Why is the duration of the lease important to me? The ultimate goal for the landowner is that the land will be in good condition when the landowner regains control of it. The landowner may desire that it be in the same condition as when it was leased, or in better condition than it was in when the lease began. Therefore, it is also in the landowner's interest that the farmer lease the land for a long enough period of time that the farmer finds it beneficial to invest and improve the land. As with the farmer, it is important for the landowner to balance over-committing the land with allowing enough time for the land to be properly worked. How can the lease be renewed or extended? If a lease is a periodic tenancy (i.e. month-to-month) it will automatically renew unless either of the parties issues proper written notice of termination. If a lease is a fixed tenancy (i.e. three years long) the lease does not automatically renew. The lease can instead be extended, although technically, the extension may constitute a "new" lease since by definition the first lease ends after the fixed period of time. The original lease can provide conditions for the possibility of the new lease, including whether the landowner maintains discretion in allowing the farmer to lease the land again and the amount of advance notice that the landowner requires from the tenant. The new lease is subject to renegotiation and the parties are not automatically bound by the terms of the original lease. If the lease is a fixed term, the parties should consider negotiating the extension or renewal of the lease well in advance of the original leases' termination, i.e. if the lease is for five years, negotiate renewal at year three. This will make the continuation of the lease easier for both parties, and can avoid the stress of waiting until the original lease terminates before negotiating the terms of the following lease. How can the lease be modified after it has been signed? Once the lease has been signed, it can only be changed if all parties agree on the change. Such changes should be recorded in writing and attached to the lease in what is known as an addendum or an amendment to the lease. An addendum is a second document that becomes part of the original lease. Any and all addendums must contain the signatures of all parties who signed the original lease. How do I end the lease early?

5 5 The lease can end early or be terminated before the end of the duration of the lease if both parties mutually agree in writing. However, depending on the language of the lease, it may be considered a breach if only one party wants to end the lease early. For example, a lease with periodic tenancy can be terminated unilaterally (by just one party without the consent of the other). Regardless of whether all parties agree to end the lease early, the parties are still responsible for all actions and breaches that may have occurred before the date of termination. However, if only one party wants to end the lease and breaches it, this allows the other party to also sue for breach of contract and attempt to have the court require the remainder of the lease be honored, either by performance (completion of the lease), or by financial compensation (payment to the non-breaching party). What are the consequences and remedies to each party if the lease is terminated prematurely? If one party chooses to terminate the lease early, without the consent of the other party, he may be subject to consequences for breach of the lease. If a farmer chooses to terminate a lease early, without the agreement of the landowner, the farmer may be liable to the landowner for the remainder of the rent owned on the lease. However, the landowner is required to make attempts to reduce his losses. Therefore, if the landowner is able to release the land and reduce his financial losses, the farmer may only be liable for the financial losses actually suffered by the landowner. If the landowner chooses to terminate the lease early without the agreement of the farmer, he may be liable for the financial losses suffered by the farmer. If the farmer has invested in improvements to the land or has planted crops awaiting harvest, the landowner may be liable for the financial investments and the actual losses suffered by the farmer. What is a breach? A breach is when one party violates the terms of the lease. Breaches include failure to pay specified amount of rent on time, failure to maintain the premises as promised in the lease, etc. Certain breaches may be minor and easily fixed, whereas other breaches may not be able to be fixed. What are ways a farmer might breach a lease? Examples of ways a farmer may breach the lease include failure to pay specified amount of rent on time, failure to maintain property as promised in the lease, improper use of the land, etc. A breach is basically a departure from an agreed upon course of action within the lease. Breaches will vary depending on the terms of the particular lease. What are ways a landowner might breach a lease? Examples of ways a landowner may beach the lease include improper or unauthorized entry in to the land, failure to provide an agreed upon resource, such as electricity or water, denying access to the land, etc. A breach is basically a departure from an agreed upon course of action within the lease. Breaches will vary depending on the terms of the particular lease. What are the consequences and remedies available to each party in the event of a breach? The consequences for a breach of the lease vary depending on the language of the lease and the

6 6 specifics of the breach. Many different actions can cause a breach, and so the nature of the breach determines the consequences and potential remedies for the breach. A breach occurs when a term of the lease is violated. Examples of breach include failure to pay the amount of rent at the time and in the manner that the lease states, improper use of the land, improper entry on to the land, and failure to maintain the property. Depending on the terms of the lease, some breaches can be cured without the lease being terminated, if both parties mutually agree to a solution. However, in some situations the breach is so severe and/or the parties cannot agree on a solution that the lease will terminate early. Even if the lease is breached and terminated the parties are still responsible for all actions and breaches that may have occurred before the date of termination. However, the breach that causes the lease to terminate may also give the other, non-breaching, party cause to sue for breach of contract. How should we handle a dispute if we do not want to go to court? The parties may choose to include a method of dispute resolution in the lease. The parties may choose to have the dispute arbitrated or mediated. Many times, the parties will attempt to resolve the issue amongst themselves by discussing and compromising. What is arbitration? Arbitration is a means of solving disputes between the parties. A standard arbitration term is "Any differences between the parties as to their rights and obligations under this lease that are not settled by mutual agreement after thorough discussion, shall be submitted for arbitration to a committee of three disinterested persons, one selected by each party hereto and the third by the two thus selected, and the committee's decision shall be accepted by both parties." This standard term can be altered to fit the needs of the parties. What is an improvement to the land? An improvement to the land occurs when one of the parties makes a change to the land that adds value. Improvements to the land include, but are not limited to, building new structures, repairing existing structures, and revitalizing or improving soil conditions. Who pays for the improvement? If a farmer makes an improvement to the land he bears the cost of the improvement unless otherwise provided in the lease. However, in some circumstances, depending on the language of the lease, the farmer may be able to receive some compensation or credit for improvements. Such an agreement also benefits the landowner because it encourages the farmer to make beneficial improvements. The farmer is more likely to make improvements when he knows he will receive a full return on the investment. The lease may also prohibit certain improvements from being made. If a structure is built on the land, who does it belong to after the lease ends? The tenant should seek written agreement from the landlord before constructing any structures on the leased property. If the tenant builds a structure without the landlord's consent, the tenant may be required to remove the structure at the termination of the lease at his own expense. If the landlord wants to keep the improvement, but the tenant wishes to remove it and the tenant financed it, the tenant may remove it as long as the property is left in the same condition as it was before the lease commenced.

7 What is waste? 7 Waste is that which adds no value or detracts from the value of the land, such as destroying, altering, or removing buildings. Waste can result from misuse of the land, degradation of the soil, actual waste or garbage left on the property, etc. The party who creates the waste may be liable (responsible) for doing so, depending on the language of the lease. I am a farmer. Why am I concerned with waste? A farmer may face legal or financial consequences if she commits waste on the property. The farmer also has an interest in maintaining the integrity of the land should she wish to extend or renew the lease. I am a landowner. Why am I concerned with waste? A landowner has a reversionary possessory interest in the land, and therefore may be entitled to damages as a result of waste. A reversionary interest is an interest one has in the land when the current use expires. In the case of a lease, the landowner has an interest in the condition of the land because he will regain possession of it when the lease terminates. If waste is committed on the land, it may be more difficult for the landowner to release the land or receive market value on a lease because the quality of the land has been degraded. How can I address waste in the lease? The parties may choose to address waste directly in the lease by defining what is considered waste, the penalties for committing waste, and who will be responsible for fixing the issues caused by the waste. What is a sublease? A sublease is when a tenant/farmer, or party leasing land from a landowner, leases the land to a third party. The third party is not a party to the lease between the landowner and the tenant, but instead becomes a party to a new lease with the tenant. Generally, the tenant remains liable to the landowner for any damage to the property. Can the land be subleased? The terms of the lease determine whether to allow subleasing. It is very common for leases to explicitly forbid subleasing. Many landowners are not comfortable with the tenant leasing to a party whom the landowner has not met. Liability Who is responsible if someone gets hurt on the land? Both landowner and farmer may be liable if someone gets hurt on the land. Many factors are important in determining who is responsible, including but not limited to why the injured person was on the land, what they were doing when they were injured, who had the ability to prevent the injury, and the age of the injured person.

8 What can I do to reduce my liability pertaining to if someone gets hurt on the land? 8 There are several different ways to reduce liability, including: (1) limit the activities that can be conducted on the land, (2) inspect the premises and alleviate any dangers, and (3) require waivers from people entering the land. Another way to be protected is to purchase adequate insurance in case someone is hurt. Insurance Who is responsible for providing insurance for the land? It may be necessary for the farmer to carry general liability insurance, with the landowner listed as the additional insured. The parties may negotiate insurance coverage and determine which party will carry insurance. A landowner may require proof of insurance on the part of the farmer if the parties agree the farmer will carry insurance. It is important to consult an insurance agent to ensure sufficient coverage. I am the farmer. The landowner already has basic insurance for the land. Should I get more insurance? The parties should address what insurance the landowner already carries and what types of insurance are necessary for the expected use of the land. If the farmer is not satisfied with the current coverage, he or she may want to consider purchasing more coverage. It may be prudent to have "double coverage" where both the landowner and the farmer carry liability insurance. Each party has its own interests that need to be protected. What types of insurance should I consider? Types of insurance the parties may want to consider carrying are: fire, theft, liability, and product insurance. Parties will want to ensure adequate policy coverage for all types of insurance. Other Issues I am the farmer. How do I know to what uses I can put the land? Many farmers may want to use the land in specific ways, for example, run a CSA, process food on the property, hunt, etc. These sorts of activities should be discussed with the landowner and stated in the lease prior to signing. The landowner may want to limit these activities because they may increase liability for the landowner. Many of these uses require additional permits and permissions from state and local government. Who pays the real estate taxes on the land? This is a particularly important issue for the landowner because the landowner will ultimately be held responsible. If the taxes are not paid on time, a lien can be placed on the property. Nonetheless, it is important to specify in the lease which party is responsible for paying the real estate taxes since the responsibility can be shifted.

9 If the land is subject to a government program, such as Clean and Green or a conservation easement, how does that impact me? 9 It is important to know which, if any, government programs the land is subject to. There may be restrictions on how the land can be used that impact the tenant/farmer. How do I know what uses the land is zoned for? It is very important to review the ordinances that apply to the land before signing the lease. You want to make sure that the land is zoned for the purposes that you intend to use it. What types of permits do I need to consider applying for? This answer relies largely on what activities you plan to undertake on the land. A good starting point is to contact the local municipality to inquire as to what permits may be needed. State and local agencies should also be contacted as they may regulate other activities.