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immediately or upon B’s death. If T is a corporate trustee, such as a bank trust department, then the funds can be combined with other trust funds and invested in a portfolio of investments, diversifying risk and improving the expected return. Meanwhile, T is subject to strict duties of honesty, prudence, and other fiduciary duties in the management of the funds (see below), and can be given detailed instructions about how to distribute the funds among S, E, M, and Y, depending on future contingencies. Once again, we can see how the trust overcomes collective action problems in a way that allows for a separation of management authority from other incidents of property and thereby permits a specialization of functions in the use of the property.

• Leasing

Let us give closer consideration to the first of these devices for separating management authority from other incidents of ownership— leasing. Leasing is a very old form of ownership and continues to be used in a wide variety of circumstances. It goes by a variety of names: leasing, leaseholds, renting, tenancies, landlord-tenant relations—all are essentially synonymous. We will refer to the relationship between lessor and lessee as “leasing,” the specific contractual undertaking between the lessor and lessee that governs their relationship as the “lease,” and the property rights the lessee acquires under the lease as the “leasehold.”

The essence of leasing is simple. A property owner—the lessor or landlord—agrees to transfer possession of property to another person—the lessee or tenant—for some time period. In return, the lessee agrees to pay the lessor rent, nearly always at periodic intervals. Leasing is similar to bailments in that it entails a temporary transfer of possession of property. It differs in that the purpose of a lease is to convey full economic use of the transferred item to the transferee, whereas in a bailment, the item is transferred for a limited and specific purpose such as repair or safekeeping. Leasing is

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also similar to the life estate in that the transfer of possession entails temporary but full economic use of the asset. However, the time period in a lease is nearly always described in terms of months and years rather than natural lives as in the case of a life estate.2

Leasing also differs from both the bailment and the life estate in that the transferee agrees to make periodic payments of rent to the transferor. Because the lessor expects to receive rental payments, the lessor is inevitably much more involved in monitoring the behavior of the lessee than is typically the case with someone who has entrusted property to a bailee or who has transferred property in a life estate subject to a reversion. The lessor will want to know, at a minimum, if the lessee has abandoned the property, which would have dire implications for future payment of the rent. Moreover, the lessor is likely to keep an eye out for other signs of trouble, such as prolonged illness or unemployment or a closing of the lessee’s business. In effect, the lessor’s expectation of periodic rental payments will naturally incline the lessor to a more interactive relationship with the lessee than will be the case as between a bailor and a bailee or a life tenant and a holder of a reversion. The continued engagement of the lessor in overseeing the property also allows leasing to be used to achieve a division of functions between lessor and lessee, as previously discussed in connection with the shopping center example.

Leasing covers a wide variety of situations and includes both real and personal property. There are very long so-called ground rent leases of 99 years or more for land on which tenants construct and own their own buildings; leases of agricultural land; leases of commercial space in office buildings or shopping centers; leases of unfurnished houses and apartments; short-term month-to-month

leases of furnished apartments; and leases of computers, automobiles, airplanes, and machinery. The fact that leasing

2.But see Garner v. Gerrish, 473 N.E.2d 223 (N.Y. 1984) (upholding an interest characterized as a lease with a life term and minimizing the distinction between leases and life estates).

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occurs in so many different contexts confirms the great utility of this property form.

Leases are sometimes divided into different types depending on the rules for determining when they terminate. A term of years terminates at a point in time predetermined in the lease. This can be measured in years, months, or even by a particular day. At common law no notice was required by either party to terminate a term of years on the day appointed, although this has been modified in many states by statute. A periodic tenancy rolls over automatically from one time period to the next, unless one of the parties gives notice of termination, usually a month in advance. A tenancy at will continues indefinitely, until one of the parties decides to terminate. At common law no notice was required. Finally, a tenancy at sufferance is created when a tenant holds over after the termination of a lease. Such a tenant has greater rights than a trespasser, but is obviously subject to eviction by whatever procedures the law allows.

Property and Contract

At the heart of every lease is a bilateral exchange: the transfer of possession of some resource, whether it be land, an apartment, or an automobile, for a designated period of time, in return for a promise to pay rent. Leasing thus includes both a contract—the agreement between the lessor and lessee called the lease—and a transfer of possession of the resource that is the subject matter of the lease. In its contractual aspect, leasing affects primarily the relations between the lessor and the lessee. The contractual aspect is in personam, in the sense that it creates personal rights and duties between the lessor and lessee and does not directly impact the rights and duties of third parties.

Yet the interest of the lessee, although grounded in contract, also has the critical features of a property right: The lease transfers possession and full economic use of the resource to the lessee. As is usually the case, the right of possession includes the right to exclude

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others from the property possessed. Absent agreement to the contrary, this includes the right to exclude the lessor. Thus, the lessee acquires primary managerial authority over the thing leased during the term of the lease. The lessee can decide who may or may not enter or use the property, how the property will be used, and so forth. Two caveats should be noted about this property right. First, the managerial authority of the tenant can be and often is cabined by provisions in the lease. For example, the lease can say “no pets” or can allow the landlord to enter and inspect the property at certain times. Second, as previously discussed, leasing is often used to achieve a division of functions, so that, in the case of an apartment lease for instance, the tenant has authority over the interior space but the landlord retains managerial authority over common areas such as the building shell, lobby, elevators, and the heating system.

Because the lease transfers possession and economic use of the property to the lessee, the lessee ordinarily assumes the risks and benefits associated with ownership of the leased property, such as crop failure, a surge or decline in profitability, or liability for injury to third parties, during the term of the lease (again, subject to specific modifications in the lease). This is very important in understanding the economics of leasing. The lessor’s economic interest during the term of the lease is in receiving the rental payment, which is typically fixed by the contract. The lessee’s interest is based on receiving the benefits of possession, which can fluctuate depending on the state of the economy and other external factors, but also on the level of effort and skill the lessee puts into managing the property during the term of possession. The lessee is thus the “residual claimant” in a leasehold arrangement during the term of the lease, meaning the lessee captures the value left over after other obligations are met, including of course the obligation to pay rent to the lessor.3 The lessee’s status as residual claimant

3.See Yoram Barzel, Economic Analysis of Property Rights 8–9, 33–54 (2d ed. 1997).

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creates a powerful incentive for the lessee to engage in good managerial practices over the leased property during the term of the lease.

After the term of the lease, the landlord reclaims possession of the premises. Thus, in addition to an expectation of the rental payments during the lease the landlord also holds a reversion. As with the temporal split between present possessory and future interest holders we saw in Chapter 5, the tenant’s incentives are biased toward present consumption and against investments that produce benefits beyond the lease term. Conversely, landlords are interested less in the present and more in the future. Not surprisingly, the law of waste can be invoked on behalf of the landlord, but because leases are typically of shorter duration than a life estate, the standard in landlord-tenant law is that the tenant must return the premises in the condition at the beginning of the lease except for “normal wear and tear.” As was the case with present and future interests, the standard provided by the waste doctrine is a default, and here can be varied in the lease itself.

Most legal issues regarding leasing concern its contractual aspect. As with most contractual relationships, the rules that govern leases are primarily default rules. This means the parties to the lease are free to specify some alternative rule in the lease if they do not wish to abide by the off-the-rack legal rule. Leasing performs so many different functions that it might be sensible to use different packages of default rules for different types of leases. What makes sense as a default rule for agricultural leases does not necessarily make sense for commercial leases, which in turn may not make sense for residential leases. But for better or worse, the common law has sought to identify a single package of default rules for all types of leases. Legislation in many jurisdictions has changed some of the default rules based on the type of leasing involved. For example, in the context of residential leases, but not generally for commercial leases, the default rule regarding risk of destruction of a building during the term of the lease has been shifted from the tenant to the landlord by legislation in most states.

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These interventions, however, have been ad hoc and do not reflect a systematic package of defaults that varies by type of lease.

A good example of the contractual nature of leasing law concerns what happens if the leasehold commences, and another tenant (or a trespasser) is in possession of the property. Who is responsible for evicting the holdover tenant or the trespasser at the onset of the leasehold—the landlord or the tenant? Jurisdictions are divided on this issue.4 Those that follow the so-called English rule imply a covenant requiring the landlord to deliver actual possession. Those that follow the American rule say there is no such implied covenant, and the tenant has the obligation to remove the holdover or the trespasser. A number of jurisdictions adopted the English rule as part of the pro-tenant trend in landlord-tenant decisions in the 1970s, making it the majority rule for residential tenancies today. In either case, the rule is a default, meaning that the parties can override the rule and can specify in the lease which party is obligated to deal with holdovers or trespassers at the beginning of the leasehold.

Following the standard analysis of default rules in the law of contracts, the better default rule is generally the one most parties would want. This “majoritarian” approach minimizes the need for drafting around the rule. Here, the rule most parties would want is probably the one that saves the most on costs spent on evicting holdovers or trespassers. The rule that saves costs means the parties have more joint wealth to share, making them collectively better off. Unfortunately, neither of the contending rules may conserve on eviction costs in every situation. The identity of the cheaper evictor probably depends on the type of leasehold. For rentals of urban apartments, where the landlord is either on the property or has a manager on the property, and where the landlord is familiar with

4.Compare Hannan v. Dusch, 153 S.E. 824 (Va. 1939) (holding that the default rule is that landlord is not responsible for removing holdover tenant) with Adrian v. Rabinowitz, 186 A. 29 (N.J. 1936) (holding the contrary).