Business/commercial leases can be dangerous territory for a company or business client's legal counsel. I have encountered many requests from business clients like, "If you have a few minutes, can you look over a new lease I am thinking of entering into for new or existing leased space?" and "I don't need a complete review, just the basics."
What business clients need to understand is that oftentimes, other than employee costs, their annual rent may be their second most expensive operating expense. Multiply that expense by several years, which is often the term of a lease, and the result is a business lease that warrants careful review and consideration, as opposed to a “quick glance” by the company's attorney.
10 Tasks for the Business Client
The business client should obtain and provide as much information about the lease as possible to its lawyer. The following are 10 tasks/questions to help develop that information:
- Basic Terms. Are the basic terms of the proposed lease correctly stated? Is there a letter of intent or term sheet that needs to be compared to the draft of the lease? The client should also confirm the dates, names of the parties, premises description (including providing a drawing, if possible, and attaching the drawing to the lease as an exhibit), the term of the lease, rent, common area charges, security deposit amount and other allowances regarding leasehold improvements. Also, if brokers are involved, the tenant should clarify the parties' relationships with the brokers and how will they be paid.
- Renewal, Contraction, Termination or Expansion Rights: Assignment and Subletting. Does the business expect to have any renewal, contraction, expansion or termination rights? Do you, as a business, have any special needs relating to an assignment, subletting or other use of the premises that should be addressed in the "permitted transfers section" of the lease?
- Permitted Use. Is the permitted use in the lease broad enough not only for the immediate purposes of the business, but also if the business changes or needs to sublet or assign the lease, does the permitted use allow for reasonable transfer of the lease to a third party? Is the permitted and potential future use allowed under the applicable zoning and any governmental regulations for the premises?
- Beyond the Premises. What other portions of the project beyond the premises itself does a business need for its business to function optimally? The business should consider needs for parking, interior or exterior storage, rooftop space, utility access, telecom chases and risers, overhead doors, vaults, overhangs, sidewalk or outdoor patio space, freight elevators, trash enclosures, lobby or other common area space, and backup generators. What about signs?
- Beyond the Base Rent. What are the expected charges for the operating expenses, taxes, insurance, common area maintenance and the like, and what is the proportionate share of the business? What services are provided by the landlord, and what are the tenant's responsibilities?
- Insurance. Does the insurance coverage of the business meet the lease's minimum requirements? A business should ask its risk manager or insurance broker or advisor to review the lease regarding the insurance, damage and destruction, exculpation (release), waiver of subordination and indemnity clauses.
- Inspections. Has the business thoroughly inspected the premises to ensure its condition meets its expectations and needs?
- Termination Rights. What are the rights of the business if the lease is terminated based on a casualty loss (damage to the building), condemnation, foreclosure or other termination rights of the landlord? Is the tenant's investment in the premises adequately protected if the lease terminated for any reason? Are the moving costs of the business covered?
- Commencement Date. When does the business absolutely have to occupy the premises? The client needs to be sure that the lease specifies exactly when the premises will be available and what penalties should apply, if appropriate, if the client is not able to have access and move into the premises as promised.
- Read the Lease. The business client should read the lease and consult with individuals in his/her organization who are going to use the premises and understand the practical needs of the tenant as they relate to the leased space.
10 Traps for the Business/Commercial Lease
- Construction/Renovation/Repair/Remediation Obligations. A lease may impose tenant maintenance, repair, construction or remediation obligations that are out of line given the nature of the lease. A three-year tenant, for example, should not have to perform upgrades required by the Americans With Disabilities Act or a fire or building code unless such alterations are required by some unusual tenant use. Similarly, other expensive alterations such as heating and ventilation costs and environmental compliance-type work should not be imposed on a client who is going to have a short-term use for the leased premises. The landlord, ultimately, should bear the costs of those types of expenses.
- Overly Broad Indemnity Obligations. A careful study of the indemnity provisions should be done in every business/commercial lease to be sure the tenant is not inappropriately assuming liabilities. Basically, the tenant needs to confirm that it can obtain insurance coverage (contractually assumed obligations coverage) for the entire insurable scope of its indemnification obligations as set forth in a lease. Generally, the indemnification should be limited to anything that happens in the premises and anything the tenant and its agents, employees, contractors and invitees do outside the premises, and without consequential, special or indirect damages being assessed against the tenant, if possible.
- Waiver of Subrogation. Confirm that the lease contains a mutual waiver between the landlord and tenant to support an insurer's consent to a waiver of subrogation. This will avoid future problems with respect to the insurance carriers for each party seeking to obtain reimbursement from the other party's insurance carrier for liability or damages that occur to the premises.
- Relocation and Remeasurement Rights. Landlords often reserve the right to move the tenant to other space in the building to accommodate a future tenant that needs, for example, a full floor or a large portion of a floor. In such a case, the lease should limit the locations to which the original tenant can be moved and compensate that tenant for moving-related costs.
- Subordination Without Non-Disturbance, Quite Enjoyment. Unless the lease provides that the tenant's occupancy will not be disturbed if the landlord's lender forecloses on the building, most leases subordinate the lease to an existing or future lender's lien and provide that the lender may terminate the tenant's lease and foreclosure. Although a tenant whose lease is likely to add value to the building may be more successful in obtaining a non-disturbance clause for future lenders, every tenant should ask for a non-disturbance protection in the lease and get it.
- Changes to Common Areas. Landlords often retain the right to change common areas. If the tenant's access, visibility, parking or other important amenities are part of the common area, a tenant will want to limit changes to those common area amenities.
- No or Limited Cure Provisions. Default provisions can really hurt a tenant. They are also difficult to negotiate because the landlord's typical response is "don't default." The most common default clause traps are no notice of the default from the landlord, no cure period, and both interest and penalties for late payments.
- Damage Penalties – Making the Landlord More than Whole. Remedy provisions are similarly difficult to negotiate, but sometimes they simply are unreasonable as presented to the tenant. Common overreaching provisions include: (a) high liquidated damages for breach; (b) excessive default rates of interest; (c) double recoveries (for example, a recovery of full rent, plus a separate recovery of the full amount of any free rent, tenant finish allowance or other allowances, all of which are amortized over the lease term and thus are already recovered if the landlord recovers full rent); and (d) unreasonable restrictions on mitigating damages.
- Extensive Removal Obligations on Surrender of Premises. A tenant may want to limit its restoration obligations when surrendering the premises, so it is not obligated to remove: (a) tenant finish that existed when the tenant took occupancy; (b) tenant finish or other alterations made during the lease term with the landlord's approval (unless the landlord told the tenant before the alteration was installed that it would need to be removed); and (c) telecom cabling that the tenant did not install.
- Unclear Work Letter Obligations. Work letters are clauses (lease provisions or addenda that define the tenant finish work to be accomplished before the tenant moves in) are often cursory and fail to clearly define: (a) exactly what work will be done, or what the step-by-step procedure will be for defining the scope of such work, as well as the procedure for approving such plans and construction drawings; (b) who will do the work; (c) who will pay for the work; (d) when the work will be completed and whether the tenant has any remedy for late completion; (e) a procedure for inspecting the work, creating a "punch list" of unfinished items, and schedule and procedure for completing those items; and (f) a warranty for the work.
10 Tips for the Business/Commercial Lease
- Keep Your Eye on the Money. A tenant should pay careful attention to all of the clauses in the lease that require it to pay money.
- Know the Market. A tenant negotiating changes in a lease depends largely on the tenant's strength in the market. A tenant knowing its position in the market helps make the negotiation process more efficient and often more successful. For example, if the tenant is coming into an area where it will benefit the landlord's other tenants and overall business community, perhaps the tenant has more leverage in getting concessions from the landlord that benefit the tenant.
- Look for Inconsistencies. Common inconsistencies in a lease include those between: (a) the commencement of the term, the commencement of rent and delivery of possession provisions; (b) the casualty loss provisions and the insurance provisions (for example, landlord and tenant each insure the same property; the landlord carries the property insurance for the tenant finish, but the tenant is required to replace the tenant finish and its costs on casualty loss); (c) the indemnity provision, the exculpation clause, the insurance requirements and the waiver of subrogation provisions; and (d) the alterations clause, repair and maintenance provisions, the casualty loss provisions, the insurance requirements, the condemnation clause and the surrender clause.
- Read the Boilerplate Language. Important provisions in a business/commercial lease are sometimes hidden in the miscellaneous section or elsewhere appearing as boilerplate language in a lease. The moral of the story here is every word of the lease needs to be read and understood before the lease is signed.
- Assign Risks to the Lease to the "Least Cost Avoider." Every lease allocates risks between the landlord and the tenant. A good principle to use for a tenant in negotiating risk allocation is to assign the risk to the party with the greatest incentive to reduce costs or mitigate risks and that has the most control over the matter, as that party will be best positioned to manage the risk.
- Consider Both Short-Term and Long-Term Issues. A business tenant is often overly focused on short-term issues in the lease, such as completion of tenant work and the moving in process. A tenant must be careful to give equal attention to long-term issues.
- The Business Client/Tenant Needs to Keep a Proper Perspective. Oftentimes, clients fixate on a potential lease space and draw a conclusion that it is the only space where the business client can be successful. No "one location" is the "be all" and "end all" of any business. If the negotiation process with the landlord is not successful, there is usually always another space available under reasonable terms and conditions.
- Be Reasonable in Your Request for Changes. A business tenant who is leasing 3,000 square feet in a 100,000-square-foot office building or retail center is not going to get a lot of changes to the landlord's standard lease. Asking for unreasonable changes can reduce your credibility and backfire. A tenant must keep a proper perspective on what the important terms are of the lease to try and impact changes to and prioritize so that the tenant does not "wear out the landlord" with requests for changes for a lease which is in some respects incidental to the landlord's overall premises.
- If You Don't Understand It, Don't Sign It. It is amazing sometimes how some leases are just plain awful. Sentences don't make sense, subjects, verbs or objects are missing. Archaic language is used as though it conveys some ancient truths. Definitions are missing or used inconsistently. All of these things can impact the enforceability of lease terms. Therefore, all of these issues are not simply editorial changes, but may have a substantive effect if they are not addressed and corrected during the lease negotiation process.
- Choose Your Landlord Carefully. Some landlords are harder to deal with than others. Always consider the financial viability of the landlord, and life is too short to deal with some landlords, if you can avoid it.
It is important to note that the above information does not necessarily include many specialized provisions particular to, for example, things like retail leases, restaurant leases, medical provider leases and other leases with special requirements. The point of this information is that there should never be an expectation of the tenant and legal counsel going through a "quick review" of a proposed lease for the business to occupy and conduct its business with its customers. Hopefully, the information above will highlight those issues that need to be addressed and cause a business client to have a substantive conversation with its legal counsel to make sure that mistakes and problems in a proposed lease are avoided.