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A well-written lease must clearly define the leased premises to include all aspects of the business’s needs, now and in the future. It is important that the tenant understand what square footage the leased premises includes in order to truly appreciate its rights and liabilities. For example, does the leased premises include the repair and maintenance of a vestibule? Is the leased premises measured from the interior walls or the exterior walls inward? Does it include the roof or other structures? Does it include the exclusive rights to parking, a garage, a warehouse or a loading pad? Does it include the right to an easement across a neighboring property for ingress or egress, or through another tenant’s space?
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A well-written lease provides for a term that includes options to renew. If location is critical to the business’s success, it is important that the lease allow for renewal options. In a down economy, it is recommended that the tenant establish the financial terms for the renewal term now, versus waiting to renegotiate at a later date. This may allow the tenant to capitalize on better economic terms. A lease that indicates the terms will be negotiated at a later date, will leave the window open for the lease to be terminated by the landlord based upon the inability to reach a meeting of the minds between the parties regarding economic terms. A lengthier lease may also give the tenant an economic advantage if they elect to sell the business and the location enhances the business’s value.
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A well-written lease allows for the assignment and sublet of all or a portion of the leased premises and prevents the right of recapture by the landlord. More often than not, a landlord will prohibit the assignment and sublet of a lease. This prohibition may result in a business’s failure by restricting the ability of the tenant to move or sell its business during changing economic times. This is especially true if the business is a retail operation. If the tenant wants to sell its business and assign the lease to its buyer, and the lease prohibits an assignment or provides the landlord with a right of recapture upon request to assign, the tenant will likely be left to sell off the remaining assets of its business at a reduced cost, or may be forced to retain the business until the lease expires and lose the value of resale. Therefore, this lease covenant must be negotiated with great care. It is also important to review the use provision of the lease so the ability to assign and sublet to a business operation that is slightly different than the company’s is not prevented by a narrowly tailored use provision. A tenant must also understand that the assignment of the lease does not relieve it from liability under the lease without a release provision or a limitation on liability for a term of years following assignment.
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A well-written lease limits personal liability. All landlords will want a full personal guarantee of the lease terms in the event the tenant defaults under the lease and does not cure the default in accordance with the lease terms. Landlords want to insure that their tenant’s have ‘skin in the game’ so that they if they default, they can’t easily walk away from their obligations under the lease by merely dissolving their business. Tenants, on the other hand, will want to limit their personal exposure to ensure a landlord cannot go after their personal assets if their business does not succeed. There are a host of ways a tenant can limit their liability through the use of a limited or good guy guaranty. Guarantees can be limited to a term of years, may have a financial cap, or may limit an individual to only fulfill certain nonmonetary covenants in the event of a default under the lease.
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A well-written lease clearly defines all financial components of the lease, including rent, additional rent, common area maintenance and percentage rent. Repairs are inevitable when a lease is for a term of years. The parties should clearly define their obligations for repair and maintenance in the lease. For example, who is responsible for repair and replacement of the heating and air conditioning systems, roof, structure, plumbing and electrical components of the leased premises? Can the landlord charge an administrative fee for common area repairs and maintenance, in addition to a management fee? Many commercial leases pass through all common area costs to the tenant, and are triple net leases.Triple net leases make the tenant responsible for insurance, taxes and repairs and maintenance. Often the definition of common area maintenance is excessively broad, and includes not only maintenance and repair, but capital expenditures. Is there a limit on the ability of common area maintenance (commonly referred to as a CAM charges) to escalate? In a multi-tenanted building, it is critical to define the tenant’s pro rata share of common area charges and understand how the pro rata share is calculated to determine that it is accurate. The tenant will also want to limit its responsibility for capital expenditures by the landlord or amortize their responsibility over the remaining term of the lease based upon their pro rata share.
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A well-written lease limits a tenant’s financial responsibility for maintenance and repair, capital improvements, management fees, administrative fees, and structural components of the leased premises, and allows for an audit of the landlord’s billing of common area maintenance (the financial pitfalls). The lease should address how frequently the tenant may audit the landlord’s books and when an audit may occur. The lease should also confirm who is responsible for paying for the audit if a mistake is found. The lease should also indicate how extensive a mistake must be before the landlord should be responsible for the cost of a tenant’s audit.
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A well-written lease requires representations by the landlord for title restrictions and ownership of the leased premises. Most tenants believe because they are not purchasing real estate they don’t need a title search of the property. This can be a costly mistake. A title search will provide valuable information to the tenant. First, it will confirm whether the landlord is, in fact, the record owner of the property or merely a tenant under a ground lease. It is important to insure that the person who is being negotiated with has the authority to enter into a binding lease. A ground lease may also expire prior to the expiration of the company’s lease, and may require the consent of the master landlord under the ground lease. The title search may also indicate that the property being leased is the subject of foreclosure or other zoning restrictions, which may impede the use of the premises, even if the municipality permits the intended use. Therefore, a title search is a critical component to any lease negotiation.
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A well-written lease provides that the tenant is the owner of all tenant improvements, and allows for their removal at the expiration or termination of the lease. Many retail clients, especially restaurants, put a tremendous amount of money into the outfitting of a commercial space. The tenant needs to insure that the improvements it makes, once installed in the premises, do not become the property of the landlord and can be removed at the expiration of the lease or transferred to any purchaser of the business. Does the tenant intend to leave certain improvements behind, and will it be costly to restore the premises when the lease expires? The parties will want to consider this during the negotiation process. Also, trade fixtures may be an important component to a business’s financing, and the tenant will want to insure their improvements can be used as collateral for any loan and do not become the property of the landlord once installed in the leased premises.
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A well-written lease contemplates financing by the tenant of the tenant’s improvements and working capital. A landlord will want to be able to place a Uniform Construction Code financing statement against the assets of any company as collateral for its lease. This lien may interfere with a company’s ability to finance its leasehold improvements or obtain a working capital loan. Therefore, a tenant will want to limit the right of the landlord to place such a lien upon its assets, and will want the landlord to subordinate any lien it may seek to that of a tenant’s primary lender. A tenant needs the flexibility to finance its business now and into the future, and any restrictions by the landlord will impede its ability to grow. If a tenant is making tremendous improvements to the property, the tenant’s lender may also want to take a leasehold mortgage against the leased premises or obtain a collateral assignment of lease. The business’s needs should be carefully contemplated and incorporated into the lease.
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A well-written lease provides for a non-disturbance agreement in the event the property is foreclosed by the landlord’s lender. Leases generally require that a tenant’s interest in the leased premises and the lease will be subordinate to the landlord’s mortgagee. This means that in the event of a foreclosure, a tenant’s rights under its lease can be terminated. In order to prevent this occurrence, the tenant will want the lease to provide that a subordination, non-disturbance and attornment agreement will be entered into between the landlord’s lender and the tenant to preserve the tenant’s rights under the lease, as long as the tenant’s lease remains in good standing and full force and effect. The mortgagee should be required to honor the terms of the lease and not disturb the tenant’s leasehold. However, in order for the lender to agree to this provision, the lender will typically not agree to be responsible for any of the defaults of its predecessor in title (i.e., the landlord), including, but not limited to the responsibility for any security deposit paid to the landlord. The terms of the agreement will have to be negotiated carefully.