By Edward U. Lee III, Esq.
When reviewing a lease, many focus their negotiations solely on the rent and other provisions that have “direct economic” impact, ignoring the remaining provisions as “boilerplate.”
Beware: ignoring those remaining portions of the lease can be detrimental to tenants. To help prevent this, my goal is to explore some key focus areas that will assist a tenant in negotiations.
This list is not all-inclusive, but it does offer a roadmap of sorts.
Important in all of the following areas of focus is knowing your ability to negotiate with the landlord. Many factors may affect this ability to negotiate, including the size and reputation of the tenant, the vacancy level of the building, market conditions, the size of the space, and the length of the lease term.
The items identified below can be pre-negotiated in the letter of intent for the space or addressed in drafting the lease agreement:
- The landlord and tenant should each release the other for damage to property caused by the other (whether negligently or even willfully caused) to the extent of the amount of insurance required to be carried on the property under the lease, whether or not self-insured. Mutual releases are fair because each party has bargained for the other party to insure its property. And, with the tenant most likely already paying all or part of landlord’s insurance premiums, the tenant should benefit from the insurance.
- The insurers for both parties should be required to waive their right of subrogation, i.e., the right of one of the insurance companies to recover from either the landlord or the tenant after paying out on a claim. For example, if the tenant negligently causes a fire that significantly damages or destroys the landlord’s building and the landlord’s insurance company pays to restore, by obtaining a waiver of subrogation, the insurance company could not then seek to recover restoration costs from the tenant.
II. Subordination, Non-Disturbance and Attornment
- A commercial lease invariably requires a tenant to subordinate its rights to the lien rights of the landlord’s lender. What this means: If the landlord defaults under its loan and the lender sells the property at foreclosure, then the lender may unilaterally elect to terminate the tenant’s lease in connection with the foreclosure sale.
- The solution is for the tenant to negotiate a right of non-disturbance — i.e., in the event of a loan default by the landlord, the tenant’s use and occupancy of the leased premises will not be disturbed. Upon a foreclosure sale, the tenant would remain in place. In exchange for obtaining the right of non-disturbance, the tenant will further agree (in addition to subordinating its lease) to recognize or “attorn to” the foreclosing lender or foreclosure purchase.
III. Tenant Improvements; Future Alterations
- Ensure that the obligation to pay rent and other charges does not begin until the tenant improvements are complete (or substantially complete). Similarly, specify clearly by what date the improvements must be completed, and then define what remedies would be available to the tenant if that deadline is not met.
- Clearly identify who is responsible for performing and paying for any tenant improvements. The tenant should review the improvement plans in advance and make sure that these plans are sufficiently detailed, if not final, to minimize exposure for cost overruns in excess of whatever the landlord’s tenant improvement allowance may be.
- Confirm whether any improvements or alterations to the premises will need to be removed at the end of the lease term. The better approach for a tenant is to obtain landlord consent in advance of any tenant improvements, in exchange for which the improvements may remain in place.
IV. Operating Costs
- In addition to paying base rent, the tenant should be required to pay some percentage of the landlord’s operating costs for the property. What may be included or excluded from those operating costs are too numerous to identify here, but the most important is specifying the percentage of expenses for which the tenant will be responsible. This percentage should be based on rentable rather than rented square feet in the building. If vacancies in the building increase, there should not be a corresponding increase in the tenant’s share of the operating costs
- Obtain information detailing historic operating expenses at the property to develop a sense of what the tenant’s costs may be, and make sure that you’re responsible only for your share of cost increases over the actual costs from prior years. Also, make sure that those prior year expenses are adjusted as if the building were fully leased, so that subsequent increases in occupancy by other tenants will not artificially increase your share of operating costs.
- Lastly, charges for real estate taxes and capital expenses are to be excluded from the calculation of operating costs.
V. Use Restrictions
Include flexibility as to how the premises may be used, keeping in mind the possible need for the tenant to change its business model in the future or to sublease a portion of its space to another user.
VI. Assignment and Subleasing
The tenant should seek to include flexibility to transfer its lease to a third party. Such transfers could include an outright assignment of the premises if, for example, the tenant’s business is sold. Similarly, the tenant may later discover that it has more space that it can readily use and that subleasing a portion of its space would be beneficial. Subleasing is particularly challenging in the current market but it is an option to be kept open. The standard landlord form lease frequently prohibits any assignments or subletting without the landlord’s consent. The tenant should look to include terms permitting assignments or subleases under certain circumstances.
VII. Default: Notice and Opportunity to Cure
Mistakes happen. The tenant should seek to include provisions allowing for notice of default and an “opportunity to cure” before the landlord may begin exercising remedies. The ability to obtain notice and cure rights frequently depends on the type of default at issue. Less flexibility may be provided as to paying the rent, with greater tolerance being shown as to other performance issues that may arise.
VIII. Consider Hiring Professionals.
Engage a broker that specializes in representing tenants. Brokers can provide invaluable information as to what lease terms are standard for your area and greatly assist in evaluating and negotiating the business terms of the lease. Get a real estate attorney, too. Landlords are regularly represented by attorneys; at the very least, the lease document is typically prepared by an attorney for the landlord’s — and not the tenant’s — benefit. Having someone working with the tenant who understands the implications of the lease terms can be extremely beneficial.
Edward U. Lee III, Esquire, is a Baltimore-based attorney specializing in real estate, bankruptcy and creditor/debtor rights. Lee is a member of Whiteford Taylor Preston, LLP; you can e-mail him at email@example.com.
Originally published: Oct 11, 2011