Things to Consider About Commercial Leases
Commercial Leasing is much more site specific than Residential Leasing
Leasing the right space can make or break your business. As a Landlord leasing to the wrong business can tie you up in conflicts and litigation with your tenant. This is a money losing proposition for both sides.
How do you avoid problems and unnecessary expenses?
1. Draft a Non-Binding Preliminary Letter Intent
Before you enter into detailed lease negotiations you need to know if you have basic agreement as to the most important price, the business terms that are particularly important to you, such as:
a. the lease term,
b. any options to extend the term,
c. the date the space will be available,
d. the location to be leased, and the square footage of the space,
e. the rent, available parking for tenant use,
f. any tenant improvements to be made and/or paid for by the landlord,
g. preliminary approval of company signs and decor,
These are the "must-have" terms which you must have agreement on before entering into detailed lease negotiations.
Having general agreement as to these terms before you enter into detailed negotiations on final lease terms, avoids the problem of having 2 parties just drafting agreements and either the Lease is a one-sided contract favoring one party, or else arguing back and forth about minutia when basic agreement as to essential terms is lacking. That just wastes time and money.
A letter of intent is generally a non-binding agreement that commits the parties to good faith intentions on major business points to be incorporated into the lease. If you cannot agree at the letter of intent stage there is no point in getting into detailed negotiations of the lease provisions.
2. Reviewing a proposed lease on your own can be very costly !:
For a Landlord or Tenant to review the Lease by themselves is tempting to avoid legal fees, but it can lead to massively expensive problems down the line because Commercial Leases are complex and can lead to unexpected results.
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Inability to keep a good location or escape from a bad one
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Inability to sell a business or a particular location
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Landlord imposed changes to the space, common areas, or rules and regulations, that hurt your business
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Inability to make desirable changes to the space or your operations
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Unanticipated costs, losses or competition from another tenant
3. In commercial leases the details matter a LOT:
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Leases have pages and pages of complicated details which most people do not know how to interpret
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The details are important and typically favor the landlord
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You need help to identify, understand and improve the important lease provisions
How to avoid conflict and speed opening? Clear descriptions and drawings.
Want to structure your lease to speed your opening and avoid conflict with your landlord? Make sure the lease clearly describes the space you are renting. Attaching a drawing with dimensions is an excellent way to do this. This or another drawing should show the location of the space within the building and development that contains it; the parking areas available for the exclusive or non-exclusive use of your customers, vendors and employees; and any other areas of importance (e.g. storage areas, trash and recycle container locations, loading docks, and the like). If you can, get the landlord to pre-approve and then attach additional drawings showing the signs you plan to use, and tenant improvements that are to be made to the leased space. A legal description of the premises or the building in which it is located is also important, as the lease may be unenforceable without it. In addition, clarify which areas are included in your premises for your use and for rent calculation purposes, such as hallways, bathrooms, and mechanical areas, and which areas are A common areas@ for use by all tenants. Putting all of this in your lease can greatly reduce the chances of future conflicts and misunderstandings between you and your landlord. It will also help you better estimate and budget for your start-up expenses.
Limiting your damages if you default — what key things do you need to know?
Sometimes the leased space you thought would be a winner for your business turns out to be a loser, and you have to shut it down even if it means defaulting on your lease. That can put you at risk of paying some big damages to the landlord. What could you have done during the negotiation of the lease to limit your exposure?
AMORTIZE THE LANDLORD'S COSTS: Typically the default provisions in a lease make the tenant responsible for all of the landlord's costs associated with securing a new tenant. But suppose the defaulting tenant had a five-year lease and defaults after four years? In another year the landlord would have to find a new tenant anyway, and all at its own expense. Why should the lease require the defaulting tenant to pay 100% of this expense? Insist on having your lease properly amortize this expense, so that if only 20% of your lease term remains at the time of default you are responsible for 20% of the landlord's related expenses. And remember to make sure this also applies to repayment of the costs of any tenant improvements that the landlord paid for when you moved in.
REQUIRE MITIGATION: The law in most jurisdictions requires that an injured party has a duty to do what it can to minimize its resulting damages. So when a tenant vacates its space and stops paying rent before its lease expires, the landlord cannot just decide to leave the space vacant, let its damages mount, and then sue the tenant. The law requires the landlord to try to minimize its damages, which usually means trying to re-rent the space at a fair rental rate. Even though the law imposes this obligation on the landlord it is best to spell it out in the lease, and better yet to require that the landlord use its best efforts to bring in a new tenant as soon as possible and paying a then fair rent in the local market.
Should you check the title to space you will be leasing?
If you are considering leasing space it is a good idea to check the title to the underlying property. Besides assuring yourself that the landlord actually owns the property, you may discover an encumbrance that is inconsistent with your business. For example, I once found a recorded restriction on outdoor retail sales in a commercial shopping center when my client wanted to offer outside dining. Even the landlord was surprised. We made removal of the restriction a condition of the lease.
Other title issues to look for are recorded liens on the property which will tell you something about what sort of a business person your landlord is; easements that might impinge on your space, such as the right to run utility lines through, over or under it; and special property tax assessments that you might be asked to pay part of.
So how do you check the title? Obtain a current title report or preliminary title insurance commitment on the premises and the building in which it is located. Try to get the landlord to supply the report but if that is not possible or the landlord's most recent report is a bit stale, then get your own. Ask a local title insurance company for a "preliminary leasehold title insurance commitment." Most title companies are happy to provide the report, though if you do not plan to purchase the insurance ask about the "cancellation fee." It is usually small. Some title companies will only provide the information in the form of a "limited liability guarantee" if they learn you will not be buying the insurance; Land America Commercial Services, for example, does this and currently charges about $250 plus sales tax. When you are risking thousands of dollars on a new location this can be a very good investment.
How to keep a good location — what key things do you need to know?
What can a tenant do to keep a good location? Create options to extend the term of the lease, make the conditions for exercising the options workable, and get the exclusive right to sell your products and services.
The landlord wants you to sign an estoppel certificate. What is it and how should you respond?
What is an estoppel certificate? It is a document designed to give third-party critical information on the relationship between your landlord and you as a tenant. The third party is frequently a prospective purchaser of the landlord's real property containing your premises, or a lender who will be secured by an interest in that property. Typically the deal that the landlord is making requires the landlord to obtain such certificates from its tenants and present them to the third party for use in its "due diligence" review of the property.
Most retail space leases have provisions which require the tenant to prepare and sign estoppel certificates (or estoppel letters as they are sometimes called) upon the landlord's request. Typically the tenant is required to certify that as of the date of the document certain things are true, or to specify in some detail why they are not true. The things usually covered include (i) whether the tenant's lease is in full force and effect and has not been assigned, modified, supplemented or amended; (ii) whether all conditions under the lease to be performed by the landlord have been satisfied; (iii) whether any required contributions by the landlord to the tenant on account of the tenant's improvements have been received by the tenant; (iv) whether there are any existing claims, defenses or offsets which the tenant has against the enforcement of the lease by the landlord; (v) whether any rent or related payment obligation has been paid more than one month in advance; and (vi) whether any security has been deposited with the landlord.
The tenant is usually required to state that its disclosures in the estoppel certificate may be relied upon by the specified third party or parties. That means that you could be liable to the third party if the certificate contains untrue statements. Thus unless you are absolutely sure about the things you are certifying, you should certify them only "to the best of tenant's knowledge." Leases usually require the tenant to prepare and sign the certificate within a relatively short period, and authorize the landlord to prepare and sign the certificate in the tenant's name if the tenant does not respond within the allowed time. For that reason, you want to be sure to attend to such requests in a timely manner and to try to extend the response time when you are negotiating the lease.
How do you keep the landlord from keeping secrets?
One client I know of entered into a ground lease for a pad in a shopping center parking lot so it could put up a building to house its restaurant. When the excavation began for the building's foundation the client discovered that much of the site contained fill material that would not safely support the weight of the planned building. The unsatisfactory fill material had to be dug up, hauled away for disposal elsewhere, and replaced by more stable material, all at a cost approaching $100,000. Who do you think was responsible for that expense, and why?
THE CRITICAL WARRANTY: Included in the ground lease at the request of the client's lawyer were a number of warranties and representations made by the landlord. One of them was that, to the best of the landlord's knowledge, the soil at the leased site was sufficient to support the weight of the client's planned building. It did not take long to determine that some years earlier when the landlord was constructing the shopping center it or one of its contractors decided to dump the inadequate fill material at this site. The landlord's leasing manager was unaware of this, did not check with the landlord, and saw no problem with putting the requested warranty and representation into the lease. Very fortunate for the client. Not so for the landlord. It had breached that warranty and as a consequence was responsible for the client's resulting damages.
HOW TO USE WARRANTIES: The landlord almost always is in a better position to know the history of the leased premises than the would-be tenant. By using warranties and representations like the one that saved the client, the tenant can keep the landlord from failing to disclose important matters known to the landlord, or make the landlord responsible for damages arising from the failure to inform the tenant. By demanding that the landlord make only "best of its knowledge" warranties and representations the tenant is saying, "look, we are not asking for any absolute guaranties, we just want to know upfront about potential problems that you know about." In other words, no secrets allowed. Other useful warranties are that the landlord is unaware of any labor, hazardous substances, legal, condemnation, construction code, encumbrance, or zoning problems that could interfere with the tenant's construction or the operation of its business at the leased location.