The Lease Really Says That?
by Jane M. Myers, Esq.
When reduced to its most fundamental terms, the commercial lease transaction is easy and straightforward – the landlord owns property that the tenant seeks to occupy for a certain period of time. The tenant moves in and timely pays rent for the right to occupy the property for the time period agreed to by the parties. The physical structure of the property is in pristine condition throughout the tenant’s occupancy. The sun is always shining. It seems simple enough, until the parties consider the “what happens if” scenarios. What happens if the tenant fails to pay the rent? What happens if the tenant damages the property? What happens if the tenant doesn’t vacate the space when the lease term expires? What happens if the landlord doesn’t provide heat and hot water? What happens if the landlord fails to maintain the roof? What happens if the tenant suffers a financial reversal and needs to surrender the space? What happens if the tenant wants to renovate the property? What happens to the tenant if the landlord loses the property in a foreclosure action? What happens if the property becomes environmentally contaminated? The variations of the “what ifs” are endless.
The key to understanding commercial leasing and to successful lease negotiations is to never lose sight of the underlying psychology of the relationship between the landlord and the tenant. When reduced to its basics, that relationship centers on control and cost. The landlord seeks to control the use and preserve the condition of its property while the tenant typically looks to lessen the landlord’s grip. Both parties seek to limit their respective costs.
Aside from payroll, the commercial lease is usually the most expensive component of business overhead. Mistakes and oversights can have enormous financial impact. To avoid costs and delays, and before a review of the lease begins, the parties should: finalize the brokerage agreement, agree on the term sheet that sets forth the business terms of the transaction including scope of build-out and expenses, identify the availability of phase-out tax incentives, tax exemptions, and tax abatements, identify the tenant’s IT requirements, have the landlord agree that during negotiations it will remove the space from the rental market, identify any possible delay in the tenant getting possession due to the landlord’s lease approval requirements (from its lenders or ground lessors) or a present occupant, confirm that the proposed landlord actually owns the property and confirm the legal existence of the proposed tenant. Once these issues are resolved, the lease negotiations can begin.
The Myth of the Standard Lease
There is no such thing as a “standard form of commercial lease”. There are limitless types of leases that cover office, retail, industrial and loft space; each form of lease is very different and each has endless versions tailored to the particular transaction. Landlords who declare that their lease is a standard lease to which no changes can be made will only have that bargaining power in a strong landlords’ market – otherwise, virtually everything is negotiable.
Those in the real estate industry often rely on industry jargon as shorthand to describe a type of lease transaction. It is not uncommon to hear the phrases “gross lease”, “net lease” (as well as “net net lease” and “triple net lease”), “industrial gross lease” and, occasionally, “bond lease” when describing a transaction. To avoid unanticipated costs and disputes, avoid industry jargon; don’t ever assume that the parties agree on their respective understanding of the phrases. The best practice is to clearly state in the lease the responsibilities and obligations of the parties since a commercial lease will be interpreted according to its terms – extrinsic evidence will not be considered by a judge, provided the lease is clear on its face.
Commercial Lease Hot Spots – Construction and Alterations
Since the landlord has a legitimate interest in controlling what happens to its property, structural modifications are almost never permitted without the landlord’s prior consent; non‑structural modifications are occasionally allowed without prior consent – usually if the modifications are cosmetic in nature and below a specified dollar amount. A tenant must keep in mind that with respect to a request for the landlord’s consent to a proposed tenant change to the premises, the landlord is under no legal requirement to act “reasonably”. In fact, given a contractual prohibition that does not require the landlord to act reasonably, it may withhold its consent even arbitrarily. This degree of restriction and control can have a profound negative impact on the way in which the tenant conducts its business. A way to minimize the restriction, where the tenant is permitted to make alterations, is to negotiate a “reasonableness” standard for landlord’s consent to alterations up-front. Consider adding language to the lease that landlord’s consent for decorative or minor alterations or construction of partition walls costing less than a specified dollar amount is not required.
Whenever modifications to the space are to be made, whether by the landlord for the tenant’s benefit, or by the tenant itself, it is critical that the lease clearly state the duties and obligations of the parties regarding the construction. Issues that are essential to be addressed in the lease include: the process and timing for completion of construction plans, the process and timing for putting plans out to bid and evaluating bids for revisions to plans, obtaining permits, insurance and risk of loss, benchmarks to determine completion of construction, costs overruns and dispute resolution.
It is common for a commercial lease to contain language to the effect that upon installation, fixtures, paneling, partitions, railings and staircases become the property of the landlord unless the landlord decides it doesn’t want them. Tenant’s often fail to appreciate the impact of lease language that obligates the tenant, at its sole cost and expense, to remove its installations and restore the premises to its condition prior to making the installation – usually with only 20 days prior notice. This can, of course, be quite costly and difficult to accomplish timely especially if the restorative work entails the removal of a staircase and closing floor penetrations. Delays by the tenant to complete restorative work could trigger additional financial penalties as a “hold over” and jeopardize return of the security deposit. The time to address the uncertainty of the tenant’s end of lease term obligations is when the lease is negotiated. The tenant should require that landlord approved alterations shall not require removal and restoration.
There are many “silent lease” issues that are often not mentioned in a commercial lease that can have profound financial impact on the parties. Tenants who are undertaking their own build-out may want to specify what the landlord is required to do to prepare the space for tenant’s construction (asbestos removal/abatement, demolition, closing floor penetrations). Consideration might also be given to a requirement that the landlord cure existing violations (not caused by the tenant) that interfere with the tenant’s proposed alterations.
Maintenance and Repairs
Most people believe the difference between interior and exterior portions of a commercial premises and what constitutes structural as opposed to non-structural portions of the premises are very obvious. Suffice it to say that failure to be clear and precise in the lease can be costly for the parties. For example, although the plate glass windows of a retail store front would appear to be exterior portions of the building, maintenance of plate glass is typically the tenant’s responsibility. Typically the landlord is responsible to maintain the public portions along with the exterior and structural portions of the building. This will also include the plumbing, electrical and HVAC servicing the premises. However, just as parties may not have the same understanding of the definition of a “net” lease or a “triple net” lease, there are no precise definitions of what constitutes “structural repairs”. The courts are inconsistent with their decisions and do not provide clear guidance. As a result, the best approach is to ensure that the terms are well-defined in the lease.
Assignment and Subletting
Assignment and subletting provisions are perhaps the most negotiated (and important) provisions of a commercial lease after rent and designation of the premises. For the landlord, it is a battle for control of its property since the landlord has selected this particular tenant with care and this tenant now seeks to transfer its occupancy to a stranger not selected by landlord. For the tenant, the opportunity to assign or sublet provides an exit from an unfortunate selection of location – either due to a business downturn or significant growth. It is also a critical consideration in the event the tenant desires to sell its business since the lease is typically one of the most valuable assets of that business. In New York, tenants have an unrestricted right to assign or sublet unless the lease contains a prohibition against assignment or subletting; accordingly most landlords make sure their leases contain such restrictions. The assignment and sublet clauses must be carefully drafted to balance to concerns of landlord and tenant.
There are many other areas of concern to be addressed when negotiating a commercial lease. The typical pre-printed lease form contains all kinds of draconian “surprises” the impact of which are oftentimes overlooked. Provisions to be scrutinized include default provisions; adding an obligation on the part of the landlord to mitigate damages in the event of tenant’s default; limiting the landlord’s right to change the location of public entrances, doors and corridors as well as the name and number of the building; circumstances where the landlord can withhold providing essential services (heat, water, elevator service) if the tenant is in default in payment of rent; limiting the number of times the tenant can be relocated within the building; remedies for a tenant in the event the landlord is delayed in giving possession due to circumstances not caused by tenant; and many other events that, if not addressed in the lease, can be costly and disruptive for landlord and tenant. If you’re considering entering into a lease, whether as the landlord or as a tenant, and would like to discuss the possibility of obtaining representation to assist you in structuring the transaction so as to best protect your interests, then please feel free to contact us in order to schedule a free initial consultation.
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Please note that this article is intended only as a general discussion of issues pertaining to commercial leases and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney before entering into any contract or agreement.