Commercial Leases in General. Commercial lease agreements are one of the more complex legal documents a lawyer will encounter in his or her practice. A commercial lease includes many separate agreements which, taken alone, are complex in and of themselves. For example, commercial leases usually include a construction contract, a security agreement, a subordination agreement, a release and indemnification agreement, and sometimes includes restrictive covenants, rights of first refusal and other agreements. As one can see, each of these agreements alone could be the subject of extensive negotiation. In a lease, these agreements are mixed in with other difficult issues such as operating expense pass-throughs, landlord services, assignment and subletting, repair and maintenance of the premises, insurance, default and remedies, and other typical lease provisions.
In spite of the complexity of commercial leases, many clients tend to think of a lease as a rather simple, "standard" document. Often clients do not consult an attorney before signing a landlord's lease form. It is only later, when a problem arises, that an attorney is consulted. Clients are often shocked to find they have signed a landlord form lease which essentially provides (1) that the tenant can occupy the space if the rent is paid (unless the landlord wants the space back for another tenant); (2) that the landlord will try to provide utilities and other services to the premises, but if the landlord fails to do so, the tenant waives all claims against the landlord, waives any right to vacate the space; and (3) that if for some reason the tenant can find an unreleased claim against the landlord, that claim can be satisfied only out of the landlord's interest in the building (which is usually heavily mortgaged). The tenant on the other hand is fully liable, has pledged all its personal property to secure its obligations, and the principal shareholder of the tenant has probably personally guaranteed the lease. Thus, the lease is effectively nonrecourse to the landlord, but full recourse and secured as to the tenant. Obviously, the tenant will find itself in a rather difficult bargaining position in its dispute with the landlord.
Representing the Tenant. In many instances, these problems can be dealt with at the "front end" during the lease negotiations. Tenants often have quite a bit of leverage in negotiating lease terms with a landlord.
One of the most time consuming aspects of tenant representation is explaining the lease and its problems to client and mapping out a strategy for dealing with the landlord. Thus, one of the most difficult problems in representing a tenant-client effectively and efficiently involves the way you communicate with your client. Although each client is different and must be dealt with accordingly, I have found that the most efficient method is to briefly discuss the situation on the telephone with the client to find out if there are any special "deal points" and to gather general information about the transaction. Then I generally go ahead and mark-up the lease and prepare an addendum with special provisions before reviewing the lease with the client. In this way, I can run through my suggested changes and explain them to the client and at the same time give the client my lease comments. This approach seems to save the step of giving lengthy lease comments to the client and then having to essentially repeat that process when discussing the suggested revisions.
Scope of Presentation. The primary focus of this presentation is to provide both attorneys and brokers doing tenant representation with a suggested approach to representing commercial tenants in an efficient, yet effective manner. Many commercial leases contain substantially similar landlord provisions. Representing a tenant requires addressing these provisions in a way that achieves some degree of fairness for the tenant. What I have attempted to do in this outline is identify what I consider to be the "Top 10" legal issues facing a tenant in a commercial lease and discuss ways of dealing with those issues. Obviously, there are other issues which will be involved in any given lease. Also, although the problems may be similar, every lease is different and must be studied for all provisions that could affect the tenant-client. However, these Top 10 issues provide a guide book to typical lease negotiating points.
In addition to the discussion of these Top 10 issues, I have prepared a sample Addendum which contains a number of provisions designed to modify typical landlord oriented provisions found in most commercial leases. This Addendum covers not only my Top 10 list, but also a number of other issues which are not discussed in this outline.
This outline and the attached Addendum are intended to be general or "generic" in that I have not focused on any particular lease form or type of lease. Commercial leases include office leases, medical leases, warehouse or industrial leases, and retail leases, each of which present a host of special issues unique to that type of lease. All these types of leases, however, include some or most of the issues raised in this paper. Other speakers on this program will deal with some of the unique issues presented by particular types of leases.
NEGOTIATING A COMMERCIAL LEASE
Lease Negotiations. The dynamics of each lease negotiation are different. Sometimes the attorney gives the suggested revisions back to the client, who then presents the revisions to the landlord; sometimes a broker (or tenant representative) will present the proposed changes; and sometimes the changes will be presented directly to the landlord's attorney. The most common approach seems to be that the client or the client's broker will present the changes to the landlord, and later the landlord's attorney will contact the tenant's attorney regarding the points of disagreement.
Additionally, there is always the issue of whether you should give generic comments or mark-up the lease and/or attach an addendum. I strongly favor an approach which involves specific requested revisions. This usually takes the form of an addendum combined with limited interlineations where appropriate. This approach allows the tenant's attorney to set the stage with specific requested changes. Moreover, if you can develop a somewhat "standardized" approach by using a form addendum to deal with most of the typical difficult issues, the revision approach will often take less time than dictating a comment letter and then later drafting suggested language for changes or responding to the landlord's own revisions.
As a lawyer, I prefer to work with a client who is represented by a broker. It is my experience that brokers who know the market can get a lot more out of a landlord than an attorney acting alone. The reason for this is fairly obvious. A broker provides a credible threat of taking the tenant to another project. Also, brokers generally are more knowledgeable than attorneys concerning what sort of concessions landlords are making at any given time, and this helps greatly in the negotiations.
The "Top 10" Issues. The Top 10 issues dis-cussed below are not presented in order of importance or in reverse ("Letterman style") order. Rather, I have tried to present them in the order in which these issues typically appear in a lease form. Also, as mentioned above, there are numerous other issues in leases and there are always special "deal" issues unique to every lease negotiation. Therefore, do not regard this Top 10 list as all inclusive.
Build-Out of Premises. Many landlords offer "turn-key" construction of leasehold improvements. That is, the landlord provides space planning and construction through architects and contractors selected by the landlord. Some landlords will permit the tenant to engage its own architect and contractor, subject to the landlord's approval. In either case, there is a construction "allowance" which is generally available to the tenant. In a "turn-key" job, the landlord agrees to perform certain specified work with anything above that work being considered an "extra" at the tenant's expense. When the tenant builds out its own space, the landlord will generally pay a specified amount of money toward the construction. It is the tenant's responsibility to bring in the
job on budget or pay for any items which exceed the landlord's allowance.
Most commercial office building leases call for "turn-key" construction, whereas retail and industrial leases may tend toward the tenant having the work done. The tenant may want to have its own construction work done if the tenant believes it can get a better financial deal negotiating with its own contractor or if the tenant has an ongoing relationship with a particular contractor who, for example, has built out other locations for the tenant. However, in most cases tenants will opt for a turn-key job.
Where the landlord is responsible for the build-out, the tenant will have three primary concerns: (a) getting the most work it can out of the landlord, (b) getting the landlord to stand behind its work with some sort of warranty obligation, and (c) achieving completion by a specified date. Many landlord lease forms provide that the commencement date of the lease may be extended without penalty to the landlord for as long as it takes the landlord to complete the premises. Additionally, many landlord lease forms provide that taking possession by the tenant will be deemed acceptance of the premises by the tenant and will waive any claims against the landlord for defects or delays. The first numbered paragraph in the Addendum is designed to deal with these issues by requiring the landlord to begin and complete construction according to a definite time schedule and allowing the tenant to submit a punch-list after it takes possession and has had a reasonable opportunity to see if the construction was done properly.
Operating Expenses. Most commercial leases provide common area maintenance and other operating expenses (such as taxes and insurance) will be passed through to the tenant. In office building leases, where separate utility metering is very rare, utilities are also included in the pass through of expenses. Three types of pass-throughs are commonly used:
"Expense Stop." In this type of lease, an amount per square foot is designated as the operating expense component built into the rent. This number is commonly called the "expense stop." The tenant is then required to pay its pro rata share of operating expenses in excess of the designated "expense stop" amount.
Base Year. In this type of lease, a calendar year (usually the year the lease is signed or the preceding year) is designated as the "base year." The tenant will be required to pay it pro rata share of operating expenses in excess of the operating expenses for the base year.
Net Lease. Under this approach, there is no "stop" or base year; rather, the tenant is required to pay its pro rata share of the actual operating expenses incurred during each lease year.
Operating expenses are typically estimated by the landlord in advance and are payable by the tenant on a monthly basis along with the base rent. An annual settlement is generally called for with 90-120 days after the end of each year.
Most landlord lease forms broadly define operating expenses. A tenant, however, will want certain exclusions. The second numbered paragraph of the Addendum contains a listing of common exclusions from operating expenses. This provisions also contains a clause giving the tenant the right to audit and challenge the landlord's operating expense calculations.
Many landlords will include a "gross-up " clause in the lease. A gross-up clause allows a landlord to calculate operating expenses as if the building were fully occupied even though the building is not fully leased. The purpose of the clause is to allocate all variable operating expenses to the occupied space. For example, if a building is 50% leased and variable operating expenses are $100,000, the tenants will pay only their pro rata share (50%) and thus the landlord will recoup only $50,000 of the actual variable expenses. A gross-up clause will allow the landlord to calculate the variable expenses as if the building were fully leased (i.e.. "grossing up" the expenses to $200,000) so that the tenants will pay $100,000, the landlord's actual cost.
The issues facing a tenant in connection with a gross-up clause are (i) to prevent the gross-up calculation from including nonvariable costs such as taxes and insurance premiums, and (ii) to be sure that the base year or expense stop calculations were made on a consistent basis (i.e.. grossed-up if the landlord is using a gross-up clause).
Failure of Building Services. As mentioned above, most landlord leases provide little or no remedy for the failure of building services. In fact, many leases waive any right the tenant may otherwise have to vacate or withhold rent if the landlord fails to provide essential services. The tenant may have a possible common law remedy for breach of the implied warranty of suitability. However, this warranty is limited to latent physical or structural defects and does not exist as to matters specifically addressed in the lease. See Davidow v. Inwood North Professional Group-Phase I. 747 S.W.2d 373 (Tex. 1988); and Coleman v. Rotana, Inc.. 778 S.W.2d 867 (Tex. App. -Dallas 1989, writ denied). Although not specifically addressed by the courts, this implied warranty is presumably waivable and most landlord leases attempt to waive implied warranties. Therefore, if the landlord fails to provide essential services, under most lease forms the tenant, at best, has a tenuous remedy, and at worst no remedy. Paragraph 3 of the Addendum is designed to deal with this issue and provide a remedy to the tenant if the landlord defaults in this regard. Specifically, paragraph 3 of the Addendum calls for an abatement of rent for a short term interruption of services (3 days or more) and a right of cancellation if the condition continues for 30 days or more. Landlords will typically seek a longer initial period (such as 5 or 7 days) and will seek to carve out a "force majeure" exception for circumstances beyond the control of the Landlord.
Another potential remedy is self-help. This is provided for in paragraph 4 of the Addendum. Landlords will strenuously resist self-help clauses. Generally speaking, self-help is of little benefit to an office tenant, unless the tenant leases all or a substantial part of the building. However, self-help may be substantial benefit to a retail or industrial tenant who may have separate HVAC systems, roofs (or portions thereof), and other systems or improvements that serve only that tenant. In these situations, a tenant may want to insist on the right of self-help with a corresponding offset against rent as provided for in paragraph 4 of the Addendum.
Restoration Following Casualty. A related issue is restoration of the premises following a casualty loss, such as a fire or flood. Most leases provide that if the damage can be repaired in some period of time (usually 120 or 180 days) the lease will continue with a temporary rent abatement and the landlord will restore the premises to the pre-damage condition except for the tenant's own personality or in some cases above building standard improvements. If the damage will take longer to repair, the lease typically gives the landlord the option to terminate the lease or elect to make the repairs, and the tenant must abide by the landlord's decision. The tenant's concerns here are (a) making sure the repair period is reasonable (a shorter period such as 90 days often can be substituted), and (b) if the landlord elects to restore, requiring completion within a set period after which the tenant can terminate the lease if the premises are not completed. Paragraph 5 of the Addendum is designed to deal with some of the issues raised by a casualty loss.
Many leases will deny a rental abatement if the casualty loss was caused by the Tenant's negligence. Fires are almost always caused by someone's negligence and that is the purpose of a waiver of subrogation. A tenant should not lose its abatement if an employee accidently starts a fire. Such a clause should be deleted or at least limited to intentional acts or gross negligence by the tenant.