Lease Negotiations – Tips for Tenants
So you’ve decided to start a new business or expand your existing business, and you’ve found the perfect location. For most businesses, that means you’ll be leasing your new space.
The first step in the leasing process will involve negotiating the “business” terms of the lease, which are generally reflected in a letter of intent. These terms will include a description of the space (by size and location), the term of the lease, any renewal options, the rental rate during both the initial term and any renewal options, a description of any work the landlord is required to do in the space, and a statement as to any “tenant improvement allowance” to be provided by the landlord to reimburse the tenant for all or part of the work the tenant performs to improve the space. Although letters of intent are often quite brief, a savvy tenant will actually want to make sure it includes everything of real importance to the tenant in the letter of intent. Want a sign at the top of the building? Put that in the letter of intent. Want some reserved parking spaces? Put that in the letter of intent.
Except in the case of large companies with numerous locations who have developed their own lease forms, the next step for most tenants will be the proposed lease from the landlord, which (supposedly) incorporates the terms of the letter of intent. The reality for many tenants will be that the lease is a 50 page document in which the landlord has very few responsibilities and no legal liability for anything whatsoever, while the tenant is obligated to do whatever the landlord says, whenever the landlord says to do it, under threat of a torrent of legal sanctions. In addition, it is not unusual to find that the lease does not accurately reflect many of the terms that were agreed to in the letter of intent. The question the tenant then faces is how much effort (and legal expense) it is willing to devote in trying to rewrite the lease to make it fair and accurate, and how cooperative is the landlord likely to be in that effort. Perhaps the only good news here is that most (but not all) landlords are surprisingly cooperative, so keep in mind the adage that “if you don’t ask, you don’t get.”
Once you’ve reviewed the lease and addressed any inconsistencies with the terms of the letter of intent, here are a few negotiating tips and some potential issues to look for:
- Reciprocity. An excellent guiding principle in any lease negotiation is the idea that what’s good for the goose is good for the gander. This principal will apply to many, many provisions of the lease. For example, if the landlord is entitled to recover its attorneys’ fees if it prevails in any lawsuit against the tenant, then the tenant should also be entitled to recover its attorneys’ fees if it prevails. If the landlord has right to cure any tenant default at the tenant’s expense (such as by hiring a contractor to fix something the tenant was supposed to fix), then the tenant should have the right to cure any default by the landlord at the landlord’s expense. If the tenant has to pay interest to the landlord on any amounts not paid to the landlord in a timely manner, the landlord should pay interest (at the same rate) on any amounts owed to the tenant.
- Landlord’s Consent. Whenever the landlord’s consent is required for anything under the lease, it should not be unreasonably withheld. The grant or refusal of the landlord’s consent should never be in the landlord’s “sole discretion.” Since leases will often have many, many provisions where the landlord’s consent is required, the most efficient way to address this concern is to simply include a section at the end of the lease that states that “In any case where the landlord’s consent or approval is required under this lease, such consent or approval will not be unreasonably withheld, conditioned or delayed.”
- Delivery Date. Although the lease will likely specify a target date for delivery of the space, most leases say that the landlord is not liable if it misses that target, and that the tenant remains obligated to take the space whenever the landlord finally delivers it – even if it’s 5 years later. Always include a “drop-dead” date by which the space must be delivered or the tenant can terminate the lease.
- Landlord’s Repair Obligations. Landlord’s leases tend to be inappropriately brief in discussing the landlord’s repair obligations. At a minimum, the landlord should be required to maintain and operate the property in compliance with all applicable laws, and in a manner comparable to comparable buildings in the same metropolitan area. Specific maintenance obligations imposed on the landlord should include: (i) structural repairs to the building(s), including the floor slab; (ii) maintaining the roof in good condition and free of leaks; (iii) maintaining the surfaces and components of all exterior walls; (iv) keeping the property clean and properly drained; (v) keeping the parking areas and free of snow, ice, water and other obstructions; (vi) maintaining and repairing all paved portions of the property, including parking lot striping; (vii) maintaining all landscaping; (viii) maintaining all utility lines to the point of entry to the Premises and any lines located beneath the floor slab of the Premises; and (ix) maintaining all electrical and mechanical systems other than those that exclusively serve the Premises. The landlord should be required to commence repairs within 30 days after written notice from the tenant, or within such shorter period as may be reasonable in the event of an emergency (the tenant shouldn’t have to wait 30 days for the landlord to fix a huge hole in the roof).
- Pro Rata Share. Leases for multi-tenant properties generally state that each tenant is responsible for its “pro rata share” of the operating costs, real estate taxes and insurance charges relating to property. Although most leases calculate each tenant’s share as a percentage of the “leasable” space on the property, some landlords will change “leasable” to “leased.” The difference can be enormous. If you are a 5,000 square foot tenant in 100,000 square foot building, and your pro rata share is based upon “leasable” square feet, your share will be 5%. If your share is based on the “leased” square footage of the property, and all of the other tenants move out, you will find you suddenly have 100% of the leased space and are responsible for 100% of these charges!
- Landlord’s Insurance and Waiver of Subrogation. Since the landlord’s cost of insuring the building is typically passed through to the tenants on a pro rata basis, the tenants should get the benefit of that insurance. This means that if a tenant accidentally leaves a coffee pot on and burns down the building, the cost of rebuilding should be paid by the landlord’s insurance and the tenant should not be liable to the landlord for that cost. Two things are important here: first, the lease should require the landlord to maintain full replacement cost coverage on the building, and second the lease should contain a mutual “waiver of subrogation” clause that says that neither party will make a claim against the other for any loss that is covered by the injured party’s insurance.
- Tenant Improvement Allowance. Getting landlords to actually hand over the tenant improvement allowance can sometimes be problematic. One standard condition for the payment of the allowance is that the tenant must provide the landlord with signed lien releases from all of the tenant’s contractors, subcontractors, and suppliers. But what happens if a subcontractor who did $500 of work on the project can’t be found or simply refuses to provide a lien waiver? In most cases, this means the landlord will refuse to disburse any portion of the allowance, even if the $500 at issue is only a tiny fraction of the total allowance. A tenant can avoid this problem by including language that states that: (i) if the tenant cannot provide a lien release from a particular contractor, subcontractor or supplier, the landlord can only hold back an amount equal to the value of the work provided by that particular contractor, subcontractor or supplier; and (ii) upon the expiration of the statute of limitations for the filing of a mechanics lien (which is typically 90 days after the work was performed or the materials were delivered), if the tenant can show that no lien has actually been filed, the landlord must release any withheld funds.
Of course, there are many more potential pitfalls for a tenant in a typical lease. As with any agreement, a tenant’s best defense will be to make sure it reads and understands its lease, and obtains competent legal counsel to help with the review and the negotiation process.
Author John L. Egloff
John Egloff serves as trusted legal counsel for scores of local, regional and national businesses, providing a full range of legal services with respect to their operational and transactional needs. John’s more than 30 years of experience as a business attorney includes the formation, acquisition, sale and merger of business entities large and small, and the negotiation, drafting and/or review of virtually every type of business agreement and business-related documentation, including real estate and equipment leases and purchase agreements; financing documents (loan agreements, notes and mortgages); private placement memoranda; employment agreements (including non-competition agreements); licensing and franchise agreements; dealership and distributorship agreements; and routine customer and vendor documents (such as purchase order forms and warranty documentation).
John has served as the Firm’s managing partner and has continued to serve on the Firm’s Management Committee.
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Posted on Nov. 30 2016 by John L. Egloff