10 basic points to commercial real estate leasing

Ten Questions for the Client

1. Basic Terms

Are the basic terms of the lease correctly stated? Is there a letter of intent or term sheet? If so, make sure you get a copy. Confirm the following: dates, names of parties, premises description (ask for a drawing, if available), term, rent, common area charges, security deposit amount, tenant finishes and other allowances, landlord’s work and condition of the premises, parking, renovation and alteration rights, payment of brokers, and other rights and personal guaranty obligations. Who pays the brokers?

2. Renewal, Contraction, or Expansion Rights; Assignment and Subletting

Does your client expect to have any renewal, contraction, expansion, or termination rights? Does your client have any special needs relating to assignment, subletting, or others’ use of the premises that should be addressed in a “Permitted Transfers” section? Does the client need anything from the landlord to obtain financing or intend to obtain a leasehold mortgage?

3. Permitted Use

Is the permitted use in the lease broad enough, not only for your client’s immediate purposes but also if its business changes or it needs to sublet or assign? Is the permitted (and potential future) use allowed under the applicable zoning and any CCRs (recorded covenants, conditions, and restrictions) or rules and regulations? Does the client need any exclusive use rights or radius restrictions (for retail tenants)?

4. Beyond the Premises

What other portions of the project, beyond the premises themselves, does the client need for its business to function optimally? Consider the client’s needs for parking, interior or exterior storage, roof top space, utility access, telecom chases and risers, overhead doors, vaults, overhangs, sidewalk or outdoor patio space, freight elevators, trash enclosures, lobby and other common area space, and backup generators. What about signs? Does the client want its name on the building or in the directory?

5. Beyond the Base Rent

What are the expected charges for operating expenses, taxes, insurance, common area maintenance, and the like, and what is the client’s proportionate share? What services are provided by the landlord, and which are the tenant’s responsibilities? What have actual charges been for prior years? Analyze the cost pass-through provisions for inappropriate costs that are too burdensome given the length of the lease, such as capital expenditures, or that are not customary in the market. Consider paying only the amortized portion of any capital expenditures. What other items must be paid as additional rent, such as parking, storage or other items, after-hours use of the premises (HVAC, utilities, security, parking), relamping, or excess water or electrical use? How will the charges increase each year, and can you get a cap on controllable operating expenses? Is there any right to review or audit such charges?

6. Insurance

Does the client’s insurance coverage meet the lease’s minimum requirements? Suggest that your client ask its risk manager or insurance broker or advisor to review the lease, especially the insurance, damage and destruction, exculpation (release), waiver of subrogation, and indemnity clauses.

7. Inspections

Has the client thoroughly inspected the premises to ensure its condition meets the client’s expectations and needs? Are the premises now in a suitable condition for moving in, or will they be in suitable condition after the agreed-on landlord’s and tenant’s work is done?

8. Termination Rights

What are the client’s rights if the lease is terminated based on a casualty loss, condemnation, foreclosure, or other termination right of the landlord? Is the tenant’s investment in the premises adequately protected if the lease is terminated for any reason? Are its moving costs covered? Does the tenant need or want the right to terminate the lease in certain situations, such as failure to obtain certain permits, certain casualty events, failure of the landlord to deliver the premises on time, interruption of services, violations of exclusive use grants, or landlord defaults?

9. Commencement Date

When does the client absolutely have to be in the premises? Be sure the lease makes the premises available when the client needs them and that the client has adequate remedies if that does not happen.

10. Read the Lease

Has the client read the lease? A person in the tenant’s organization who is going to use the premises and understands the practical needs of the tenant has to read the lease to see if it works for the tenant.

Ten Traps

No matter how small a space nor how short a term, a lease can trap a tenant into unexpected and significant liabilities. The following are traps for the unwary tenant.

1. Construction, Renovation, Repair, and Remediation Obligations

A lease may impose tenant maintenance, repair, construction, and remediation obligations that are out of line given the nature of the lease. A three-year tenant, for example, should not have to perform upgrades required by the Americans with Disabilities Act or the fire or building code unless such alterations are required by some unusual tenant use. Check the following clauses closely: maintenance and repair beyond ordinary maintenance and repair of the premises, such as the building’s roof, heating, ventilation, and air conditioning system, other building systems, and common areas; compliance with laws (for code compliance upgrades, retrofits or other construction requirements, or possible capital expenses); environmental compliance (for remediation obligations for existing environmental conditions or contamination not caused by the tenant); and casualty loss and condemnation (for restoration obligations).

2. Overly Broad Indemnity Obligations

Study the indemnity provisions very carefully to be sure the tenant is not inappropriately assuming liabilities. Confirm that the tenant can obtain insurance coverage (contractually assumed obligations coverage) for the entire insurable scope of its indemnification obligations. Generally, the indemnification should be limited to anything that happens in the premises and anything the tenant and its agents, employees, contractors, and invitees do outside of the premises, and without consequential, special, or indirect damages, if possible. Be sure the tenant’s indemnification obligation (and the exculpation or release of landlord provision) excludes actions and negligence (or at least gross negligence) of the landlord and its agents, employees, and contractors.

3. Waiver of Subrogation

Confirm that the lease contains the mutual waiver between the landlord and the tenant to support an insurer’s consent to a waiver of subrogation. Confirm that the landlord’s and the tenant’s insurance policies each allow such a waiver.

4. Relocation and Re-measurement Rights

Landlords often reserve the right to move the tenant to other space in the building to accommodate a future tenant that needs, for example, a full floor or a large portion of a floor. In such a case, the lease should limit the locations to which the original tenant can be moved and compensate that tenant for moving-related costs. The landlord also might reserve the right to re-measure the premises or the building, both of which the tenant should resist. Area measurement can affect the base rent or the percentage share of expenses the tenant is required to pay. Obviously, a landlord is going to exercise the right to re-measure only if it benefits the landlord. Re-measurement not only includes changes in the square footage of the premises, but also can change the way the space is measured (for example, to the outside glass rather than to the baseboard) and the allocation of common area to the premises. The new widely used Building Owners and Managers Association International (BOMA) standards increase the “rentable area” of office space by a substantial amount over “rentable area” determined under the 1996 standard. Office Buildings: Standard Methods of Measurement (ANSI/BOMA Z65.1—2010).

5. Subordination Without Nondisturbance, Quiet Enjoyment

Unless the lease provides that the tenant’s occupancy will not be disturbed if the landlord’s lender forecloses on the building, most leases subordinate the lease to an existing or future lender’s lien and provide that the lender may terminate the tenant’s lease in a foreclosure. Although a tenant whose lease is likely to add value to the building (usually a large, credit-worthy tenant) may be more successful in obtaining a nondisturbance clause for future lenders and an SNDA from the existing lender, every tenant should ask for nondisturbance protection in the lease and agree to an SNDA if needed to get it. Does the lease otherwise require the landlord to protect the tenant’s quiet enjoyment and possession?

6. Changes to Common Areas

Landlords often retain the unfettered right to change common areas. If the tenant’s access, visibility (especially for retail tenants), parking, or other important amenities are part of the common area, the tenant will want to limit changes to those common area amenities.

7. No or Limited Cure Periods

Default provisions can really hurt a tenant. They also are difficult to negotiate because the landlord’s typical response (not completely meritless) is “don’t default.” The most common default clause traps are no notice of the default from the landlord, no cure period, and both interest and penalties for late payments. Ideally, the tenant should have a cure period after notice from the landlord that a payment is late, which protects the tenant if there is a snafu in making the payment of which the tenant is unaware. For nonmonetary defaults, the practical ideal is a 30-day cure period following notice from the landlord that is extended for the reasonable time necessary for the tenant to actually effect a cure.

8. Damage Penalties—Making the Landlord More Than Whole

Remedies provisions are similarly difficult to negotiate, but sometimes they simply are unreasonable as presented to the tenant. Common overreaching provisions include (a) high liquidated damages for a breach; (b) excessive default rates of interest; (c) double recoveries (for example, recovery of full rent, plus a separate recovery of the full amount of any free rent, tenant finish allowance, or other allowances, all of which are amortized over the lease term and are thus already recovered if the landlord recovers the full rent); (d) unreasonable restrictions on mitigating damages (for example, a long list of types of tenants the landlord need not consider as a replacement tenant, often including the landlord’s existing and prospective tenants); (e) excessive costs to restore or alter the premises for the next tenant; (f) very low rates of interest (for example, Treasury rates or less) for discounting the future rent to present value; and (g) landlord’s liens (perfected as a UCC security interest) covering all of the tenant’s property (which could include the tenant’s proprietary information and assets it may need as collateral for business loans). Is each party entitled to payment of its attorney’s fees if it is the prevailing party in any dispute?

9. Extensive Removal Obligations on Surrender of the Premises

A tenant may want to limit its restoration obligations when surrendering the premises so it is not obligated to remove (a) tenant finish that existed when the tenant took occupancy; (b) tenant finish or alterations made during the lease term with the landlord’s approval (unless the landlord told the tenant before the alteration was installed that it would need to be removed); and (c) telecom cabling that the tenant did not install. Does the tenant have trade fixtures to install? Make sure they are approved and that the tenant can remove them at the end of the term.

10. Unclear Work Letter Obligations

Work letters or clauses (the lease provisions or addenda that define the tenant finish work to be accomplished before the tenant moves in) are often cursory and fail to clearly define (a) exactly what work will be done, or what the step-by-step procedure will be for defining the scope of such work, as well as the procedure for approving space plans and construction drawings; (b) who will do the work; (c) who will pay for the work; (d) when the work will be completed and whether the tenant has any remedy for late completion; (e) a procedure for inspecting the work, creating a “punch list” of unfinished items, and a schedule and procedure for completing those items; and (f) a warranty for the work. The tenant should ensure that the consequences of delay are spelled out and that the tenant does not bear the responsibility or burden for the landlord’s delay. Ideally, the work letter or clauses will address the landlord’s responsibility for latent defects. Also, if the landlord is performing the work, watch out for provisions that trigger rent commencement before the premises are completed and the tenant can move in.