Part 11 – last Article blog

11. Lender issues: Landlords will frequently reject tenant’s suggested lease modifications because they would impair the “financeability” of the property, so the tenant must understand lender concerns. In general, the lender’s primary concern is the assurance of uninterrupted cash flow; anything that might jeopardize cash flow will be carefully scrutinized. Sensitive lease provisions generally include tenant remedies such as rent abatement, offset rights (deducting damages against rent) and lease termination rights.

 Successful negotiation means more than just the rent  As noted above, each step of the commercial lease process and each provision of the lease agreement provides ample opportunity to improve the deal, and conversely, expose the landlord or tenant to costly and unnecessary expense. The successful negotiation will focus on more than just rent. By reducing risks and avoiding surprises, the frantic calls for help may be a thing of the past.

Part 11

9. Defaults and Remedies: The rights and remedies of the parties in the event of a default by the other are largely governed by the express terms and conditions of the lease. In many states, there is no comprehensive statutory scheme governing such rights and remedies. The parties should assure that the lease document accurately reflects their understanding as to what constitutes a default and what will be their respective rights and obligations following a default. There are many economic considerations triggered by the remedies afforded, and therefore it is imperative to limit the exposure to avoid expenses above and beyond what is reasonable in the marketplace.

 

10. Insurance and indemnity: Risk of loss and damage between landlord, tenant and third parties is managed and allocated by a combination of indemnification clauses and insurance requirements. A full understanding of the requirements imposed upon both parties, to fairly allocate those risks in conformance with each party’s risk management policies, will always help reduce exposure to expensive and unwanted problems. It is advised that the negotiating lawyer always consult with the appropriate risk management professionals to insure compliance with lease requirement in light of such policies.

 

Article blog – Part 10

7. Repair, maintenance and alterations: Every lease will address maintenance and repair of the leased premises and common areas, and should also address alterations to the premises. Typically, the tenant will maintain the premises (except the structure) and the landlord will maintain the structure, the remainder of the building (not occupied by a tenant) and any common areas. For alterations to the premises, the lease will allocate responsibility between the parties to provide appropriate controls over the types of acceptable changes. The tenant wants flexibility to accommodate its business, while the landlord wants control over any changes, especially involving the structure, exterior elements and building systems (such as HVAC, plumbing and electrical).

8. Compliance with laws: Compliance with applicable laws and ordinances is usually a boilerplate provision, but can be very costly if not properly negotiated. The lease should address who is responsible for making capital expenditures for structural alterations required by laws enacted during the term of the lease (e.g. installation of sprinkler systems or improvements providing access for the disabled). These matters can be substantial and, if they are required to be made by the tenant, may end up being of relatively little utility.

Compliance with laws relating to the specific business conducted from the premises should be the responsibility of the tenant, and should not be included in common area maintenance expenses. ADA improvements necessary within the interior of the premises resulting from tenant’s work should be the responsibility of the tenant. On the other hand, improvements to the common areas necessary for access by of disabled individuals should be the landlord’s responsibility.

Further, compliance with environmental laws is quite significant because of the extensive nature of improvements and attendant costs, which could include the potential for removal of asbestos or lead, responsibility for insuring compliance with environmental laws and indemnification for non-compliance. Leases typically include lengthy representations, warranties and covenants regarding tenant’s compliance with applicable environmental laws.  However,  the tenant should limit responsibility to noncompliance by the tenant, its agents, contractors and agents, as well as ask for the same limitations and rights as granted to landlord (landlord should be responsible for compliance unless caused by a tenant). The definition of “hazardous materials” should ensure that common business materials (e.g. copier toner, batteries, etc.) and normal cleaning supplies are excluded.

Article blog – Part 9

6. Assignment and subleasing: Landlords want to restrict tenant transfers to control the use of the property, to eliminate harmful competition between tenants (avoid disadvantageous mix and violation of exclusives), and to maintain the landlord’s right to negotiate the lease. The issue of “control” is usually the focal point on assignment and subleasing rights. This is particularly important to retail tenants, who need to assure compatibility with other tenants. The landlord may also argue that, in a project that is not fully occupied, a tenant remarketing its premises is a direct competitor.

The most common compromise is to prohibit the landlord from “unreasonably” withholding, delaying or conditioning its consent to a sublease or assignment. The law often implies a good faith standard, and provisions that purport to allow the landlord to withhold consent in its “sole, absolute, and unfettered discretion,” may be unenforceable. Tenants sometimes require the landlord to specify the reason for withholding approval and include corrective actions that can be taken to make the transfer acceptable. The landlord may be required to respond within a specified period of time following request for consent, with landlord’s failure to respond timely deemed to be consent. Another variation is to define all factors the landlord may consider to determine if it has acted reasonably.

Another landlord approach is to reserve a recapture right if consent is requested, which allows the landlord to exclude an unacceptable tenant, control competition with existing tenants and capture any upside in rents. The landlord may also recapture the upside potential by requiring that some or all of the “net profits” from the transfer to be paid to the landlord, and then the challenge is to define “net.” Typically, direct costs, such as brokerage commissions and tenant improvements, are recoverable, but sunken costs usually are not. A provision requiring the tenant to disgorge “all profits” may not be optimal, since the tenant would have no incentive to realize profits.

7. Repair, maintenance and alterations: Every lease will address maintenance and repair of the leased premises and common areas, and should also address alterations to the premises. Typically, the tenant will maintain the premises (except the structure) and the landlord will maintain the structure, the remainder of the building (not occupied by a tenant) and any common areas. For alterations to the premises, the lease will allocate responsibility between the parties to provide appropriate controls over the types of acceptable changes. The tenant wants flexibility to accommodate its business, while the landlord wants control over any changes, especially involving the structure, exterior elements and building systems (such as HVAC, plumbing and electrical).

 

Article blog – Part 8

3. Permitted uses and restrictions on use: The lease will describe what the tenant may do within the leased premises as a “Permitted Use.” Use restrictions will also be included to prevent  objectionable uses, incompatible uses and (particularly in a retail context) exclusive rights. A lease may require the tenant to use the premises only for one specified purpose or may provide for any lawful use. A tenant must analyze how such restrictions might affect its business, as well as its needs for flexibility to allow assignments and subleases, and a landlord desires to maintain a compatible tenant mix and general character of the project (prohibiting unwanted uses).

Lastly, the tenant must comply with use restrictions affecting the premises under recorded documents (for example, a Declaration of Covenants, Conditions and Restrictions recorded against the property), under applicable zoning ordinances, or even other leases. Tenant’s counsel should always ask the landlord to provide all use restrictions applicable to the premises for review and approval during negotiations.

4. Exclusive uses: Exclusive use rights arise primarily in the retail context, which prevent others from selling competing products or services. The trend today is for retailers, particularly large national chains, to demand broad exclusive rights. The landlord tries to negotiate the narrowest rights possible to maintain its ability to lease to a wide variety of tenants. To guard against overly broad restrictions, it is advisable to limit exclusive rights to the single “primary business” of each tenant and to carve out exceptions for “incidental uses,” which may be left undefined or defined by percentage of sales or maximum floor areas. Another safeguard is to require exclusive rights to lapse if not actively used. The negotiations will focus on what constitutes a default by the landlord and subsequent remedies available to the tenant, as tenants want to assure the landlord will honor these rights, and the landlord does not want to be responsible for a “rogue tenant” who violates the terms of its lease.

Part 7 – Common lease components

Below is a discussion of several provisions found in a typical lease agreement, and a brief summary of the issues and negotiating positions for each party. These are critical to focus on in every lease transaction as each could ultimately make or break the deal. Please also see the sample tenant checklist available on my webpage for other issues to consider for each lease review.

1. Construction and tenant improvements: Almost every lease provides for the construction or installation of tenant improvements to the leased premises or the surrounding areas for the tenant’s use, ranging from construction of an entire building to moving a wall. There are aspects of this process, including design, approval, timing, and execution of the construction, that are common to all leases, and are often found in the Work Letter attached to the Lease (which is often fully negotiated with the LOI). Each aspect should be dealt with to avoid unpleasant surprises later. The Work Letter can be very specific and must accurately reflect the complete arrangement of work between the parties. Also, the construction contract and related documents (not just the plans and specifications) are often prepared by an architect or other non-lawyer who relies heavily on forms and fails to notice conflicts between the language of the form and the deal as understood by the parties. The lawyer must review the construction provisions and exhibits carefully, as most construction disputes flow from the failure of the parties to have a common understanding, as reflected in a clearly worded document, and all terms and conditions should be reviewed and fully approved by the project manager or other construction personnel before execution of the lease.

 

Part 6 – Negotiating a favorable agreement

Before the parties begin negotiating the lease document, and before the lawyer is consulted, the design process typically has already begun. By the time the LOI is prepared, the parties usually have at least a preliminary space plan for an office lease or a site plan for an industrial or retail project. The basic scope and nature of the construction will have been discussed and an understanding of some sort reached. The negotiations should flush out the unstated assumptions and expectations of the parties and resolve points of conflict.

Negotiating the lease should not be difficult! In fact, many landlords recognize that providing “superior tenant service” begins by making the lease negotiation process as simple and efficient as possible, as long delays over minor details serve neither party. Increasingly, landlords are shortening the lease negotiation process through a system of alternate lease clauses used to substitute standard clauses as appropriate, to avoid having to write specific language each time an issue arises.

Part 5 – The Letter of Intent

For purposes of this article, the negotiation process begins with the Letter of Intent (or LOI), which can only be developed after the tenant understands its needs. The LOI represents a compilation of the many considerations that a tenant might have. All of the tenant’s needs and core requirements (both business and legal) should be considered when developing the LOI, as it is difficult to obtain the best result when important considerations are introduced late in the negotiation. Further, the LOI should be consistent with market conditions and what the particular tenant can attain in the current marketplace (i.e. Fortune 500 credit will normally be able to ask for more than a smaller tenant with local credit) and the LOI should be customized to properly reflect the same.

The LOI, once presented, becomes the basis for the negotiation and helps maintain a focus on issues not fully resolved between the parties. Even if non-binding, deviating from terms agreed upon in the LOI is difficult. Accordingly, the importance of initially addressing all significant items in the LOI cannot be overemphasized. For example: (1) the tenant’s negotiating leverage will be reduced if provisions such as options to extend or terminate, liability limitations, escalation and security deposit provisions, rights of first refusal, and other items of significance are not included in the LOI, and (2) it serves everyone’s interests to spend extra time on the details of the LOI to minimize misunderstandings during negotiations, together with the associated cost of attorneys and other professionals engaged by the parties. To preserve that the LOI will not be binding, the document should not only provide as such, but should further provide that it imposes no legal obligation to continue negotiations to reach agreement. Alternatively, the parties may be obligated to negotiate in good faith, and if no formal agreement is reached within a prescribed period of time, either party may terminate negotiations.

As a result, it is important to employ an effective method of tracking the progress made on deal points, while also assuring that the original points eventually are addressed. This has the added benefit of documenting the negotiation, which is useful to understand the intent of the parties and to draft language accurately reflecting all negotiated points.

Part 3 – the Process

The selection and acquisition of a facility for a company’s business is one of its most important decisions it will make, and it can mean the difference between profitability and failure. Commercial leases are made for the long-term, and the payments made under a lease often represent a significant portion of the business’ expenses. The total financial burden of rent, costs of tenant improvements and other lease charges can significantly impact the overall success or failure of a business. To reach the best deal, and to prevent costly disputes, it is crucial to negotiate a favorable and highly detailed agreement. Understanding all of the lease details will allow you to negotiate effectively and creatively, and will also keep you from being surprised by unfavorable or unfamiliar terms.

The process basically consists of site selection, business terms negotiation and document negotiation and drafting. To be successful, each component of the lease must be identified, analyzed, prioritized and negotiated. Also, the timing required to complete the lease transaction should not be overlooked. Ample time should be allowed and the participants should not permit themselves to be rushed through the process in the pursuit of unnecessary or arbitrary deadlines. Decision-makers and participants in the leasing process should be consulted early to determine the amount of time required for each step and a timeline should be considered allowing an orderly selection, negotiation and documentation process.

Identification of all business and legal needs, and subsequent prioritization of such needs, should occur at the very beginning to avoid losing sight of the most important issues. Identification is facilitated by each side asking itself a number of questions relating to their respective needs and attaching a level of importance and priority to such needs. A list of questions a tenant might ask is provided in the table below [See Table 1 – I will post this soon], however each party should consult qualified professionals to help ask the right questions and develop an understanding of their own business and legal needs.

Blog Series – Successful Lease Negotiations, part 2

Types of leases Leasing is a complex subject because there are so many different kinds of leases, and it is a field of law, which can change rapidly as market and general economic conditions require new approaches to addressing the parties’ rights and obligations in the transaction.

Most commercial leases are categorized according to whether the use is office, retail or industrial in character. Each lease category tends to have more of a focus on one area or another. For example, office leases typically include services provided by the landlord, including janitorial services, maintenance, repair and operation of building systems, elevators, utilities, air conditioning and security. Industrial leases usually involve few services, except maintenance and repair of any shared parking or landscaping for a multi-tenant project. Retail leases are generally similar to industrial leases, but they include operational concerns particular to the retail context, including use restrictions, signage and site plan issues. There are also considerable differences between multi-tenant and single tenant projects, and the structure of any lease will be highly influenced by whether the property involved is leased to a single tenant or is part of a larger project.

A “gross lease” is one that involves payment of a fixed rental amount without any additional charges for taxes, insurance, utilities, or other charges. True gross leases are typically used only for short-term tenancies of relatively small lease areas. A “modified gross lease” is one in which some, but not all, operating costs of the property may be passed through to the tenant, in addition to base rent. In some forms of modified gross leases, the charges that may be passed through are taxes or other expenses of the property only to the extent that they exceed an “expense stop” or “base year amount.” Modified gross leases often are also “full service leases,” because the landlord directly provides all janitorial and utility services to the leased space. Further, a “net lease” (also called “triple net”) requires the tenant to pay, in addition to base rent, the tenant’s proportionate share of all utilities, insurance premiums, real property taxes, and maintenance and repair expenses for the property.

Further, specialized leases have evolved to serve financing functions, including ground leases (separate ownership of land from building), sale/leaseback transactions (shifting risks and benefits of ownership to a third party), build-to-suit leases (capital for building construction designed by tenant supplied by landlord), synthetic leases (operating lease for financial accounting reporting purposes and a secured loan for all other) and securitized leases (structured and packaged so income stream can be sold to third party investors through the securities market, often as a pool of leases).

It is important to fully understand the type of lease transaction being negotiated, regardless of what it’s called, in order to effectively negotiate the deal.

Blog Series, part 1

Both landlords and tenants seek help to resolve a dispute that has arisen with their commercial lease because they signed a misunderstood or poorly negotiated agreement. This is especially true of less sophisticated tenants who, for whatever reason, have chosen to sign the landlord’s “standard form lease” with few, if any, changes. Additionally, inexperienced landlords often use a form lease without fully understanding the terms and conditions imposed upon them.

The potential for dispute in a commercial lease can result from many things; however, the focus of lease negotiations is often limited to rent, concessions and other economic considerations. As a result, many important issues are often overlooked; misunderstood or under-negotiated (even by sophisticated landlords and tenants) that could materially affect the long-term success of the deal and are often the reason for their calls for help.

Commercial leases are often called “living” documents, as they govern the ongoing relationship of the landlord who owns or manages a property and the tenant who operates its business on that property. A lease is like a partnership agreement because it provides the parameters of a business relationship, and unlike many legal documents, the real work of a commercial lease commences when the document is signed and the deal is done. Negotiating the best possible deal is done throughout the entire leasing process, from the initial decision to move forward through lease execution. There are many significant terms and conditions that should always be considered when negotiating the deal.  This article sets forth a few of the major lease provisions that landlords and tenants should focus on, but is not intended to serve as a substitute for consulting with a real estate attorney.

Rent: Just One Side of a Commercial Lease Agreement

My blogs for the next week or so will contain excerpts from an article I co-wrote for the ACC Docket, November 2010 edition, titled “Rent: Just One Side of a Commercial Lease Agreement.”  The discussion contained in the article was written for corporate lawyers, but applies to a much wider audience as it describes the importance of careful planning and analysis throughout the leasing process, and also emphasizes the need for the tenant to focus on each provision contained in the definitive lease agreement.  A successful lease negotiation focuses on more than just the base rental amount, as vital components of reducing a company’s occupancy costs include mitigating risks and exposure to unforeseen expenses, maximizing flexibility and operating efficiencies, and aligning the company’s real estate strategy with its overall business plan. 

I hope these postings will be enjoyable to read and informative.  Feel free to call or email, and we’ll show you why we’re Studley!

How well does your lease protect you?

The selection and acquisition of facility for a company’s business is one of its most important decisions it will make, and it can mean the difference between profitability and failure. Commercial leases are made for the long-term, and the payments made under a lease often represent a significant portion of the business’ expenses.  The total financial burden of rent, costs of tenant improvements and other lease charges can significantly impact the overall success or failure of a business. 

The focus of lease negotiations by a tenant is often limited to rent, concessions and other economic considerations. As a result, many important issues are often overlooked, misunderstood or under-negotiated (even by sophisticated tenants) that could materially affect the long-term success of the deal and the company.  Negotiating the best possible deal is done throughout the entire leasing process, from the initial decision to move forward through lease execution.  To reach the best deal, and to prevent costly disputes or unforeseen expense, it is crucial to negotiate a favorable and highly detailed agreement. 

This really speaks to the heart of a serious problem.  On-the-job training has traditionally been the primary path to knowledge by brokers when it comes to leasing, and as a result, you could spend years of expensive trial and error and still never attain competency.  Did your tenant rep professional help protect you throughout the lease negotiation process, or were your left to fend for yourself once the base rental amount was agreed upon?  Was your broker willing to fight for you when negotiating lease provisions with the landlord?  Did your broker bring years of legal training and lease negotiation experience on behalf ot the tenant to your transaction, and take ownership of the terms and conditions of the lease agreement? 

How well does your lease protect you?  Are you confident that you’ve negotiated a favorable lease?  Let us protect your company from unpleasant problems, it’s not just about rent when it comes to negotiating a good lease deal.  You can better serve your company’s interests by mitigating the risks concerning your corporate occupancy, to negotiate the best possible deal in the marketplace.  We’d be happy to show you why we’re Studley!

Ty Gives His Views: Experience Matters.