Your Hours May Be Set By Your Landlord

RESTAURANT LEASING: Part 4 of 5

The Continuous Operation Clause in Restaurant Leases

Most landlords will insist on including a continuous operation clause in a restaurant lease. These clauses require a tenant to be open for business continuously during the term of the lease on specific days and at hours dictated by the landlord. It is in the landlord’s best interest to make sure it’s tenants are fully operating because this attracts customers. More customers increase a tenant’s sales, which in the case of a lease with percentage rent, means more rent owed to the landlord. While these clauses vary considerably from one lease to another, it is important to read and understand them before you enter into a long-term agreement as continuous operation clauses have several hidden problems that could affect the unsophisticated restaurant tenant.

When negotiating a restaurant lease it is crucial to address the days and hours of operation up front. If a landlord isn’t flexible on these items, it’s better for a tenant to know right away so the tenant doesn’t waste their time and money on a site that won’t work for their business model. A clause that requires a tenant to open earlier, or remain open later, then times customers are predicted to patron the restaurant will quickly erode its profitability. For example, a brewpub restaurant concept probably shouldn’t be expected to serve breakfast, but it probably would want to remain open late to maximize alcohol sales. Likewise, a coffee shop serving breakfast and lunch probably won’t want to be required to remain open until 10:00 p.m. Also important for tenants operating in shopping centers that desire to remain open past normal center hours, the lease should address the party responsible to cover increased operating costs, such as additional lighting, security, parking and access.

Another important issue to address in continuous operation clause is the ability of the tenant to close an unprofitable restaurant and/or terminate the lease. Under a typical continuous operation clause, a tenant would be in default under the lease if it ceased operating, opening itself up to damages and penalties. A tenant in this situation would be forced to decide between closing the restaurant to reduce its costs and expenses or default on the lease. However, a tenant can protect themselves from this situation by insisting on including a “go dark” clause.

A “go dark” clause permits a tenant to stop operating at a site without being in default under the lease. This clause is typically dependent on tenant complying with all of its other lease obligations, including paying rent. A “go dark” option may be available immediately or after a period of time operating (e.g., 1, 2 or 3 years). A tenant will still be obligated to pay rent under the lease, but its expenses will be reduced because it is no longer operating. Landlords may require a tenant to provide a reasonable amount of notice of its intent to go dark so that it can find a suitable replacement for the tenant. Since such a notice requirement will extend a tenant’s ability to stop the bleeding, the tenant should insist on minimal amount of notice as possible.

In the event a tenant goes dark during the term of the lease, a landlord is left with an empty space that isn’t generating sales or attracting foot traffic. In order to protect its interests, the landlord may insist on a recapture right. This recapture right permits a landlord to regain control of the space after a tenant goes dark for a period of time and re-lease the space to another tenant of its choice. When the landlord elects to recapture the space the lease terminates. Tenants should include carve out language in the recapture clause for periods of time tenant closes due to a casualty, repairs, maintenance, alterations or periodic reimaging. A landlord may attempt to include language in the recapture clause that requires the tenant to reimburse landlord for certain costs, such as improvements and brokerage fees. A tenant may argue that since the landlord has the ultimate decision to terminate the lease, but for landlord recapturing the space, it would have paid rent for the entire term.

Continuous operation clauses have many moving parts and are complicated.  While this article touches upon some of the issues that commonly arise in a lease negotiation, how these and other issues are resolved will depend upon many factors, including the relative bargaining strength of the parties involved.

If you have questions about your restaurant lease, please contact our attorneys at Morsel Law.

Exclusive Use: Before Adding Coffee to the Menu Check Your Lease

RESTAURANT LEASING: Part 3 of 5

Restaurants are constantly adding and subtracting menu items to meet customer demand. Whether it’s adding healthy options for calorie conscious consumers, like salads and wraps, or craft cocktails and beers, rarely will a restauranteur review its lease prior to changing menu items. However, it’s important to know whether your lease is subject to an “exclusive use” provision granted to another tenant by the landlord. Violating this provision can be costly to wary restaurant owner.

For example, I recently spoke with a business owner who was sued by a neighboring tenant over the right to sell pizza. The business owner sold thin-crust artisanal pizzas as an appetizer, even though its neighboring tenant had an exclusivity clause in its lease to sell “traditional pizzas.” What qualifies as “traditional pizzas” is at the center of the dispute, but regardless of the outcome litigation is expensive and can be potentially avoided if an exclusive use provision is carefully crafted.

As a tenant, including an exclusivity clause in your lease may be key to maintain a competitive advantage over other tenants. While most large chain restaurants will require an exclusive use provision, it is just as (if not more) important for mom-and-pop restaurants to also insist on exclusivity in order to eliminate the competition within the tenant’s own backyard and help ensure a steady stream of potential customers. On the other hand, each time a landlord grants an exclusivity to one tenant it narrows the pool of potential tenants from which the landlord may lease space. No landlord wants to make it harder than it has to be to fill vacant space, or have to turn down a request from an existing tenant to change its use.

Tenants should seek an exclusivity clause that is a broad as possible that accurately captures the types of uses and businesses from which the tenant seeks to be insulated. While a tenant may want an exclusivity clause prohibiting any other restaurant use, this is probably an unrealistic and unnecessary request. Landlords will try to narrow the scope of the exclusivity in order to maintain flexibility in future leasing activities. As such, the tenant’s permitted and/or actual use may not be precisely the same as the tenant’s exclusive use. For example, a local coffee shop may seek the exclusive right not only to coffee sales, but also to the sale of tea. If the coffee shop also sells sandwiches, muffins and bagels, but those sales only make up a small portion of overall sales, the owner may not be as concerned about extending the exclusivity to full-service diners that serve breakfast. Conversely, a diner’s exclusivity clause may prohibit only businesses that derive more than a small percentage of their total sales from breakfast food items, such that the coffee shop and the diner could coexist within the same shopping center, as could a quick service sandwich shop. Further, the exclusive use clause could be crafted to prevent a national coffee chain from moving into the center, but might permit the diner and the sandwich shop to sell coffee.

But how is a tenant supposed to know whether their use will violate another tenant’s exclusivity clause or if a current use in the shopping center would violate the tenant’s exclusivity clause? Tenants can seek assurances in the lease from the landlord in the form of representations and warranties, but some landlords may object to such representations and instead agree to provide the tenant with all existing exclusives for the tenant to review on their own. Landlords may also carve out preexisting tenants from the scope of the exclusivity, so tenants should make sure to perform their own due diligence on the existing tenants. The parties may agree to add as a compromise that the landlord cannot agree to a change in the use given to a preexisting tenant if such change would violate the tenant’s exclusivity clause.

Exclusivity clauses may also extend within a certain proximity of the restaurant, which such restriction can apply to both landlords and tenants. Landlords may want to prohibit tenants from operating another restaurant in close proximity to its current restaurant, especially when the lease includes percentage rent, because this could lead to declining sales receipts. In order to prevent this from occurring, landlords may insist on a clause that prohibits a tenant from operating another restaurant with the same primary use within a certain radius of the existing restaurant. On the other hand, Tenants may seek to prevent the landlord or any affiliates of landlord from permitting a violation of the exclusivity within a certain radius of the shopping center. While landlord may resist including such a provision because it could affect the marketability of the shopping center, a reasonable compromise may be to carve out any existing tenants within the specified radius.

Another important consideration for restaurant tenants is the practical effectiveness of exclusivity clauses.  Often tenants focus on obtaining the exclusivity language but neglect to address how to actually enforce this language in the event of a violation. Given the catastrophic effect a competing use may have on tenant’s business, a tenant will want extensive remedies for a violation of the exclusivity clause. Tenants should push for language discouraging landlords from ignoring the exclusivity restrictions and also requiring them to take action in the instance of “renegade” or “rogue” tenants who disregard the protected exclusive use. A tenant may negotiate the right to abate a portion of the rent during the period their exclusive use protection is compromised or permit the tenant to seek injunctive relief. In addition, tenants may seek to include a termination right in the event the violation continues for a certain period of time. Some landlords may permit a tenant to terminate the lease only if the violation is caused by a rogue tenant, the violation continues beyond a specified period and the violation has a material impact on the tenant’s business. After a specified waiting period, a landlord may well require the tenant to either exercise the termination right or start paying full rent again.

Exclusive use provisions in restaurant leases provide critical protection to a tenant’s business. A tenant’s ability to obtain acceptable exclusivity protection is often proportionate to their bargaining power with respect to the landlord and other tenants, and is also related to how the desired protective language relates to the overall negotiation of the lease. In the event a tenant is able to successfully negotiate exclusivity, such clause should be included in a Memorandum of Lease and the memorandum should be recorded with the appropriate recorder’s office in order to put other parties on notice of the existence of such exclusivity.

If you have questions about your restaurant lease, please contact our attorneys at Morsel Law.

What Do You Mean I Can’t Change My Restaurant?

RESTAURANT LEASING: Part 2 of 5

You have a great idea for a restaurant concept in an emerging area of the city, let’s say fast-casual barbecue, focusing on pork using your grandfather’s secret rub to give the meat an out of this world flavor. Six months after opening, sales are less than stellar. You’ve received rave reviews from local food critics, but unbeknownst to you when you signed the lease, the immediately surrounding neighborhood is comprised middle eastern families who abhor pork. Realizing the concept is probably best used elsewhere, you inform the landlord that you’re reinventing yourself as a Mediterranean grill, refocusing your barbecue skills on grilling kebabs and meats (other than pork of course). The landlord is sympathetic to your unfortunate situation, but informs you the lease only permits a barbecue restaurant and any other use violates the lease. What is a food entrepreneur to do?

This scenario is quite common; however, the risk can be minimized by proper planning. Restaurants by nature require periodic re-imaging. Whether it’s a complete change of concept or some minor updates and sprucing up, tenants should make sure the lease provides flexibility and an exit plan. This is important in order for restaurants to remain profitable and adaptable to continually shifting market trends. If the restaurant is part of a franchise it will be subject to a variety of image and use requirements imposed by the franchisor and franchise agreement, so these factors must be taken into consideration during lease negotiations.

To protect its flexibility, tenants should attempt to negotiate a broad use clause to permit a “restaurant or any lawful use.” Similar concepts should be addressed in the alterations and signage provisions of the lease in order to permit tenant to reimage or rebrand as necessary. Since the lease term for restaurants are generally longer than most other retail businesses, such broad use clauses will protect a tenant from future changes in the market.

Landlords may not be willing to provide such flexibility out of fear that a restaurant may become a nightclub, bar or coffee shop. Some landlords may not be flexible at all and may insist upon attaching a menu as an exhibit to the lease to establish the parameters of a potential tenant’s use. However, having an agreed menu can limit innovation, even when a tenant is not looking to drastically change its use of the premises. It is important to point out that many landlords are concerned with maintaining a mix of tenants at the property in order not to duplicate certain cuisines or themes. To further protect this tenant mix, landlords may include language in the lease that requires approval or recapture rights for a change of use.

While initially in the lease negotiations parties may appear to be at an impasse when it comes to defining permitted use, there is still room to reach a mutually acceptable compromise. If the landlord rejects including a general restaurant use provision, the tenant may suggest an expanded use clause. This would permit the tenant to modify its use of the premises after operating for a period of time under the initial permitted use, so long as not in conflict with any prohibited or exclusive uses granted by the landlord. Another option is to limit the percentage of sales or square footage of the premises which are devoted to the new use. If the landlord is unwilling to consider any of the suggestions above to provide tenant with sufficient flexibility in the use clause, tenant may try to include a right to terminate the lease if the restaurant does not generate a certain amount of sales.

When negotiating a restaurant lease for a franchise particular attention should be paid to the requirements under the franchise agreement. Too often tenants overlook the terms and conditions of the franchise agreement in regards to reimaging and rebranding, which may conflict with the permitted use provision in the lease. In such event, the tenant may be in a position of having to choose between defaulting under the lease or franchise agreement, neither of which results in a desirable outcome. In order to prevent this from happening, the parties may want to include a provision that permits the tenant to change the use and/or name of the business under which tenant is operating if the change is made across the franchisor’s franchise system. Usually, if the qualification is that such changes are done in the majority of the franchisor’s locations, the landlord will permit this.

If you have questions about your restaurant lease, please contact our attorney’s at Morsel Law.

Landlords May Have the Right to Keep Your Restaurant Equipment

RESTAURANT LEASING: Part 1 of 5

When a restaurant lease expires it is fairly common for disputes to occur between landlords and tenants over what is the landlord’s property and what belongs to the tenant. Disputes may also occur upon a tenant default, where the landlord sues to terminate the lease and recover possession of the premises. However, what constitutes the “premises” is not always clear. For tenants, who spend significant amounts of money on equipment and trade fixtures to build out a space, this can be a major issue.

Property is divided into two distinct classes: real property and personal property. Real property consists of the land and building, whereas personal property is removable and includes the furniture, fixtures and equipment (FF&E) the tenant uses to operate its business. FF&E is usually defined as a “trade fixture,” which means the tenant may remove it at the end of the lease. Examples of common restaurant trade fixtures include coffee makers, soda machines, tables and chairs, and certain kitchen equipment.

However, certain fixtures that are affixed to walls that cannot be removed without causing damage or injury to the premises or building are not considered trade fixtures and therefore remain with the premises at the end term, regardless if they were paid for by the tenant. Items that may be considered “affixed” to the property include stoves, ovens, walk-in coolers and exhaust vents. During the lease negotiation period tenants should take steps to identify the equipment considered “trade fixtures” in order to avoid costly lease end disputes with landlords.

So what can tenants do to protect themselves? The following are some suggestions to include in restaurant leases:

  • Listing FF&E in the Lease.  Tenants may want to identify their trade fixtures at the execution of the lease in an attached schedule, including items that may be installed at a later date. During the term of the lease tenants may replace items that are not considered FF&E, but could be considered affixed to the premises and therefore landlord’s property. The lease should address who owns the replaced item and whether tenant has the right (or obligation) to remove it at the expiration of the lease. For example, if a tenant is operating an upscale restaurant and intends to install expensive fixtures in the restrooms or lighting in the dinning area, the lease should include language that permits removal of these fixtures. These fixtures are considered leasehold improvements that remain landlord’s property, but the landlord may agree to their removal so long as they are replaced with lesser quality fixtures.
  • Improvements and Alterations.  Leases typically provide for landlord’s prior consent to the installation of fixtures and trade fixtures on the premises. While tenants may want unlimited rights to install equipment and improve the premises, including such language in the lease may not be in their best interest. Even if the lease provides tenant with substantial discretion to alter the premises, the landlord should get notice of tenant’s work in order to establish a paper trail of what was installed. At the expiration of the lease the parties can rely on such documentation to determine ownership should a dispute arise. Alternatively, if the landlord won’t agree to provide a tenant with broad alteration rights, the tenant may try to negotiate the right to remove all improvements at any time.
  • Catch-All Provision.  Regardless of how FF&E is defined in the lease, it is important to include a provision that protects a tenant from breaching its other legal obligations.  For example, restaurants frequently lease major equipment used in the kitchen from third-party lessors.  If, at the expiration of the lease, the tenant is prohibited from removing equipment affixed to the premises (e.g., stove, dishwasher, refrigerator), then tenant would be in breach of the equipment lease by conveying ownership to the landlord.  The risk of this occurring can be reduced by including language that permits removal of any equipment leased to the tenant by third parties.

Restaurant leases are unique and contain provisions specific to the industry. Although there are obvious similarities between many lease transactions, each transaction is different and accordingly so is each lease. There is no “standard form” lease that is appropriate for all situations. Having a lawyer who is familiar with the restaurant leasing process, lease documents and their hidden traps is the best way of ensuring that your transaction will go as smoothly as possible and that the lease accurately represents your understanding and expectations, and protects your interests.

If you have questions about your restaurant lease, please contact our attorney’s at Morsel Law.

Leasing “Bootcamp” for Startups

You’ve finally made the decision to leave coffee shops behind and rent office space. You begin searching online, maybe even find a few places you like. You contact the listing broker and make an appointment to tour the space. It’s perfect for your business. The broker tells you the market is hot and you need to move fast (FYI, they always say that!). By the time you get home you find an email from the broker sitting in your inbox with a overwhelming 30 page lease attached. The broker says “don’t worry it’s a “standard” lease and fair to both parties, besides the only important part is the term and rent.” While this is your first foray into commercial real estate, you wonder why then do we need the other 29 pages? The answer is because commercial leases are binding legal documents that outline your responsibilities and protect your rights, and, most importantly, they can have a substantial impact your business going forward.

Whether you’re “office sharing” or entering into a more traditional leasing arrangement, there are five things to focus on:

  1. Letter of intent (“LOI”). This document is exchanged up front, and lays out the general terms to be incorporated into the lease. Many brokers will insist on skipping this step and go right to the lease, but if the landlord hasn’t agreed on the basic business terms you’re wasting time and money presenting him a formal lease. The LOI makes sure everyone is on the same page before drafting the lease, thus saving you unnecessary legal fees. The broker will usually prepare the LOI, but before you sign it make sure it says that it is a non‐binding expression of interest, and not a binding contract. Bottom line, make sure what is in there is what you want from a business perspective (i.e., rent, build‐out, security deposit, type of use, access, kitchen, pets, bicycles, ect.).
  2. Insurance and Indemnity. Allocation of the risk is an important concept in leases that determines which party bears the responsibility to respond to risk when something occurs in the leased space or building. Your ability as a small business to respond to the risk is satisfied by obtaining insurance coverage. Work with an insurance agent to review the insurance requirements in the lease, and, unless you have a prior relationship with the agent, make sure to obtain several quotes as prices many vary significantly. Included in leases are long provisions where the tenant indemnifies the landlord if certain events occur (i.e., tenant assumes the risk whether or not caused by tenant). As your company grows, indemnity provisions can be negotiated—but for a startup “it is what it is”—so insurance is critical.
  3. Assignment and Subletting. Your name is going on the lease, so you are ultimately responsible. If plan on sharing the space with others, make certain to discuss this in advance with the landlord, as many leases will contain a default provision if you try to assign or sublet the space without the landlord’s permission. For businesses that expect to grow through new or additional rounds of financing, this provision is particularly important because these could trigger a “change in control” of the ownership of your company which could lead to a default under the lease. Make sure to discuss this possibility as well.
  4. Personal Guaranties. Startup tenants may have a difficult time negotiating a lease that doesn’t include a personal guarantee; however, you may be able to negotiate to limit the scope or impact of such guarantee. There are several ways to accomplish this (see Negotiating Personal Guarantees in Commercial Leases), so it is important to discuss these options with your attorney.
  5. Tenant Improvements. It is extremely important to understand how the space will be built out, including electrical, HVAC and data/voice. While some tenants may want to control of this process, in the long run it’s better to have the landlord perform the work (at landlord’s cost). You have your own business to run, so let the landlord deal with construction delays and legal compliance issues. This after all is their expertise, not yours.

Rent in commercial leases usually has three components and you should get familiar with these as they go directly to the bottom line:

  • Base Rent. This is the base amount you are paying for occupying the space.
  • Additional Rent. The amount that is based on your percentage share of expenses incurred by landlord in owning and managing the building. These expenses can vary based upon what services are included as landlord’s operating expenses, so it is important to review this list.
  • Tenant Expenses. The lease may require tenant to pay service providers directly for certain services instead of reimbursing landlord as part of additional rent. For example, this can be janitorial services within the leased space, separately metered electrical, and taxes on your personal property.

Negotiating commercial leases involves a wide array of terms and options. If you need assistance in negotiating your commercial lease, please contact the attorneys at Morsel Law.

Negotiating Personal Guarantees in Commercial Leases

Since the economic collapse a few years ago, there have been many significant changes in the business landscape. As tenant defaults have increased, landlords are frequently requiring personal guarantees of commercial leases. However, personal guarantees can be negotiated to provide terms reasonably acceptable to both landlords and tenants.

Generally, the individual who signs a commercial lease on behalf of a tenant does so in their capacity as an officer of that company. If the tenant goes out of business and the lease was not personally guaranteed, the landlord’s only recourse is to file a claim against the failed company. The officer who signed the lease has no legal obligation for the debt. Landlords may perform financial due diligence on the tenant’s officers and require the individual entering into the guarantee has the financial ability to fulfill the tenant’s obligations under the lease in the event tenant defaults. Landlord’s can also require annual updates to the officer’s financials and, if the officer’s financial health has declined, require tenant to replace the guarantor with another individual acceptable to landlord.

Unless you are a major corporation with extremely strong financials, a tenant may have a difficult time negotiating a lease that doesn’t include a personal guarantee; however, a tenant may be able to negotiate to limit the scope or impact of such guarantee. One potential option would be to include an expiration date of the guarantee in the event tenant meet certain milestones. The milestones can include things like establishing a history of timely rental payments and tenant’s financial stability, which over a period of time may give the landlord the confidence to release the guarantor from its guarantee. For example, on a seven-year lease term, the personal guarantee would only be in effect during the first three years if the tenant meets the milestones set forth in the guarantee.

Another possible limitation that could be included in the personal guarantee is what’s commonly referred to as the “good guy” guarantee. This type of guarantee protects landlords against tenants who vacate the premises early with no prior notice. The landlord agrees not to enforce the obligations of the tenant against the individual guarantor, even though the tenant has vacated the premises prior to the end of the term of the lease, but only if the tenant (a) provides the landlord with advance notice of its intent to vacate, (b) leaves the premises in good condition and (c) is current on rent up to the date of departure.

Another way to limit the guarantee is to cap the amount guaranteed by listing a fixed dollar amount. Alternatively, the cap could be set based upon a fixed number of months of rent. For example, in the event the tenant breaches under the lease and we assume the landlord should be able to find a replacement tenant in no more that five months, the guarantee could set a liability cap of five months of rent. Also, the tenant can request that the guarantee be waived upon transfer of ownership. So in the event the ownership of tenant is transferred to a new owner, the guarantee terminates.

Negotiating a commercial lease involves a wide array of terms and options. If you need assistance in negotiating your commercial lease, please contact the attorneys at Morsel Law

Legal Pitfalls in Negotiating Your Commercial Lease

Signing a lease is an important decision for any business, whether you’re expanding your operations or a newly formed startup moving into its first space. Retaining an attorney to review your lease is important because entering into a lease for your business is a significant investment, even if your business does not require a huge space. For example, a 10-year lease at $7,500 per month means a $900,000 investment across the life of the lease. With such a substantial sum of money on the line, investing in legal advice to ensure you have an agreement that protects the interests of your business makes considerable sense.

Lawyers experienced in lease negotiations understand how duties, costs and risks of ownership should be shared between a landlord and a tenant. A good lawyer with experience in leasing will be on the lookout for several legal landmines that can result in significant financial burden for a small business owner. Small costs can add up quickly for a small business owner and understanding the language of your lease with the help of a lawyer can prevent getting buried by unexpected costs in the long-term.

The location.

Everyone at one time or another has heard the saying that the three most importance factors in real estate are “location, location and location.” Although many tenants understand this concept, they fail to address the conditions that make the location so desirable in their lease.

For retail tenants, visibility and access can be of critical importance, yet tenants fail to address this issue in their lease. Sometimes, to their dismay, they are left with few options when trees or signage obscure visibility, a fast-food restaurant is built on an out-parcel immediately in front of their storefront, or the curb cuts in the parking lot are changed that results in impeded access to their store. Perhaps the store was initially in an attractive location in the mall, but visibility has been diminished due to the landlord’s installation of a fountain or redevelopment of the mall directs foot traffic away from the store.

For an office tenant, perhaps the key points are the amenities and condition of the property. Office tenants can negotiate to include a provision in the lease that requires landlords to maintain the property in a certain condition and provide services that are consistent with the level of service that made the location desirable to the tenant.

Tenants are sometimes surprised to find that in many leases the landlord has reserved the right to relocate the tenant to a different space in the building or shopping center. Although it is preferable to delete this provision, this is not always possible; however, a tenant can often address the provision in other ways. Perhaps the tenant will have a termination right if it is dissatisfied with the relocated space, or the number of relocations can be limited, or the area of the relocation can be limited (e.g., the lease could provide that the relocated space must be on one of the top five floors of the building).

Understanding the Rent Obligation.

Many clients focus solely on the base rent rate and fail to understand the many other components that can affect the total rent obligation. For example, the manner and method by which a landlord measures the space will affect the amount of rent you pay. Rent is typically calculated on the basis of rentable square feet in the leased space; however, there is a significant difference between rentable square feet and usable square feet, particularly in office buildings where the common areas on multi-tenant floors are allocated and included in the calculation of rentable square footage. Some landlords are more aggressive in the manner in which they calculate rentable square footage, which ultimately results in higher rent.

In addition, unless you have a true “gross lease,” base rent is but one component of the total rent expense. Typically, the tenant is also responsible for its pro rata share of operating expenses, which can include a share of the real estate taxes, common area maintenance expenses and insurance expenses. Tenants can end up paying for costs that aren’t core to the operating of the office building or shopping center or that extend beyond the life of their lease if they don’t read the language carefully. These additional pass-through charges can be substantial and can represent a significant rent expense.

Some leases allow a landlord to put a new roof on the building and charge the entire cost of the roof under operating expenses in a single year, even though a roof is considered a structural element which can have a lifespan of 20 to 25 years. Replacement of a roof is usually considered a landlord’s expense, but at the very least, operating expenses associated with capital expenditures should be spread out over a number of years, with charges stopping at the expiration of the lease.

When comparing locations, a prospective tenant needs to consider these expenses and the manner in which the prospective landlord calculates them. Also, don’t forget to consider the meaning of any “free rent” periods. Many tenants have been surprised to find that the landlord’s offer of “free rent” did not extend to operating expenses.

Repair and Maintenance Obligations.

Who is responsible for what repairs? Leases differ widely on this issue. In a “triple net” lease, the entire obligations for repair and maintenance are shifted to the tenant. In an office lease, most repairs are performed by the landlord, although the landlord typically charges the tenant for alterations or improvements such as new carpet or repairs that are due to an act of the tenant. Many tenants are surprised by the repair provisions of their leases, and first become aware of them when a major repair is required. In a retail lease it is not uncommon for the tenant to be responsible for the maintenance, repair and, if necessary, the replacement of the HVAC unit serving its space, which can be quite a shock and expense for an unsuspecting tenant.

Although it may not be possible to shift these obligations to the landlord, a prospective tenant should have the premises and its mechanical systems inspected prior to entering into the lease so it is better informed as to the likely costs it can expect to incur for maintenance and repair. The tenant must also remember that shifting the responsibility for maintenance and repair to the landlord may not absolve the tenant from financial responsibility if the costs for such maintenance and repair are included in operating expenses that are charged back to the tenant as additional rent. For example, a landlord may be responsible for the maintenance and repair of the roof and the parking lot, but if such costs are passed on to the tenants, then the tenants are really bearing the financial burden.

Accordingly, in order to have a complete understanding of the maintenance and repair obligations, and the financial burdens they entail, the maintenance and repair sections of the lease must be carefully reviewed in conjunction with the lease provisions dealing with operating charges.

Understanding the Assignment and Subletting Provisions.

Most leases provide that the tenant may not assign or sublet without the landlord’s consent and that the landlord may withhold its consent for any reason or no reason. In addition, many leases provide that an assignment includes by definition a change of control in the equity or management of the tenant. These provisions can have a major impact on a tenant’s ability to engage in corporate transactions or exit a location for an alternative site.

Many tenants are surprised that landlords, and particularly retail landlords, are often resistant to a request that their consent to assignment or subletting not be unreasonably withheld. The landlord will often take the position that it should be the sole judge as to the suitability of a proposed subtenant or assignee. However, when pushed, most landlords will at a minimum set forth the requirements and parameters which will be used to judge the suitability of a proposed subtenant or assignee. These parameters may include, for example, suitable financial statements, reputation and experience.

For the retail lease it is also important to remember that the permitted use provisions can have a direct impact on the ability to assign lease or sublet the premises. For example, if the lease allows the premises to be used solely for a retail sales, then any assignment or subletting would have to be for the same use. Most tenants would prefer the flexibility of being able to assign or sublet for a use that is different from their own; however, most landlords would prefer to limit this flexibility.

Improvement Allowances.

Leases can get even more complicated with construction obligations, therefore, it’s important to negotiate which party is responsible for what part of the construction process. Included in this negotiation is the amount the landlord is willing to give in allowances. Since construction projects can take years, and recessions and budget cuts can occur between a project’s start and end date, tenants should be aware of what they’re responsible for and what they’re owed in the event that things go differently than expected.

For example, the landlord is responsible to pay a tenant improvement allowance after the tenant had finished the tenant’s work; however, between the signing of the lease and completion of the tenant’s work, the landlord suffered financial problems. The lender foreclosed on the property and, since there wasn’t any assurance to provide financial support for the landlord’s promise to pay the allowance, the tenant found itself in the unhappy predicament of not having its allowance easily forthcoming and having to work through issues with the foreclosing lender, at substantial unbudgeted expense.

 

The common pitfalls listed above are only a few of the problems that can be encountered in a typical commercial lease. Leases are negotiated documents that represent the written culmination of a negotiated transaction and although there are obvious similarities between many lease transactions, each transaction is unique and accordingly each lease is different.

There is no “standard form” lease that is appropriate for all situations. Having a lawyer who is familiar with the leasing process, lease documents and their hidden traps is the best way of ensuring that your transaction will go as smoothly as possible and that the lease accurately represents your understanding and expectations, and protects your interests.

If you need assistance in negotiating your commercial lease, please contact the attorneys at Morsel Law.