Key Drivers for Negotiating a Commercial Lease for the Small Tenant
In negotiating and drafting a commercial lease, the lawyer representing the small commercial tenant is advised to keep in mind her client’s business and those matters which can be critically impacted by the lease. Most of your client’s leasing decisions will be driven by one of these three concerns:
- Business Operations
- Protecting the Bottom Line
- Preserving an Exit Strategy
Since it is highly unlikely the small tenant will be able to use its own lease form, the prudent lawyer will carefully review the landlord’s form for minefields which, if triggered, could spell disaster for her client’s business.
1. Business Operations – The small tenant will want to ensure it can operating its business profitably from the premises. Look for benefits and pitfalls in these lease sections:
- Permitted Uses : Advocate for broad language or a method which accommodates changes to permit tenant to maximize profitability.
- Exclusive Use : Argue for a restriction on leasing to competitors, if competition will be the death-knell. Note that your tenant is more likely to an exclusive use right if the right is limited to critical areas of income.
- Non Disturbance by Lender: Obtain a non-disturbance agreement to ensure that landlord’s lender will allow tenant to continue its business under the current lease terms if the lender forecloses.
- Financing : Your client may need to grant is lenders first priority on all its property, senior to landlord’s liens. The lease should, therefore, include landlord’s agreement to subordinate its rights in the tenant’s property ( e.g. landlord’s liens). Also, the lender may have a “landlord’s consent” form to negotiate with landlord – this should be done early in the process as it the lender’s form may not start out as being acceptable to the landlord.
- Franchises : For franchisees, the Lease’s transfer section will need to reflect certain franchisor rights to replace the tenant - review the franchise agreement and incorporate necessary terms.
- Expansion: Speed in often important in expanding, thus critical terms such as rent should be negotiated and included in the original lease.
- Maintenance: The landlord base form may overburden the small tenant, at a minimum try and make it the landlord’s duty to maintain the structure, exterior, all common areas and any shared building systems (e.g. plumbing and HVAC).
- Disruption of Services and Casualty: It will be difficult to get the landlord to agree to allow the tenant to terminate for long disruptions in services or casualty, but for a small tenant being closed too long will be its death-knell. Negotiate for short deadlines for repairs and restoration of services, and advise your client of the importance of obtaining business interruption insurance.
- Parking: Depending upon the tenant’s business, convenient, sufficient and reasonably priced parking may be critical to its success. Watch for separately operated parking garages, and try and get rates established, reserved parking and sufficient spaces.
- Signage: Get any necessary signage pre-approved by landlord, and negotiate a reasonable process for future signage.
2. Bottom Line – The small tenant needs to avoid financial surprises and wants to know in advance and be able to budget for expenses. Consider the following minefield of unanticipated costs:
- Building Out the Premises: Attempt to shift some or all of the risk in cost overruns to the landlord. This could be accomplished by requesting “turn key” space, rather than a shell which will be built out using an “allowance.” Franchisee tenants may face additional challenges embedded in their franchise agreements.
- Complying with Laws: ADA and other code compliance may differ depending upon the premises’ use. Ask for the landlord to deliver the premises in compliance with laws relating to the permitted use (rather than as-is); and state who is obligated for subsequent changes in laws – perhaps agreeing to a cap on tenant’s future costs or, with if no cap then at least a right to terminate if costs become prohibitive.
- Utilities: Landlords are often unwilling to install separate meters for small tenants; watch for landlord reserving the right to bill tenant for “excess usage” in addition to pro-rated utilities; or the converse – having a small tenant which does not use excess utilities pay for the others’ excess (e.g. a stationery shop paying extra for the hair salon’s water use or the restaurant’s trash).
- Operating Costs: The small tenant is unlikely to have much leverage in negotiating exclusions on passed-through operating costs, the best way to control costs is to agree upon a cap on its share of costs. Expect the landlord to exclude from the cap those charges over which it has no control (utilities, taxes, insurance). Also, for insurance costs, review and determine what insurance is included in the landlord’s current operating costs, is there the potential for a huge increase (e.g. to add earthquake) and if some reasonable limit can be placed on the pass through of such costs to tenant.
- Surrendering Premises: Always have the tenant document the condition of the property upon delivery, and try and limit any repairs or improvements required at the end of the lease ( e.g. except of ordinary wear and tear, and insured casualty).
3. Exit Strategy – The small tenant’s lease needs to incorporate exit strategies both for the sale of business and its possible failure.
- Lease Transfer: Every tenant needs some right to transfer the lease as part of an overall exit strategy. Look for clauses which impose reasonable limitations on landlord’s consenting to assignments and transfers. Where the lease requires tenant to share any excess rent with the landlord, make sure it only includes rents and not any other consideration the tenant received from its assignee in connection with the sale of the business; and also make sure that any tenant expenses get deducted before the excess rent is split. Watch also for unlimited expense reimbursements for landlord consents. Consider also, where the transferee is creditworthy, asking for a release of the current tenant and guarantors.
- Lease Termination: Early termination rights and termination agreements are difficult to obtain because landlord’s lender often has approval rights or may discount the value of a lease which includes them. If early termination is permitted, expect the clause to be one-time, a few years into the term, and require the payment of a termination fee (equal to some of the lost rent), plus at least the unamortized cost for landlord’s expenses (improvements, leasing commissions).
- Guaranties: Try and include some limitations in lease guaranties – terminating after a certain number of years without a tenant default, limited to a certain amount of rent, number of months’ rent or unamortized landlord costs. Also try for a release where there is a creditworthy successor tenant or guarantor.
- Relocation and Transition: Timing certainty and cost are important factors for the small tenant faced with relocation. Ask for delay damages if delivery of premises or relocation cannot be done when promised ( e.g. 2 days free rent for every day late); and for relocation make sure all tenant’s expenses associated with a landlord imposed move are paid by landlord. For retail, consider limiting relocation if foot traffic or visibility is critical to the tenant’s success.
- Disputes: Make sure attorney’s fees clauses are bi-lateral and awarded to the substantially prevailing party, and that the clause applies to include arbitrations, appeals and bankruptcy proceedings. Also try and get quick and cheap arbitration provisions inserted, uses indices when possible to avoid arbitration ( e.g. CPI for rent rates) and identify and designate neutral experts in advance to decide some issues ( e.g. measurement of the space or extent of a casualty).