General Practice, Solo & Small Firm DivisionMagazine
American Bar Association
General Practice, Solo, and Small Firm Division
The Compleat Lawyer
Spring 1997
copyright American Bar Association. All rights reserved.

Commercial Leases
Troubleshooting for the Tenant

BY KEITH J. KANOUSE

Keith J. Kanouse practices corporate and real estate law, with an emphasis on franchise and distribution law, in Boca Raton, Florida.

While your client may think that a landlord's form of lease is standard and innocuous, you know better. The lease was drafted by the landlord's counsel to protect the interest of the landlord. Certain provisions need to be negotiated and finalized by you and your client with the landlord.

After you and your client have reviewed the landlord's form of lease, prepare a letter to the landlord or his or her leasing agent enclosing an Addendum to Lease Agreement, which modifies the standard lease to the terms your client wants.

Typical Lease Provisions
Other Issues to Consider

Other provisions may also need to be addressed in the lease. Lawyers who specialize in real property can provide more information on:
  • Abandonment of premises
  • Alterations and improvements
  • Attorney fees
  • Audit by landlord
  • Broker commissions
  • Condemnation
  • Cost of living adjustments
  • Covenant of quiet enjoyment
  • Damage by fire or other casualty
  • Default by landlord
  • Description and size of the premises
  • Estoppel certificate
  • Expansion rights for additional space
  • Free rent
  • Force majeure
  • Hazardous waste
  • Holdover rent
  • Hours of operation
  • Indemnification
  • Ingress and egress
  • Insurance by landlord
  • Insurance by tenant
  • Landlord's consent or approval
  • Landlord's contractor
  • Landlord's right of access
  • Late charges
  • Maintenance and repair
  • Option to purchase
  • Option to renew
  • Parking
  • Plans and specifications
  • Real estate taxes
  • Relocation
  • Right of first refusal
  • Right of set off against rent
  • Rules and regulations
  • Security deposit and prepaid rent
  • Signage
  • Use and operation
  • Use of the premises
  • Waiver of jury trial
Also, don't forget to get a copy of the landlord's owner's title insurance policy and copies of existing mortgages, restrictions, and easements. - K.J.K. While all leases are not identical, the following are commonly included provisions, some of which may not apply to your client.

Acceleration of rent.

Most leases contain language allowing the landlord to accelerate the total rent due for the remaining lease period following its premature termination due to the tenant's default. The best approach to this issue is to state to the landlord unequivocally that you do not allow your clients to sign leases containing acceleration language as any acceleration can prove to be costly to your client and should be deleted. This approach may work if your client is in a good bargaining position. At a minimum, change the acceleration language to limit the tenant's liability to either a present valuation of the total rent (for example, a present value discount of 8 percent) or the difference between the total rent due and the value of the rent that the landlord could anticipate receiving from a successor tenant.

In addition, the landlord must agree to mitigate (minimize) its damages by using its best, or at a minimum, reasonable efforts to relet the premises at comparable rents. While some states require landlords to mitigate damages without the need for express language, you should insist upon incorporating this protective language.

Anchor stores.

Where the premises are located in a newly constructed regional mall or a strip shopping center, determine the importance of a particular anchor store. In a brand-new mall or shopping center, the anchor stores may provide a significant flow of customer traffic. Delayed openings of anchor stores might adversely affect your client's business. If you think this scenario could occur, negotiate a substantially reduced base rent, and eliminate the payment of percentage rent, if applicable. Or try to negotiate paying only a straight percentage rent for the period from your client's opening until the opening of the anchor store or stores.

If the premises is located in an older center that has experienced a loss of tenants, then a reduced rent should be negotiated if one or more anchors close or if a significant percentage of non-anchor tenants go out of business and their premises remain unleased.

Similarly, but somewhat contradictory, if a lease contains a provision for increasing the base rent if additional anchor stores open during the lease term, attempt to have this provision deleted. Often, new anchor stores are built onto outlying sections of a shopping center, and rarely benefit the smaller tenant with increased foot traffic. Therefore, there is no rationale for increasing your client's base rent.

Assignment and subletting.

Most leases prohibit a tenant from assigning the lease or subletting the premises. A transfer of controlling interest in a corporate tenant (for example, a transfer of 50 percent or more of the voting stock) may also be considered an assignment. Sometimes this is an absolute prohibition; at other times, the landlord's consent is required. Make sure your client has the right to assign or sublease with the landlord's consent, and that consent cannot be unreasonably withheld or delayed (no more than 30 days). Specify reasonable conditions to assignment or subletting that are fair to the landlord and with which your client can live. Try to provide that upon assignment, you are released from any further obligations under the lease. In addition, negotiate to provide that the assignee may use the premises for any lawful purpose provided the use does not conflict with any exclusive use previously granted by the landlord to any other existing tenant in the building.

Commencement date.

If the premises are not ready for occupancy or the existing tenant doesn't vacate on time, you will want to provide that, if the landlord fails to deliver the premises to your client by a certain date, your client can elect to terminate the lease, get any deposit back, and go somewhere else. Furthermore, notwithstanding your client's entry into possession of the premises, rent should not begin until a certain anchor tenant opens for business or until a certain percentage of the building or shopping center is occupied by tenants. Try to negotiate a delay in paying rent for 60 to 90 days while any tenant improvements are being made.

Condition of the premises.

Most leases provide for the tenant to accept the premises "as is." Make sure your client thoroughly inspects the premises before signing the lease. You may want to submit to the landlord an inspection report or "punch list" of items that need repair before your client takes occupancy. If equipment is being included, it should be in good working order at the time your client takes possession. Have the landlord warrant that the premises comply with all applicable building codes, including the Americans with Disabilities Act.

Default by tenant.

A lease will usually contain a laundry list of ways your client can default under the lease. A minimum of ten days should be granted before the late payment of rent and other charges is deemed a default. All other obligations should have a minimum 30-day period (or longer) after written notice detailing the nature of the default and what steps should be taken to cure the default, before a failure to perform is considered to be a default under the lease. With respect to bankruptcy or insolvency proceedings, make sure that the time frame for dismissing, discontinuing, or vacating the proceeding is at least 90 days.

Entire agreement.

Most leases have a provision near the end of the lease, usually in the "Miscellaneous" or "General" provisions, which provides that the lease represents the entire agreement between the landlord and the tenant. This is legally referred to as an "integration" or "merger" provision. Any oral representations, promises, or understandings by the landlord or its leasing representatives that are not specifically included in writing in the lease are not enforceable or binding on the landlord.

Exclusivity.

In certain instances, you and your client can negotiate exclusivity for the sale of your client's products and/or services. Your client doesn't want a competitor next door or in the same center. In street locations and strip center malls, a landlord will generally agree to an exclusivity provision as long as it is specific and reasonable. Try to negotiate a radius for exclusivity if the same landlord owns other buildings or strip centers in close proximity to the building or shopping center in which the premises will be located.

Guaranty of tenant's obligations.

Try to have the tenant be a corporation or other form of business entity with limited liability for its owners. Try to negotiate out your client's personal guarantee. The landlord is usually a corporation with no personal guarantees. Your ability to do this may depend on the financial strength of your client's corporation. If a personal guarantee is required, try to limit it to the first year or two of the lease. Don't have your client's spouse also sign the guarantee. This will expose most of your client's joint personal assets.

Landlord's lien.

The landlord should not be granted any security interest in, or lien on, the leasehold improvements and equipment owned by your client, if this can be negotiated into the lease. Many state laws grant the landlord a statutory lien on the tenant's personal property located on the premises as security for the tenant's obligations. At a minimum, the landlord must agree to subordinate its security interest or lien in these improvements and equipment to the entity or entities that have provided or will provide your client financing. Certain landlords try to insist that subordination be limited to the initial financing of the business, but this sharply limits your client's ability to obtain subsequent financing to refurbish or expand the business operations.

Leasehold improvements.

You should closely scrutinize the provisions relating to your client's and the landlord's obligations with respect to the construction of leasehold improvements. Be very specific as to what is the landlord's work and what is your client's work. A detailed work letter should be signed. In an overbuilt real estate market, you should require the landlord to contribute toward your client's costs or for the landlord to obtain a loan on your client's behalf for the improvements. With respect to improvements by the landlord, you should demand an outside date when such improvements will be completed; if not completed by that time, your client should have the right to either terminate the lease or impose certain penalties such as a per diem charge against the landlord.

Any provision within the lease whereby your client is deemed to accept the condition of the premises upon occupancy should be subject to the completion and correction of punch list items and latent defects. Negotiate not paying rent until the leasehold improvements are completed. Also, make sure the landlord agrees to review and approve your client's plans and specifications promptly and not unreasonably withhold or delay in giving its consent. Be certain to incorporate language that delays in the landlord's construction and delivery of possession automatically extends the period of time within which your client must complete its leasehold improvements.

Leasehold title insurance policy.

In addition to a landlord's warranty of title and covenant of quiet enjoyment, if the lease is for a long period of time and for a significant rental, you may want to consider obtaining a leasehold title insurance policy insuring your client's interest under the lease, and perhaps requiring the landlord to supply this at its expense. If the leasehold is to be mortgaged, the tenant's lender will probably require a leasehold mortgagee title insurance policy. Merchant's association and advertising. You should determine the extent to which your client has to contribute to any merchant's association and should weigh this against the benefit to be derived from the association. If the association is inactive you may wish to resist having your client join, unless your client is placed on the governing board of the association. Any required contributions for advertising charges should be reviewed as far as the individual benefit your client will derive from such advertising.

"Most favored tenant" clause.

A "most favored tenant" clause is a provision where the landlord agrees that your client will pay lower rent (usually on a per square foot per year basis) if another tenant in the building is charged a lower rent. This allows you to get the benefit if rents fall after your client signs the lease. This is a difficult provision to get. Your client must be in a superior bargaining position with the landlord.

Non-recourse against landlord.

Many newer leases include a provision that the tenant's claim for damages against the landlord is limited to the landlord's equity in the building or center and the landlord is not personally liable for its obligations. If the building or shopping center is mortgaged, there may be little or no equity and your client will be out of luck. Try your best to negotiate this out or at least exclude the landlord's willful acts or negligence from the non-recourse provision. You should also cite this provision in trying to negotiate out any guarantee of the tenant's obligation.

Operating (CAM) costs.

In regional mall locations in particular, tenant contributions toward operating costs or CAM charges are often more costly than the base rent itself. In addition, tenants located in food courts are assessed additional food CAMs. Try to negotiate a cap on these contributions either by basing the figure as a percentage of your client's gross revenues or by establishing a base figure for year one of the lease and limiting increases to a set percent of the CPI. If the CPI is utilized, cap the CPI increase.

Scrutinize the description of items that comprise the CAMs. Require that the landlord delete those items that are not expenses, but rather are capital expenditures such as replacement (or new construction) of roofs, buildings, parking lots, and common areas, major equipment, and mechanical systems. These costs should be amortized (deducted) based on their useful life and not totally expended during a single year. Try to negotiate for non-contribution to any significant common area refurbishment or major capital improvement costs during the final year of the lease term, as your client will derive little benefit from these capital costs. Negotiate a reasonable cap on administrative or management fees, particularly if the management company is affiliated with the landlord.

Your client's proportionate share, which is used to determine the amount of total operating costs that your client will pay, should be based upon the proportion of the area your client leases to the total leasable areas in the entire building or center rather than only the areas actually leased from time to time within the center. This way, the landlord is responsible for operating costs with respect to unleased premises. Consider some type of provision whereby your client will not be adversely affected by increased operating costs in the event of additional buildout of the center. An annual accounting should be given to all tenants incorporating the computation of CAMs and the disbursement of tenant contributions. Your client should also have the right to review the landlord's books and records concerning the shopping center to determine the accuracy of the operating costs.

Percentage rent.

Verify the percentage rent (rent or additional rent based on a percentage of your client's gross sales) and break point figures. Make sure that the language regarding when percentage rent is paid is clear. Some leases contain language that could be construed to require payment of percentage rent from the first dollar earned, rather than above the break point figure. If percentage rent is collected, be certain that the definition of gross sales is limited to sales made from the premises and that it does not include sales from other locations. If no percentage rent is collected, then gross sales need not be reported to the landlord.

If the lease contains language requiring an audit or preparation and certification of an annual financial statement by an independent certified public accountant, require instead that you certify the accuracy of the statement so as to save your client accounting fees. If reports of gross sales are to be submitted by your client to the landlord, then add a provision by which the landlord agrees to maintain your client's sales figures in confidence, except in connection with financing, the sale of the shopping center, tax proceedings, and other legal requirements.

Services and utilities.

Verify what utilities are available, whether they are sufficient for your client's particular needs, and who pays. Consider hook-ups, utility impact fees, cost of utilities, janitorial services, and pest control. If possible, separate electric and water meters should be installed in the premises to track your client's actual use rather than basing payment for utilities on square footage. Make sure that payment for electrical service is not based upon the landlord's perceived estimate of your client's use. This type of clause often refers back to your client's plans, and your client's anticipated electric charges can be significantly higher than your client's actual usage.

Provisions about the HVAC system should be scrutinized in conjunction with your client's architect. Regional malls generally provide access to a universal HVAC system, but may limit the amount of service. For food court tenants with heat-generating equipment, such as ovens, grills, or refrigeration equipment, an increase in the level of service that the landlord provides should be negotiated into the lease. In strip centers, your client may be required to install its own HVAC equipment or additional HVAC equipment onto the roof. You should negotiate access onto and the ability to make cuts into the roof without need of the landlord's consent.

With respect to electrical service, negotiate increased service to the premises at the landlord's expense, and always require the landlord to bring all utilities into the premises.

Subordination, non-disturbance and attornment.

In all likelihood, the landlord borrowed money to construct the building or shopping center and has granted one or more mortgages to lenders as security for the loan. The landlord's form of lease probably provides that a tenant's interest under the lease is subordinate and inferior to the interest of any mortgagees now existing or hereafter placed on the property. Having a covenant of quiet enjoyment is not enough. You should, as a condition to agreeing to this provision, demand a non-disturbance agreement whereby the landlord's mortgagees will recognize your client's rights under the lease and not disturb your client notwithstanding a foreclosure of the building or center so long as your client is not in default under the terms of the lease. Otherwise, if the landlord fails to pay its lender and the lender forecloses, the lender can join your client in the foreclosure suit and your client can be evicted from the premises or be subject to a higher rent, or other more onerous terms, even though your client was never in default under the lease!

Surrender of the premises; removal of trade fixtures. Agree in advance what fixtures, furnishings, machinery, equipment, and other personal property are your client's and what are the landlord's. The provision for surrendering the premises should enable your client to remove all trade fixtures and other property owned by your client without recourse. Don't agree to have your client restore the premises to its original condition. Generally, the landlord will require a provision that a tenant agrees to repair any damage caused by the removal of the trade fixtures. Upon expiration or termination of the lease (other than due to your client's default), your client must be allowed two or three days within which to remove its equipment, fixtures, and inventory following receipt of written notice of expiration or termination from the landlord.

Use of common areas.

The landlord should be restricted in its right to change freely the access to and through the common areas, the addition or removal of structures within the common areas, and the access to and use of the parking areas, if any such changes will affect the access or visibility of your client's premises. These changes can include a relocation of access to the shopping center, which could eliminate the flow of traffic that passes the premises; the construction of kiosks or fountains that can eliminate or substantially block the visibility of your client's premises and signage, and the elimination of proximate parking, which can serve as a major deterrent for customer traffic.

Zoning; restrictive covenants.

Don't just rely on the landlord's or his or her agent's representation that the zoning for the building allows your client's type of operation. You or your client's contractor should check the applicable city or county zoning department to make sure your client's use of the premises is within the property's current zoning classification. Also, review any restrictive covenants that may affect your client's usage. If the property is not properly zoned, you will need to obtain rezoning or a variance from the municipality and/or county before your client takes occupancy.

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