Landlords’ vs. Tenants’ Forms in Commercial Leasing

Sidney G. Saltz and Jeffrey L. Richman

Most landlords that own commercial properties, whether they are retail, office, or industrial/warehouse, have lease forms that have been developed expressly for them by their lawyers. In multi-tenant situations, such as retail facilities or office properties, landlords seek uniformity to simplify the leasing process as much as possible and to assist the landlords’ staffs in administering the properties.

One should not underestimate the value to the landlord (or its lawyer) in being able to fill in the specific business terms in its forms and then to send them to the tenants for their review and, possibly, their signatures. Even in a situation in which a tenant has numerous comments to the lease form, the landlord or its counsel may have developed standard provisions, which have been used in prior leases, that can be inserted to deal with those comments. These provisions may not only expedite the finalization of a lease but also substantially reduce the landlord’s legal fees for doing its lease deals.

Many tenants have lease forms, too. These tenants are usually big companies that lease a lot of space. Their goals are similar to those of their landlords. They seek uniformity to simplify the administration of their various locations and to use their own standard provisions in connection with lease negotiations.

It may be difficult to reconcile the goals of the two parties. Each seeks an advantageous position and the use of its own form may facilitate that goal. Each party’s form may be a one-sided document seeking all the benefits and as few of the burdens as possible, or it may hope to be evenhanded to expedite the process.

It depends on the nature of the landlord’s lawyer’s practice for how often he encounters tenants’ lease forms. Counsel representing regional malls with national tenants are likely to encounter them frequently. Others—not so often.

In the authors’ experience, being required to use a tenant’s lease form when representing a landlord has proven troublesome for several reasons. First, reviewing a tenant lease form inevitably takes more time and ultimately results in higher legal fees for the client. Second, a tenant lease form will not include the specific provisions the landlord may have developed that are unique to the particular building being leased. In one case, one of the authors reviewed the tenant’s form, advised the client of the issues, and, based on the client’s direction, told the attorney for the tenant that the landlord was unwilling to proceed. He received a very strange answer. He was told that the tenant’s principals were merely interested in seeing the form and that if he added language to the effect that, notwithstanding the form, the rights and obligations of the parties were governed by the attached material (which was the landlord’s form, as somewhat negotiated), it would be acceptable. That is what was done.

In another case, the client owned a strip center. One of the authors reviewed the lease form presented by a tenant (a tax preparation firm) for a relatively small space. He called the client to tell him that there were a lot of issues and that it would be very expensive to negotiate based on that lease form. The client phoned the tenant’s representative and told the representative that he would not do the deal using the tenant’s form and, if the tenant wanted the space, the transaction would have to be completed using the landlord’s form. The tenant agreed, and the lease was finalized.

One of the major issues confronting landlords and tenants is the cost of negotiating and finalizing the documentation of the transaction. Of course, every situation is different. In the case of a major tenant proposing to lease a substantial amount of space in a major development, whichever form is used makes comparatively little difference to the parties because the negotiation of the lease will most likely be long and drawn out, and the cost to each side will not be considered a major factor. In other, and possibly more common, situations, however, the cost of negotiating a lease can be a big consideration. In addition, if the landlord contemplates selling or financing the property, the fact that the prospective buyer or lender is required to review a set of leases on different forms may make a sale or refinance more difficult.

Whether the lease is written on the landlord’s form or the tenant’s form, the ultimate outcome, after negotiation between experienced lawyers, may be substantially the same. The tenant will review the landlord’s form and negotiate for the provisions it would have included in its form, or vice versa. The main concerns for a landlord that does not have many big leases with major tenants are the length of time and amount of expense to review the tenant’s form and ferret out the provisions that could have a material adverse effect on it. And let’s face it, there will be many.

A major tenant, on the other hand, may have in-house or other counsel who is very familiar with the typical landlord lease form and will be able to pinpoint customary problems and also notice any provisions that may not be “usual” and will highlight them for negotiation. The effect of using the tenant’s form is to shift a major portion of the time required and the expense incurred to the landlord. For example, because most obligations in a lease are on the tenant, if a tenant’s form lease is insisted on, the landlord’s attorney must review the tenant’s lease form, then go through every provision of the landlord’s lease form and add provisions required by the landlord that are missing from the tenant’s form.

In addition, the attorney who represents the tenant may have had limited (or no) experience representing landlords. Thus, he or she may believe that every provision in the tenant’s form is fair and reasonable and may not fully understand that the landlord has its own concerns that are not dealt with in the tenant’s form.

It is probably obvious to assert that everything in a lease is there for a reason. Further, the party that drafted the lease being negotiated can be presumed to have a commitment to the terms of that lease, be they part of the form or the business terms. In addition, a tenant that is a high-powered company and uses its own lease form or a landlord that is a major property owner will each have a sense of power arising from its economic strength. So, even though the party may want to make a deal, it may find it difficult to make concessions.

Based on the authors’ experiences, it seems that most retail tenant’s lease forms have been drafted on the assumption that the property that is to contain the tenant’s business is only a retail building (for example, a shopping center). The few provisions that deal with the landlord’s concerns are drafted based on that assumption. In the present business climate, that assumption turns out to be incorrect more and more frequently. It is just as likely, and maybe more likely, that the premises to be leased will be located in an office building, or a residential building, or even in a college dormitory. Likewise, a tenant’s form for an office tenant will be drafted on the assumption that the premises will be in an office building, whereas the office may be in a shopping center, an apartment building, or other mixed-use facility. Those landlords will have unique needs, such as the allocation of pass-throughs, hours of operation, noise, and odors, which may not have been contemplated in the assumptions underlying the drafting of the tenant’s form.

In summary, there are some major factors to be considered in dealing with the forms issue: the economic strength or weakness of each party, the nature of the property being leased, and the cost to the parties of negotiating the lease. With those factors in mind, this article next addresses some typical lease issues that arise or that are dealt with differently in landlords’ and tenants’ forms and discusses the reasons for the differing attitudes toward them.

Credit Issues

The identity of the tenant entity is an issue that arises in all leases, but it is particularly crucial in leases with major tenants because such tenants may use their economic power to obtain concessions not available to others. The tenant’s lease form may specify a business division or a subsidiary as the named tenant. Because a division is not a separate entity, the landlord will be concerned that the execution of the lease by that division may not bind the actual company. If the person signing is not properly authorized to bind the parent, the company may reject the lease unless or until its obligation is confirmed by substantial part performance. A subsidiary is a separate entity, but does it have the financial wherewithal to perform its obligations? The parent company’s financial statement provided to the landlord will, most likely, be a consolidated statement of the parent and all its subsidiaries, and the landlord will have to negotiate to get separate financials for the subsidiary. Even if they are provided, they may not be certified in any meaningful way. In any case, the landlord may not get the credit it thought it was bargaining for.

If the parent entity with adequate net worth is itself the tenant, no guaranty is required. If, however, the tenant is a subsidiary and there is no separate reliable financial statement showing adequate tangible net worth to assure payment and performance under the lease (or the subsidiary’s financial strength is not adequate), the landlord should request a guaranty or other security, such as a security deposit. In such case, the landlord would want a guaranty of payment and performance of all of the subsidiary’s obligations during the term and any extensions. Needless to say, however, the company with the deep pocket will seek to limit the guaranty in various ways. For example, it may seek a guaranty of payment only or a guaranty limited in duration or in amount. Alternatively, it may seek to make the guaranty one of collection only and not of payment, thus requiring the landlord to exhaust its remedies, or at least sue the tenant and fail to collect, before it is obligated to pay.

A related issue might arise if the tenant’s form permits the tenant to self-insure. No landlord wants to permit a tenant to self-insure unless it has the financial strength to cover the losses it is self-insuring against. But unless the landlord receives appropriate satisfactory financial statements, the landlord may not have adequate information to ascertain the tenant’s financial strength to cover self-insurance. In any case, the right to self-insure should not inure to the benefit of an assignee or sublessee of the tenant.

Pass-Through Issues

We have seen occasional situations, particularly if the tenant is a major tenant in a shopping center, in which the tenant’s lease form provides that the tenant pays less than the share of taxes and operating expenses than would be required based on its rentable area. The theory is that, because the tenant is bringing traffic to the center, it should be subsidized, in effect, by the other tenants. The tenant also may attempt to cap the amount of pass-through expenses that it is required to pay. For example, a tenant may try to cap expenses in the first year and possibly cap increases thereafter. That may be a basis for considerable contention between the parties.

In a mixed-use building where the landlord’s form has allocated taxes and expenses based on the different uses of the property (as in an apartment building with retail users, where the taxes are higher than they would be for a building with apartments only), the tenant’s form may provide for a straight pro rata calculation, whereas the landlord’s form makes a different allocation (which may, itself, be controversial). But in a situation in which the retail tenants pay more rent per square foot than the residential or office tenants, the landlord has a fairly strong argument as to why the retail tenants should pay a disproportionate amount of the taxes.

Purpose Issues

The tenant’s form may provide for a much broader purpose clause than the landlord wishes to grant (that is, it may include use for any “lawful purpose”). This can result in the premises ultimately being used for a far different purpose than the originally contemplated business use. A tenant’s form also may contain an extremely broad exclusive to protect the tenant against a competing use, or language prohibiting leases for designated uses or classes of uses the tenant deems undesirable. Other provisions regarding the tenant’s rights and the landlord’s obligations for the appearance of the balance of the property may have the same effect, which is taking from the landlord the right to operate its property in the landlord’s best interest.

Construction

If construction is being performed in the premises by the landlord and the tenant, there will be issues between the parties about that. Who is building what? And what happens if there are delays? Are the premises to be re-measured when construction is done? What standard is to be used for re-measurement? What is the effect on the amount of rent and pro rata share based on the re-measurement? The tenant’s lease form may provide answers, but those answers may not be acceptable to the landlord.

Remedies

If the landlord fails to perform its lease obligations, then the tenant may seek a self-help remedy, to which it feels it is entitled because of its stature. But there are reasons a landlord may not want to grant that remedy. For example, the premises may be smaller than that of other tenants and the landlord may have already given a self-help remedy to another tenant and may not want to have more than one tenant with that right, or the landlord simply may not want tenants making repairs that should be performed under the landlord’s supervision.

A major issue of this type in many leases is the tenant’s right to terminate the lease because of a default by the landlord or in certain other circumstances. Many tenants seek the right to terminate their leases if certain events do or do not occur, but in the case of a big company tenant, the request is not only more powerful but also more dangerous to landlords. The reason is that the credit of the big company may be critical to financing the project or its possible sale, especially if the size of the premises leased to that company is a substantial portion of the project or the income from that lease is a material part of the income from the property. Some reasons why a tenant may want the right to terminate include the landlord’s failure to timely deliver the premises to the tenant, changes in the law that prevent the tenant from operating its business at the location, violations of the tenant’s exclusive by other tenants, failure of the landlord to perform its maintenance obligations, interruption of utilities to the premises, fire or other casualty, and the landlord’s default. These are conditions that create serious problems for tenants, but the consequences of lease termination are very damaging to landlords because the continuation of the lease with this tenant may be the basis for the landlord’s obtaining or continuing to maintain financing, or may be a condition for the sale of the property, or may even be a condition of other tenants’ obligation or economic ability to operate on the property. Thus, the landlord will try to negotiate other remedies in these situations.

Signage and Appearance

Another issue between a tenant form and landlord form is signage. Even if the space is relatively small, a major tenant may feel it deserves primary signage on pylon signs and in other places, and that is an area where the landlord may agree if the tenant has wide public recognition.

Transfer

Sometimes a big company will seek the right to transfer the lease to some party that proposes to use the premises for a different purpose, without regard to the landlord’s balance of uses on the property, or to seek a release from its obligations under the lease or guaranty if it assigns the lease to another tenant. The landlord may need the credit of the tenant or guarantor for its loan or possible sale or simply to assure continued performance of the tenant’s obligations under the lease. Of course, the tenant will not want the lease to state that the transferee must have the same net worth as the transferor, which may be very substantial. The parties, however, will have to negotiate an amount of the transferee’s net worth that both will be able to live with for the landlord to be willing to release the original tenant from continuing to be liable under the lease.

Operation

Often, major tenants’ forms will provide for the right to cease operating on the premises. In the case of a large retail operation, that can mean the death of a retail facility. The landlord will not want the tenant to have the right to terminate, because that would interrupt the rent flow. On the other hand, if the tenant closes, the landlord may want the right to terminate the lease at some point if it finds a suitable tenant that will operate a strong retail business in the premises. If the landlord terminates, however, the tenant might want the right to collect its unamortized costs in creating tenant improvements, or other concessions. It is another complex issue.

Holding Over

Holding over can be a further major stumbling block. The landlord really needs certainty that the tenant will vacate at the end of its term, whereas the tenant’s form may provide only limited remedies to the landlord. For example, a tenant’s lease form may state that if the tenant holds over, it simply becomes a month-to-month tenant at the rent previously paid by the tenant. Often, a tenant will agree to pay 150% of prior rent if it holds over, but not be responsible for other damages incurred by the landlord. But, if a tenant holds over and the landlord loses a new deal (and has to pay damages to its new tenant, to boot), that is a major problem for that landlord.

Conclusion

Certainly, many other issues between big company tenants and landlords will arise, as in all leases, but they are too numerous to discuss in the same detail as above. Those issues, and their resolution, will depend on the factors described above. In that regard, the tenant may have financial and reputational strength, but the landlord has major advantages, too. It may have comparable financial strength, but its main advantage is that it has a piece of property that the tenant wants to occupy for the conduct of its business. Only if those strengths can be reconciled can a deal beneficial to each party be concluded.

Sidney G. Saltz and Jeffrey L. Richman

Sidney G. Saltz is the principal in Sidney G. Saltz PC in Chicago, Illinois, and a member of the Section’s Groups and Substantive Committees Committee. Jeffrey L. Richman is general counsel of M Development LLC in Chicago, Illinois.