THE TOP “GOTCHAS” TO BEWARE OF IN A COMMERCIAL LEASE – PT 2

This is the second of a three-part series on leasing commercial property or space, we’ll discuss the ins and outs of the financial obligations within a lease.

DISCLAIMER: This article is not intended to constitute legal advice. The author is not an attorney. Legal counsel should be sought out for answers to specific legal questions, or advice on specific circumstances.

In almost all commercial leases, all clauses are subject to negotiation and most landlords are prepared for this. In many cases, the quality of the relationship between the landlord and tenant is established during this negotiation, as the tenant demonstrates how savvy they are, and how much attention they pay to detail.

Typically, this negotiating stage will tell the landlord how much the tenant may resist being pushed around, or how accountable and upstanding they will be.

LATE CHARGES

“In addition to paying close attention to the contractual language in the lease, it is important to be proactive near the end of a lease term in deciding whether to renew, or finding another space...”

As with virtually all payment plans, commercial leases almost always include a provision for a penalty to encourage the timely payment of rent. As with the other clauses, this is typically negotiable, however, depending on the tact, this negotiation may indicate to the landlord whether there will be forthcoming problems with timely rent payment.

In most cases, the rent and other charges are due on the first day of the month and are late a prescribed number of days thereafter, usually 5 to 10. This can be, however, subject to negotiation depending on the creditworthiness of the tenant and so on. While tenants often request written notice prior to assessment of a late fee, landlords will often strenuously resist any provision for written notice not specifically limited to the default provisions of the lease, and justifiably so. One possible compromise might be to require the landlord to provide 10 days written notice upon the first occurrence of a late payment in any 12 month period, or similar.

In many leases, interest will also begin to accrue on that date at which any payment is deemed late. If this is in addition to a late payment penalty, a savvy tenant will negotiate for interest charges to be effective only after the 1st of the month following the payment due date.

HOLDOVER

Sometimes, and often through no fault of their own, a tenant may need to remain in leased premises past the end of the lease term. Among many and varied other reasons, this may be due to:

• Delays in availability of a new space;

• Unplanned emergency workloads; and

• Weather or other delays affecting moving companies.

Leases typically provide for a variety of solutions to these issues, making the Holdover section one that bears special attention, especially for tenants with significant inventory, or whose operations preclude downtime.

Some such remedies may include liquidated damages and automatic renewal for a pre-determined period of time (i.e.: month-to-month). Potential damages create a significant exposure for the tenant, as they may include costs stemming from the landlord being sued by another tenant leasing the space, or loss to the landlord of such tenant due to breach by the landlord.

In addition to paying close attention to the contractual language in the lease, it is important to be proactive near the end of a lease term in deciding whether to renew, or finding another space, as well as being communicative with the landlord before any serious problems arise.

I recently worked through an issue with a client who was forced to vacate a leased space they had outgrown and decided not to renew. This presented challenges on many fronts due to the high demand in this market:

• Their prior space leased quickly, so holdover was not an option.

• Their urgent need for somewhat specialized space put them at a tremendous disadvantage when selecting, and negotiating for, a new location.

• Their large inventory and continual in/out flow of materials created a significant financial hardship from any disruption in their operations.

ASSIGNMENT/SUB-LEASE

“The assigning or sub-leasing tenant should always be concerned about recourse against the assignee/sub-tenant...”

This section bears much consideration in both the explicit definitions of assignment versus sub-leasing, as well as the responsibility of the original lessee after they have assigned or sub-leased.

This section is an important consideration, especially for today’s dynamically growing businesses, due to the 3-year, 5-year, or longer terms of commercial leases.

Assignment: In the case of an assignment, the assignee and landlord are said to have privity of estate, but not privity of contract. Therefore, the landlord may sue the assignee while it possesses the property, but not if it transfers assignment to another party and is no longer in possession.

Sub-Lease: Under a sub-lease, the sub-tenant and landlord have neither privity of estate or privity of contract. So, neither of these parties may sue the other. The only option, in a situation of non-payment of rent, is for the landlord to evict the sub-tenant in accordance with the main lease terms.

As far as the original lessee’s liability under an assignment or sub-lease, the law is pretty clear: The original lessee is still bound by their contractual obligations, unless a release is specifically granted by the landlord. Therefore, the assigning or sub-leasing tenant should always be concerned about recourse against the assignee/sub-tenant, and should incorporate language allowing for retaking of possession of the property and indemnification.

In a case where the landlord allows for them to recapture, or take profit from, an assignment, the original lessee may request that they be released from any further liability, as long as the assignment is in compliance with the terms of the original lease.

In many cases, a landlord will be willing to grant an assignment or sub-lease, and allow a tenant to get out of their original lease to move into more suitable space when that tenant takes on the responsibility of finding a suitable replacement tenant.

WARRANTY OF SUITABILITY

While a common clause in commercial leases, and not typically a huge issue, I’ve run into a couple of situations recently where this section bears consideration: Imagine you’re a day spa, leasing space in a shopping center. Your business is well established, and you’ve got a great, large clientele who prefer your central location. Perhaps, there are no other similar spas nearby.

Now, after the neighboring optometrist moves out, a custom metal art fabricator moves in. Seemingly overnight, what was once a quiet location, is inundated with the sounds of grinding metal and loud music.

Often, leases exempt the landlord from any sort of obligation or warranty to the tenant, such as “quiet enjoyment.” Leases are typically worded so as to minimally limit the landlord in choosing a new tenant to occupy a space. Understandably, landlord’s simply want to lease out their space, and leave the responsibility of determining suitability to the Tenant.

In the case of this clause, if you are a business that has specific requirements or needs in order to operate most effectively, such as a reasonably quiet environment, it bears some cognizance. Landlords are typically hesitant to grant any specific warranties, or place limitations on their ability to select tenants, but I have seen successful negotiations in this regard, especially for “good” tenants, such as medical offices, or long-term leases.

PROPERTY INSURANCE

This clause requires the Landlord to insure the building structure for at least 90% of its replacement cost. The Tenant has no right to the proceeds from any such insurance policy, however, even though they may be responsible for its cost, in the case of a NNN or similar lease.

However, it is not the Landlord’s responsibility to insure the personal property, equipment or furnishings of the tenant, nor does the Landlord provide for liability insurance for the Tenant. More and more, leases require Tenants to carry both property and liability insurance, often with specific policy limits, and sometimes including the Landlord as a named insured.

Improvements bear some consideration, as they may be paid for by the Tenant, but become part of the Landlord’s property. Therefore, a savvy Tenant will have the Landlord include them under their building policy.

Business interruption insurance is another type of coverage more and more Landlords are requiring Tenants to carry. This insures that the rent will be paid in the event that the Tenant’s business is prevented from operating due to unforeseen circumstances, such as a catastrophic weather event, or other situation that does not allow for a terminatino of the lease.

Business interruption resulting from damage to the premises will be discussed in more detail in the third and final installment of this series, coming soon.