Here is an overview of some common issues that arise when a small (or any) business owner negotiates with a landlord over a lease agreement. Routinely, landlords write leases and tenants sign them without negotiating, changing language, or having their attorneys read over them. Having an attorney spend a half hour reading a lease can save you tens of thousands of dollars in losses down the road. Keep in mind as you read that this is a negotiation and some landlords may not be willing to budge on some of these issues. The idea is not to have the upper hand, but for things to be fair between the parties. Most leases are written by landlords and are pretty slanted in their favor. Here are some common commercial lease snafus and how to deal with them.
Almost every commercial lease has an exclusivity clause. However, these clauses are rarely, if ever, mutual. You move into a retail shopping center. You operate a smoothie business. There is a CVS drug store in the center. You sign a covenant “Not to compete with, sell, display, or sublease to any business selling or displaying health, beauty, vitamins, dietary supplements, prescription drugs, or over the counter drugs.” Sounds fair, right? The problem is that most exclusivity clauses protect the “Anchor” tenant, but fail to give you protection.
An acquaintance recently ran into this problem. He agreed not to compete with any retail business currently in place at the date of his lease agreement. However, the covenant was not mutual. The landlord never promised not to lease space to another tenant competing with him. A competing smoothie business moved in two doors down from him. Did he have any recourse? Probably not. He may have a breach of good faith and fair dealing claim, but that’s tenuous as best.
Make the feeling mutual. Something like:
“Tenant, and any successor, assignee, or sublessor covenants not to compete with any other business occupying the premises, while Landlord covenants not to allow the operation of any business that would compete with tenant, successor, assignee or sublessor operating a _______ business.”
- Commencement Date
So many leases set commencement upon, “Substantial completion of tenant improvements.” What does that mean? What are substantial? Which tenant improvements? Avoid ambiguous language. Set guide-posts that are concrete and in yourcontrol. Lease commences upon grant of certificate of occupancy? Lease commences upon clearance with Department of Health? Lease commences upon completion of flooring, signage, and certificate of occupancy? Give the commencement date clause something to hang a hat on. Make sure that you don’t pay rent until improvements are complete—or that rent is reduced at a calculable rate.
- Operating Expenses
Most commercial leases require tenants to pay a percentage of operating expenses. Many times this is called “Additional Rent.” Review the expenses that the landlord will pass on and make sure that they are reasonable and directly related to the building’s operations. Certain costs should not be passed on to the tenant. Determine whether the allocation of expenses is based upon a fully occupied building or, if not, that they are properly adjusted. You may want to negotiate a cap on “Additional Rent/Operating Expenses.”
- Common Area Maintenance Charges
Yes, there is rent, additional rent, and now common area maintenance fees. Sure you want to be a tenant? Common area maintenance charges (CAM) are similar to “Additional Rent” except it commonly covers items such as security costs, painting, maintenance of common areas, etc. You need to review records to determine what CAM charges are been historically and whether or not they are based on full occupation or adjusted. If a number of tenants move out, you don’t want to be stuck with the whole CAM bill. Similar to operating expenses, it’s advisable to negotiate a cap on CAM charges.
- Attorney Fees
Almost any lease contract is going to mention attorney fees. Don’t get too hung up on it. California Civil Code 1717 ensures that any contract provision about attorney fees has to be reciprocal even if it doesn’t say so. That’s great. However, lawyers have become savvy and write clauses like, “Any attorney fees or costs incurred in collecting rent or commissions are payable by the losing party.” Uh oh. Even if § 1717 demands reciprocal fees, the clause only applies to actions regarding the collection of rent or commissions. Tenants are not going to be collecting rent or commissions, landlords are. So, although § 1717 demands that if a tenant sues the landlord in an action regarding commissions, they can also get attorneys fees—the chances are they would sue about something other than the collection of commissions or rent. Make sure that any attorney fee provision is as broad or narrow as you want it to be. Like, “Any costs or attorney fees that arise from this contractor its enforcement are payable by the losing party.”
- Use Restrictions (and subleases)
Use restrictions are common and are another means of creating exclusivity. That’s well and good, but they may be extremely restrictive and prevent subleasing. Common use restrictions sound like, “the premises may be used for the operation of a retail shoe store and for no other purpose without the prior written consent of the landlord.” You may want to negotiate a broader clause like, “the premises may only be used for operations of any lawful retail business,” or “any lawful professional business practice.” The less restrictive, the greater chance you will have of subleasing if you have to in the future.
Most tenants have trouble understanding recapture. That’s because its economically ludicrous. Here you have promised to pay rent, completed improvements on the lease space, for some reason you inquire about assignment or subleasing and the landlord comes and pulls the rug out from underneath you, kicking you out. Permitted? Yes, if there is a recapture provision. Common recapture provisions sound like:
“Landlord retains the right of termination and recapture upon tenant’s inquiry into assignment or sublease or any other event that gives Landlord reason to believe that due performance will be impaired.”
The point is that they don’t want you subleasing for a rate lower than the lease amount. Having a below-par tenant brings down the value of the property or makes the anchor-tenant nervous. That makes sense. That’s why there is probably a clause that requires any sublease to be commercially reasonable. But, holy cow. Under the language above, if you simply ask whether or not you can assign the lease to an affiliate– they can terminate the lease. Make sure there is no recapture provision.
- Exit Strategies: Vacancies, Retail Mix, and More
Have an exit strategy. What happens when operating expenses and/or common area maintenance charges exceed what is reasonable for your bottom line? What happens with the anchor-tenant leaves and you are leasing space in a dead retail shopping center? We have all seen those shopping centers where there is one lonely video rental store and ten empty units with weeds growing in the parking lot. Have a clause that allows termination electable by tenant upon certain events. It can sound something like the following:
“Landlord agrees that tenant and any successors in interest may terminate this lease without penalty if any one of the following events occur:
i. Retail occupancy falls below 65%;
ii. The Anchor-tenant Ralphs Supermarket terminates or otherwise fails to occupy retail space within the complex;
iii. Combined monthly Common Area Maintenance fees and monthly Additional Rent equate more that 33% of monthly lease rental payments;
iv. Landlord fails to accept a commercially reasonable assignment or sublease;
v. Landlord leases space to another business who competes with tenant named on this lease or any successor in interest in a similar line of business.
vi. The Retail Mix of the complex is significantly altered from the Mix at the commencement of the lease. Significant alteration is defined as a change of more than 25% in any given business category. At the date of this agreement, the Retail Mix of the complex is 50% professional, 40% consumer retail, 10% industrial.”