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Commercial Leases – Drafting and Review

January.16.2014

Locating a property or a tenant for leasing can be a very time-consuming process, so it’s understandable that parties often rush to get the lease signed; however, having a good lease agreement that’s been drafted and reviewed by an attorney can be essential.  If issues or disputes arise between the landlord and tenant, it will be too late to address problems with the lease agreement.

Almost everyone has had the opportunity to review a lease during their life, but commercial leases are far more complex.  Further, consumer protection laws that save renters from bad landlords often only apply to residential leases, not commercial.  With commercial leases, the laws generally assume you are a sophisticated business person and were not “taken advantage of” if your landlord or tenant gives you an unfair lease agreement.

Some aspects of the lease that should be reviewed will be the term, or duration, of the lease and any lease extension options.  Lease extension options typically have specific notice requirements and deadlines to renew. These requirements should be noted and marked in your calendars.  I suggest using Google Calendar or similar and having it send you a reminder e-mail with sufficient time to reevaluate your lease.  Realizing you missed your lease renewal date can be a very unpleasant experience, particularly if the landlord knows there is a high demand for your location or if you made substantial improvements to the property.  If you fail to include a fair option to renew, your landlord may receive higher rent from a new tenant for your improved property.

Regarding improvements, the landlord is often willing to contribute some amount toward the improvement of the property.  This advance may be referred to as an amount for “build out”.  Depending upon the type of business and location, the landlord may want the business open by a certain date and may have penalties if the date is missed.  Typically, the leasehold improvements will become the property of the landlord at the end of the lease, so if the tenant has any expensive equipment being installed on the property, they may want the lease to specifically exclude that item from being considered a “leasehold improvement”.

When the tenant and the landlord intend the lease to be for a longer term, or to allow for numerous extensions, the lease will often include rent escalator clauses.  In the most simple form the rent escalator could be an arrangement whereby the rent will increase by a fixed percentage each year.  A more complex form which is often used is a rent escalator that accounts for inflation by using the government-generated Consumer Price Index (CPI), or, more specifically, the “CPI-U” table.  Depending upon the property and the economy, the landlord may offer a rent escalator that provides the tenant with a “teaser rate”, which allows the business an opportunity to become established before paying the full rent amount.

Repair and reimbursement provisions in the lease will allow the landlord to shift some expenses to the tenant.  This will typically be more appropriate when the lease if for a longer duration.  For instance, a short-term mall tenant rightfully may not feel obligated to pay for a long-term overhaul of the mall’s parking lot or replacement of its air conditioning system.  The majority of all long-term commercial leases, particularly of industrial or stand-alone properties, will be a so called “net net net” or “triple-net” lease, meaning the tenant is responsible for all taxes, insurance, and maintenance for the property during the lease.  Certain major repairs or foreseeable issues may be excluded from the tenant’s responsibilities.

Commercial leases can include extensive default provisions and limitations of use.  The most obvious default cause will be the failure to pay rent, but the lease could be customized to consider many other landlord concerns and to limit the use of the property.  For instance, a landlord who owns a garage may limit the type of services a tenant may provide, or a dry cleaner’s landlord may prohibit on-site dry cleaning, or a shopping center may require a tenant to meet a specific revenue goal (which may also be a component of the tenant’s rent calculation).  If there is a default, the lease will generally provide the landlord with an assortment of remedies.

Remedies for a default under the lease will typically include an “acceleration” clause which will cause all future rent payments to be immediately due.  While this may be considered a harsh penalty, it does improve the landlord’s standing in relation to the tenant’s other creditors, for instance, if the tenant has filed bankruptcy.  The lease will often provide for the landlord being able to reenter the property, i.e. to evict the tenant.  Though, caution must be used with reentry provisions because courts sometimes limit other remedies available (such as the landlord’s right to future rents) when the landlord reenters their property.

The landlord will often ask that the lease provide for personal guarantees from the owners of the business, and these guarantees will often become enforceable even without a default of the company.  Following an eviction, the law will typically require that the landlord use his best efforts to find a replacement tenant.  A portion of the replacement tenant’s rent, after costs, will be applied against the future rents due from the former, defaulted tenant and, therefore, reducing the amount due.

Lease agreements often do not receive the attention that they deserve, particularly considering the dollars involved and considering the agreement will determine the rights and obligations of the parties for a very long time. An attorney’s quick review of your lease agreement will allow you to feel more comfortable that your interests are being protected.

For additional information or to discuss your lease agreements, please contact Jeff Rogyom at (410) 929-4578.

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