Protect Your Business In Commercial Leasing Disputes

When preparing to acquire a commercial property, either by lease or purchase, the principal of "caveat emptor" should be at the forefront of our minds. This is because the many protections often afforded by statutes or common law to the purchaser of a home are absent from a commercial transaction. This article attempts to address the basic items that must be included in your project list before leasing a commercial property.

Remember that the structure of a commercial lease is very different from an ordinary residential lease. Assuming that you have conducted a diligent market analysis and selected the right location for your business, here are the next steps that you must follow before executing your commercial lease.

The Letter of Intent

The parties to a commercial lease typically enter into a Letter of Intent (LOI) that contains the primary terms of the final written agreement, such as the base rent, square footage, lease term etc. Such agreements are typically non-binding, but the language of the LOI may render if a valid and enforceable contract. Please consider the pros and cons of each approach prior to signing the LOI. Some LOIs contain a "Non-Shop" provision that keep the tenant from considering other locations while negotiations are in progress.

The Leased Premises: Rentable vs Usable Space

Tenant must ensure that rentable versus usable spaces are clearly defined. Usable space is the space that the tenant may actually use, which may not be "rentable" space – that is, space on which the tenant is charged rent. In this respect, it is important to recognize that rentable space usually includes a tenant’s pro rata share of space in the building that is considered "beneficial" to the tenant despite not having exclusive possession of such space. These include areas like staircases, bathrooms etc.

Leasehold Title Insurance and Search of Local Government Records

Furthermore, you can also conduct a search of the local governmental departments to determine whether there are any violations filed against the building and the landlord. If the space contemplated to be rented by the commercial tenant is very important to the tenant’s business and its operations, then the tenant should discuss the cost of purchasing a leasehold title insurance policy with his attorney.

Permitted Uses

Most commercial leases restrict the right of the tenant to a certain use for the premises. For example, a restaurant lease may limit the tenant to conducting activities on the premises directly related to the sale of food or other beverage items. Prior to leasing, the tenant must make certain that its intended use is permitted under the applicable county zoning laws and recorded restrictions.

Rent Clause

Rent is one of several expenses that a commercial tenant has to pay during the lease term. Rent is generally defined as Base Minimum Rent, with Additional Rent typically including Common Area Maintenance (CAM) expenses and the tenant’s proportionate share of real estate taxes.

  • Rent Escalation or Pass-Through Provisions. Ensure there are no rent escalation or pass-through provisions that could come as a potential surprise during the lease term.
  • Step-up Charges. These are charges that are fixed adjustments to the base rent at certain stages of the lease. The are designed the estimate market value of the leased premises at a particular time in the future. The tenant would want to limit these charges to prevent paying more rent in the future where the value of the building or the character of the area declines.
  • Common Area Maintenance (CAM) Charges. These are typically costs related to the buildings operation and which benefit all the tenants in general, including heating, cleaning and maintenance related costs. The commercial tenant usually pays his or her proportionate share of the CAM expenses for the building. In this regard, the manner in which the Common Area is defined is key. A broad definition of the common areas could result in higher proportionate CAM payments by the tenant. You may want to consider negotiating caps on the increase in CAM charges.
  • Real Estate Taxes. A commercial tenant usually pays real estate taxes on his or her proportionate share of the taxes for the building. The real estate taxes are usually charged as Additional Rent in 1/12 increments per month.

Tenant Build-Outs and Tenant Allowances

Generally, a commercial landlord constructs and finishes the premises to suit the basic needs of the tenant. The landlord and tenant usually negotiate the specific work to be undertaken by the tenant in a Work Letter. Alterations to be performed later during the lease term generally require the review and consent of the landlord. Such spaces are typically advertised as Pre-built (the space is ready to accommodate typical usage of the type of business the tenant is in, for example, a restaurant), or Built to Suit, where the landlord and tenant work together to design a layout that makes sense for the tenant's business. The tenant should negotiate several matters related to the initial build-out, including the amount of the Tenant Allowance – the amount given by the landlord to the tenant as an incentive to rent, which tenant uses to cover construction costs for the leased premises, design and architect fees and moving expenses etc.

Rent Commencement vs Lease Commencement Dates

Most tenants do not want the lease rent payments to commence until after they have installed their equipment and set up their business. For such purposes, the Rent Commencement Date starts after the lease commencement date, and is usually tied to the tenant’s completion of renovations within a certain timeframe – like 3 months.

Right to Relocate

Another land mine in most commercial leases has to do with the Landlord reserving the right to relocate the tenant to any other similar location in building at any time during the lease term. Landlord’s want this protection to be able to offer that same space to a more credit worthy tenant, whereas tenants do not like being displaced suddenly during the lease term. The tenant must carefully evaluate the pros and cons of agreement to such a clause.

Personal Guaranty Clause

Personal liability clauses in today’s commercial leases are drafted in a manner that renders the tenant absolutely and unconditionally liable for the entire lease rent payments in the event of default. Most commercial leases give the landlord the Right to Accelerate all rent payments due until the end of the lease term if there is a default by the tenant. These clauses are broadly worded and give the commercial landlord carte blanche to attach and dispose of the defaulting tenant’s business and personal assets to satisfy any outstanding amounts owed. Accordingly, the tenant must keep the following considerations in mind when negotiating personal guarantees:

  • Capping the amount of liability, if possible, to a certain dollar amount is a viable way for the tenant to limit the extent of his liability;
  • Specifying a time limit within which the debt may be collected, which may or may not be less than the time provided under the specific state’s applicable statute of limitations period;
  • If borrowing or undertaking a responsibility as part of a corporation or other business entity such as an LLC, then avoid "joint and several liability" language for the entire rent. Instead, try to spread the risk among all equity holders in the company who stand to benefit from the rent or obligation being undertaken. Such risk spreading can be proportionate to each individual borrowers or obligor’s equity in the corporation or LLC;
  • Do not sign any personal guarantees on behalf of an LLC/corporation if the operating agreement or bylaws do not give you reasonable access to the books and records of the corporation. As a rule of thumb, if you are not aware of the state of the company’s finances and have no means for verifying the company’s financial health, then it would be foolish for anyone to agree to be held personally liable on a company obligation;
  • For multi-member LLCs, if you foresee leaving the business at some time in the future, then negotiate a full release of personal liability upon the expiry of your interest in the LLC;
  • If a tenant must provide a personal guaranty or become a surety, then he or she must negotiate exemptions that cover assets like tenants primary residence, personal vehicle, important household items, wife’s jewelry and other such property.

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