In a prior article, we examined the preliminary considerations for a Tenant in leasing retail or commercial space. Once the Tenant has a space picked out, it is time to understand the lease terms and negotiate the lease. The terms of the Lease will be summarized in a document called a “Letter of Intent.” This can be a complicated process, especially considering all the legal terminology and lease-speak that is often more confusing than it is helpful. Keep in mind, a larger more well established Tenant may have more of an ability to negotiate better terms than a new start-up company without any experience.
Typically, the Tenant’s broker prepares the first version of the Letter of Intent (LOI) or Term Sheet. These documents are critical to set forth the major terms of the transaction.
Here are some tips to help you navigate the lease-negotiation process successfully.
- Use a retail-experienced attorney whenever possible. When you sign on the dotted line, you do not want to be worrying whether or not you remembered everything. Leave it in the hands of a professional.
- Negotiate Clauses that Protect The Tenant’s Business. There are certain clauses that can be included in the lease contract that will help protect the Tenant’s business. Three of the most common clauses are:
- Sublease or Assignment A sublease is an agreement where the Tenant can lease a portion or all of the premises to a third party (but the term of the sublease cannot be the full remaining term of the main lease). An assignment of lease is an agreement which transfers all rights that the Tenant has to another party who assumes the terms of the main lease. In a sublease, the subtenant pays the Tenant and the Tenant is still responsible for the rental payments even if the subtenant does not pay. In an assignment of lease, the new party takes over the lease and is responsible for paying the Landlord directly and the Tenant is released. A sublease or assignment clause gives the Tenant the option to sublease the space to another business if they run into financial difficulties. Many Landlords do NOT want to give the Tenant the right to sublease or assignment the lease.
It is conceivable that you may have a Tenant/client who wants to sublease space from another Tenant. In such instances, you will need to review the main lease to determine the terms.
- Exclusivity An exclusivity clause prevents the Landlord from leasing any other spaces on the premises to a direct competitor of the Tenant.
- Co-Tenancy Certain malls or shopping centers have one major business that brings in the traffic. This is known as an anchor Tenant. A Co-tenancy clause allows the Tenant to break the lease if an anchor Tenant would happen to leave and the landlord did not replace the anchor Tenant within a specified period of time.
Failing to address as many issues as possible up front ultimately delays the process and increases cost to both Tenant and Landlord. Set forth below is a list of issues that should be considered by commercial Tenants for discussion and inclusion in the terms sheet or letter of intent. Addressing these issues during the early stages of negotiation will ultimately save time and money when the parties reach the lease negotiation phase.
A comprehensive term sheet may delay the lease negotiation process and the longer it takes to prepare there is a possibility the Tenant may find other space. Alternatively, a short simple LOI may result get the ball rolling quickly but more issues may arise during the lease negotiation.
The Letter of Intent should address the following provisions:
- Names of the Parties. – Name and address of Tenant (Entity or Individual) and name and address of the Landlord. It may be wise to check ACRIS to confirm the owner of the property http://a836-acris.nyc.gov/CP/
- Premises and Square Footage – Be sure the space is clearly depicted in a diagram and attach it to the Letter of Intent. Many Term Sheets do not specify the square footage. The Tenant’s architect should confirm the square footage.
- Use – The Landlord will want this to be as specific as possible. The Tenant wants the use to be as broad as possible which may help if the Tenant ever wants to sublease or assign the lease. Look at the C of O. Make sure the space allows the Tenant’s use.
- Term – How long is the lease (Tenants who are start-ups may want a shorter lease with renewal options).
- Base Rent – Most leases do not state the dollar amount per square foot. The term sheet usually reflects rent at a dollar amount per month. Base rent does not include additional rent (see below). Are the rent increases fixed? Typically, New York escalations are 3% per year (usually compounded annually) beginning year 2.Generally rent increases will either be fixed or will be based upon increases in the Consumer Price Index (CPI). Fixed rent increases provide a degree of comfort and assurance that a huge increase in rent will not occur, but at the same time may result in Increases that do not reflect current market conditions. If a CPI Formula is used, the lease should provide that the CPI may result in a reduction of rent. A Landlord will generally attempt to insert text providing that “in no event shall rent be less than the previous year.” If the Landlord insists on this text, request a ceiling on the maximum amount of rent increase in any year (e.g., “in no event shall any annual increase exceed 3%”). Before agreeing to a CPI increase provision, the Tenant may want to perform some basic research on increases in the CPI during recent years and be aware that large increases over a short period may result.
- Security Deposit – Security Deposits range from 2 months to 6 months. The weaker the Tenant, the higher the security deposit. Try to negotiate a periodic reduction of the security deposit during the term if the Tenant pays the rent on time (called a “burn down.”). Alternatively, the Landlord may allow the Tenant to secure a Letter of Credit from a bank (there is a significant cost to secure a Letter of Credit). Sometimes, Tenants do this when they do not have the cash for the security deposit or do not want to entrust the Landlord with such a large sum of money.
Commercial Tenants should be aware that the Landlord has no obligation to segregate the deposit and may commingle the deposit with other funds of the Landlord. For this reason, Tenant’s may want to keep the funds out of the Landlord’s hands in the event the Landlord files for bankruptcy at any time.
- Rent Concessions – Will the Landlord provide any improvement allowance money to Tenant? If so, how and when is the allowance paid (payable 1/3 each month over three months). Is there a rent concession during T’s construction period (ex. 3 months)? Will the Landlord provide any type of rent concession (free rental period)?
- Lease Commencement Date And Term Commencement Date – The Lease usually starts upon execution and delivery of premises. Term Commencement dates can be at a later date than the lease date (i.e. – 90 day after Landlord or Tenant builds out the property – Is there a condition precedent that must occur like a build-out or amended C of O?).
- Additional Rent – If the lease is a net lease, set forth the terms who pays for building operating expenses, repairs to common areas, water/sewer, electricity). Electricity can be directly metered or billed by Landlord at flat rate or sub-metered at a percentage of the actual Landlord cost (ex.106%). You will need to determine the Pro-Rata Share (the amount of Tenant’s space set in terms of a percentage of the entire building) Ex. If the building is ten floors and each floor is the same size, then each floor has a pro-rata space of 10%. This is important to understand when if comes to real estate taxes.
- Real Estate Taxes – Tenant shall pay its pro-rata share of any increases in real estate taxes over base tax year 2016/2017 which run from 7/1 to 6/30 (or it can be blended between 2 tax years).
- Condition of Premises – Is the space being delivered in “AS IS” condition or is either party responsible for building out the space?a. Tenants Work – Will the Tenant be installing an HVAC system, demising walls, paint, etc.. If so, what is the cost and who pays? The Tenant will need to obtain estimates and time to build out the space from a contractor. The Landlord will need to review the Tenant’s plans before any work can commence. The Tenant should impose a limited time frame on the Landlord’s review so there are no delays (ex 5 days after delivery). The Tenant may have to pay for Landlord’s architect to review Tenant’s proposed alterationsb. Landlord Work – Is the Landlord responsible for improving the space at no cost to Tenant (called a “turnkey build out”). If Landlord undertakes work, the lease commencement date should start upon “substantial completion” of the Landlord’s work.If the Landlord is performing all work, the commencement of rental payments should not begin until the work is completed and Tenant is provided with a certificate of occupancy and any and all governmental approvals necessary to allow the Tenant to occupy the premises for its intended use. There should also be a deadline by which the Landlord must deliver the premises. A Tenant cannot be expected to wait for the premises indefinitely. If the Landlord fails to meet the deadline date, Tenant should have remedies available to it such as a right of termination and/or a rent abatement equal to one day for each date of delay.If Landlord or Tenant is performing work prior to occupancy, (i) try to eliminate up front any “supervisory” or “administrative” fees payable to Landlord (ex. Landlord’s architect fees); (ii) clarify that the Tenant will not be required to remove any of the improvements at lease expiration; (iii) if there is a Tenant allowance, clarify what costs may be applied against the allowance. Allowances often provide for an “up to” amount and you will want to be able to apply as many costs as possible, including engineering and architects fees, against the allowance. If the Landlord is performing the work, try to be as specific as reasonably possible concerning the work to be performed.If there is asbestos, who is responsible for removing it?Zoning issues should be addressed as early in the negotiation process as possible. The need for use variance, change in use or occupancy or other similar governmental approvals may delay the Tenant’s ability to use and occupy the premises for its intended use. Tenants must avoid placing themselves into a situation where the payment of rent may commence prior to their ability to use and occupy the property. Try to require the Landlord to obtain all zoning and other governmental approvals required to enable you to occupy the premises and conduct business for its intended use. If the Tenant is required to obtain approvals, the lease and the Commencement Date should be contingent upon those approvals being received.
- Subleasing and Assignment – Tenant shall have the right at any time to assign all or sublease the premises for all or a portion of the lease term to any unrelated entity with Landlord’s consent, which is not to be unreasonably withheld, conditioned or delayed.
- Access – Try to allow Tenant access 24 hours/7 days a week. The building hours should include Saturday hours and holidays if needed.
- Option to Renew – With respect to renewal options, rent is often based upon either a CPI increase formula, fair rental value at the time of renewal or, best scenario, a fixed rent. If fair rental value is proposed, make sure that the terms sheet or LOI indicates that there will be a dispute resolution process involving the use of appraisers.
- Good Guy Guaranty –A good guy guaranty is a limited personal guaranty. Distinguish between a personal guaranty and a good guy guaranty. Most Tenants form an entity like a corporation or LLC. In such instances, the Landlord will want a personal guaranty of the rent from the principal of the entity (this covers the Landlord in the event the corporate Tenant goes out of business). The difference between a good guy guaranty and a personal guaranty is that a good guy guaranty is that in a good guy clause, the individual’s personal guaranty ends when the space is vacated. The termination of the guaranty may be tied with other conditions (ex. Notice period and substantial fee). If the Landlord insists upon a guaranty, try to have the Landlord agree to a “good guy” guaranty.
- Signage – The Tenant’s name should be added to the building directory free of charge. Tenant should be allowed to add signage on the door of the premises.
- Fire System – Set forth is responsible for maintaining the fire system/sprinklers in the premises.
- A/C Heat – Set forth who is responsible for maintaining and providing heat and air conditioning.
- Repairs – The Landlord should be responsible for structural or roof repairs or replacements to building systems.
- Expansion and Option to Purchase – if the Tenant believes that there may be a need to expand and take additional space at the site, it should request a right of first offer requiring the Landlord to offer any space that becomes available to the Tenant prior to offering it third parties. Tenants that may have an interest in one day purchasing the site may also seek a purchase option, right of first refusal or other option. The lease should contain the terms of the purchase and address the broker commission.
- Services – The lease should be specific what services the landlord provides. (including janitorial and trash removal) Leases will often provide for overtime charges for HVAC , service elevators and other services.
- Subordination and Non-Disturbance – A Subordination, and Non-Disturbance Agreement is an agreement among a commercial mortgage lender, its borrower (in its capacity as landlord), and the borrower’s tenant, establishing the parties’ legal rights should the landlord (borrower) default on the loan and the lender forecloses and becomes landlord to the tenant The Tenant should request that as a condition to subordination of the Lease the Tenant will be provided with a non-disturbance agreement from the holders of every superior position (mortgagees, ground lessors, etc.). This provision is generally provided to larger tenants.
- Cancellation Clause – Sometimes the Landlord will agree to give the Tenant a lease cancellation clause or early termination option. This usually comes with a penalty and the Landlord will want to recover its costs (ex. Build-out costs, broker commissions, rent concessions).
- Brokers – Clarify what brokers are involved and confirm that Landlord will be obligated to pay them pursuant to a separate written agreement.
- Disputes, Mediation and Arbitration – If a dispute arises can they be addressed by mediation or arbitration. If the matter is litigated, who pays for the legal fees?
- Landlord and Tenant’s Attorneys – Specify names and addresses.
- Broker fees – The Landlord agrees to pay the broker one full commission split 50/50 with co-broker disclosed in a separate broker agreement between Landlord and brokers.
- Letter of Intent Is Non-Binding. Make sure the LOI includes a provision that any writing is non-binding and subject to execution of a lease satisfactory to both parties. The terms of LOI is subject to the approval of both the Landlord and Tenant and their respective attorneys. Landlord and Tenant shall have no obligations to one another until a formal lease agreement is signed by both parties and delivered to both parties.
Special Concerns if rent in a co-op or condo building (noise affects Tenants in the building). Condo or Co-op provides water, heat, must get board approval for renovations, repairs, signage, condo or co-op repairs). Subject to By-Laws, Condo Declaration. Possible changes in Condo docs that can have an impact on the lease. If Tenant is in violation of by-laws – it is a default under the lease.
*DISCLAIMER – Nothing herein is offered as legal advice. All information in this article is for informational purposes only. Please consult with an attorney before taking any legal actions.