Almost every person or business (the “tenant”) that seeks to occupy space in another’s building (free standing, multi-tenant office or shopping center) will enter into a contract, known as a lease, with the owner (the “landlord”) of the building. A lease is an amalgam in nature, comprised of (i) the conveyance of an interest in real property by the landlord to the tenant, and (ii) a contract between the landlord and tenant that defines all of the elements of the relationship between them regarding the building and premises for the duration (the “term”) of its use by the tenant. Because commercial leases are typically in effect for a relatively long period (three or more years), the lease is a dynamic document that has very real implications for the tenant in years to come.
The lease is comprised of a variety of provisions that define aspects of the landlord/tenant relationship – ranging from the direct economic ones (such as rent, taxes and maintenance) to non-economic ones (such as the manner of use, renewal and tenant relocation). Because the landlord’s and the tenant’s interests are typically divergent, the provisions require negotiation between the landlord and tenant. But which ones are of most significance to the tenant? Unless the tenant is leasing a substantial amount of space in the building the bargaining positions of the tenant and landlord are generally weighted in favor of the landlord, so the tenant must decide which provisions are most crucial to modify in order to meet its needs and which ones can be accepted as proposed by the landlord.
The following are key provisions that merit special attention by a tenant.
1. Rent: While this seems obvious, the tenant must be sure that base rent (per square foot rental rate times the total square feet in the premises) is clearly stated for the term of the lease, and that there are no overlooked rent escalations (such as cost-of-living adjustments) included that have not been specifically agreed to.
In addition to base rent, leases generally provide that the tenant will pay its pro rata share (based on square footage of the premises divided by the square footage of the building) of building operating expenses, taxes and insurance. This will be discussed later in more detail under the heading Building Operating Expenses.
2. Use: This provision defines what the tenant can use the premises for. Landlords will frequently seek to limit the use to a specific one, while it is in the tenant’s best interest to keep the scope of use more broad. For example, the landlord may seek to limit the use to “law offices”, but the tenant should try, at a minimum, to expand the approved use to include “general office purposes” or, better still, any purpose not prohibited by law.
3. Maintenance and Repair: It is critical that the division of responsibility for maintenance and repair of the building (together with its common areas) and the premises (the space within the building actually occupied by the tenant) be fair to the tenant. The tenant will typically be responsible for repairs and maintenance to the premises, while the landlord is otherwise responsible for the building and common areas. In this situation the definition of “Premises” within the lease is very important. The tenant should seek to define the premises for which it is responsible as “below the ceiling grid, above the surface of the floors and inside of the exterior windows”. If the definition of the Premises is not so limited, tenant could find itself liable for maintenance and repair of electrical systems and HVAC above the ceiling grid and plumbing systems below the floor. Additionally, the tenant should try to avoid being made responsible for any “replacement” of components of the premises, like plumbing and light fixtures unless the replacement is necessitated by the tenant’s negligent acts or omissions.
4. Building Operating Expenses: While landlords are typically responsible for maintenance, repairs and replacements of the building and common areas, the costs incurred by the landlord in fulfilling that responsibility are almost always passed to the tenant on a pro rata basis. The amount involved can be substantial, sometimes as much as 30/40% of base rent. The lease will include a comprehensive definition of all such costs which will include taxes (unless addressed separately), insurance and virtually every other cost incurred by the landlord in operating and maintaining the building and common areas and providing services to the building.
During the lease negotiation the tenant should try to avoid including the following items in the definition of building operating expenses:
- Depreciation on improvements and equipment, especially if a capital reserve is already part of the definition;
- Costs properly chargeable to landlord’s capital account such as repaving, new roof and construction of additional improvements; and
- Paying a percentage that varies from 10-20% of base rent, to the landlord for its administrative costs, rather than its actual out-of-pocket costs for administration.
The tenant should also seek to limit its obligations for building operating expenses to paying only those expenses that represent an “increase” over the building operating expenses for a base year established in the lease. The “base year” is typically the year that the lease is entered into. However, many landlords seek to pass on all building operating expenses to tenants, not just increases over a base year.
Payments of the building operating expenses are typically made monthly based on the landlord’s estimate of such expenses, with a reconciliation in the first 90 days of the next calendar year based on the actual operating expenses for the preceding year.
5. Extension/Renewal Options. When negotiating for the use of space, the tenant should consider having an extension/renewal option provision included in the lease. This grants the tenant the option (or several consecutive options) to extend/renew the lease for one or more fixed terms on substantially the same terms and conditions as are contained in the original lease, with the exception of base rent, financial incentives and the renewal option itself. This provision will provide that the option may be exercised, if at all, by written notice to the landlord, given within a specified number of months before the then current term expires. Landlords frequently resist such provisions because they restrict the landlords’ rental options in the future. Nevertheless, landlords may be persuaded to agree – particularly if the lease includes a relocation provision in favor of the landlord (see below).
Rent for the renewal/extension period is negotiated by the landlord and tenant and is often based on “market rent” at the time of renewal, with stated criteria for determining “market rent” such as (i) similarly situated second generation space in comparable buildings, (ii) where the building is located, (iii) annual rent escalations, (iv) definition of rentable space, and (v) other similar factors affecting the rental rate.
If the landlord and tenant cannot agree on “market rent”, the option will often provide for determination of market rent by one to three arbitrators who are experienced in representing landlords and tenants of buildings comparable to the building.
The option will almost invariably state that in no event shall the base rent for the renewal term be less than base rent in effect on the last day of the preceding term.
6. Relocation: Landlords of multi-tenant buildings (and sometimes landlords of shopping centers) often include a provision in the lease that allows them to move tenants to other spaces in the building. Landlords want to include such a provision as it allows the landlords the flexibility to adjust its leases in the building to accommodate prospective tenants who need large spaces within the building. If a tenant does not have the leverage to get the landlord to agree to omit the provision, it needs to negotiate adequate protection against the cost and disruption of a “forced” move. If a relocation provision is included it should provide for, at least, the following:
- No less than 60 days’ advance notice;
- The new premises should be substantially the same in size, dimensions, configurations, tenant improvements and finishes as the original premises, all paid for by landlord;
- The relocation shall be at landlord’s sole cost and expense;
- The relocation shall take place over a weekend and be completed, if possible, before the Monday following the weekend of the move; and
- Tenant shall be reimbursed for all costs incurred by tenant as a consequence of the relocation including without limitation, moving costs, changing stationery and business cards, moving of computers and telephone systems and re-cabling the new premises to meet the tenant’s technology requirements.
7. Assignments: Leases will frequently prohibit a tenant from assigning the lease or sub-letting all or part of the premises without the landlord’s prior consent. The tenant should seek to limit the landlord’s discretion in prohibiting assignment or sub-letting by providing that the landlord may not unreasonably delay, condition or deny its consent to an assignment or sub-lease. Further, to account for future business transactions and restructurings, the tenant should seek the right to assign the lease, or sub-lease the premises – without any required landlord consent – to any entity controlling, controlled by or under common control with the tenant, or to any entity into or with which the tenant has merged or consolidated or which purchases all or substantially all of the tenant’s assets.
8. Surrender of Premises: This provision often does not receive the attention it needs when the tenant is negotiating the lease. The lease will typically require that, upon expiration or termination of the lease, the premises must be returned, broom clean, in good order and condition (except for normal wear and tear), substantially in the same condition as it was when the lease commenced.
While a provision of this sort is customary and should not be objectionable to the tenant, many leases go further, and require that, in addition to removing its trade fixtures and personal property, tenant must remove all communications wiring and cabling installed by it from the ceiling and walls of the premises – and sometimes even from the premises to the point where it terminates to the building’s wiring. Further, some leases seek to obligate the tenant to pay for the removal of all tenant improvements made to prepare the premises for tenant’s occupancy. Both of these provisions should be rejected if at all possible as the cost to tenant of complying can be substantial. However, tenant should retain the “option” of removing cabling and wiring as tenant may wish to reuse these items in its new location.
