Negotiating Commercial Lease Agreements

Comercial Lease Agreements

Commercial lease agreements are long, complicated, and important documents. Further, the proposed agreement you receive from the landlord will be slanted in the landlord’s favor almost to the point of absurdity. Despite this, perhaps from the excitement and rush to start a new business, many business owners to neglect the care and attention commercial leases require. Put as plainly I know how, awful things await commercial tenants who just sign the agreement they are given. I mentioned in an earlier post that hiring a  commercial law attorney is an upfront cost that can save you untold sums in the future. When I wrote that, commercial leases were front and center in my mind.

In this article, I briefly describe some of the important negotiating issues in commercial lease agreements from the point of view of a tenant (there are many more). Commercial leases, by the way, are among my favorite kinds of agreements to negotiate.

Common Area Maintenance

A common area maintenance (CAM) charge is a particular charge imposed in addition to your monthly rent. Your CAM charge is usually computed by dividing the total amount the landlord spent on common areas by your percentage of the total leasable property. So, in a simple example, if the landlord spent $5,000 in one month on CAM, and your leased space constitutes 10% of the property, your CAM charge for the month would be $500. As you can imagine, CAM has the greatest potential to surprise the tenant with unforeseen rental costs. CAMs, which are common in retail property leases, originally were meant merely to cover the costs of things such as the parking area, sidewalks, landscaping, common eating areas, and so on. Intuitively, this is fair: Well-maintained common areas attract more business for tenants; therefore, tenants should pay a pro-rata share of CAM costs. However, landlords frequently craft definitions of CAM to include many things the relationship of which to common area maintenance is loose at best.

The first part of a CAM clause is defining its applicable common area. Obviously, tenants would like the area defined as narrowly and as proximate to their space as possible. In representing a commercial tenant, I once encountered a lease proposal that would included CAM costs for maintenance done on what was a nearby but completely separate property. Further, while the costs of this large area were counted against the tenant, by means of what I thought was ambiguous language, the area was not counted in determining the tenant’s pro rata percentage of the property. In other words, the landlord was using the CAM definition to receive an unfair windfall. I objected to the CAM definition, and we successfully negotiated a more reasonable CAM definition.

The second issue with CAM clauses is defining the kinds of “maintenance” it covers. As with the area, it is in the tenant’s interest that the kind of covered maintenance be defined as precisely and narrowly as possible. Of course, landlords want to avoid the risk of necessary costs lacking sufficient revenue, and therefore want broad definitions of CAM.

Many CAM definitions include administrative costs and management costs. Because the difference between an administrative cost and a management cost is hard to define, inclusion of these vague charges opens the door for landlords to “double-dip.” The landlord can “administer” the hiring of a third-party property “management” company and in theory charge you for duplicative work done by both the landlord and the management company. A good way to avoid double dipping, short of drafting an exhaustive ten-page definition of each term, is to simply include a provision that prevents duplicative expenses. And who could object to that?

Of course, a term preventing duplicative expenses, to have any teeth, needs to be coupled with a right to an itemized list of CAM expenses. So, I insist on the inclusion of that right.

In addition to the above-mentioned terms, other terms that can protect tenants include specific CAM exclusions and CAM caps. Just be prepared to make some concessions to the landlord elsewhere in the agreement.

Moving Out

Any number of things can happen that would make it impossible to continue your business. The revenue might not be as expected, your franchisor may revoke your franchise, or you may have family emergency or get in a car wreck. All these things could make it highly desirable, if not unavoidable, to vacate the premises — yet, in the absence of contractual protections, vacating the premises would not prevent rental debt would keep piling on. Because most lease agreements require personal guarantees from the business owner, you need to protect yourself from the worst consequences of having to move. In this section and the next, I discuss three possible ways to do just that.

I begin with the method that landlords dislike most: the duty to attempt to fill a vacancy. Many states, before a landlord can sue a tenant for debt, impose a duty upon a landlord to attempt to fill a rental vacancy when a tenant moves out. Unfortunately, Arkansas law is not clear on this. Because the law is unclear, it would be best to make this requirement clear in the contract.

In the negotiating process, my first proposal to the landlord will include this requirement. Most of the time, the landlord finds this term unacceptable, which means I’ve leveraged my bargaining position for the next best thing: subleases.

Subleases

A sublease is an agreement between the tenant and a sub-tenant, by which the sub-tenant (or “sublessee”) rents the leased space from the tenant. Ultimately, the tenant is still responsible to the landlord for rent, but in most states, including Arkansas, the subtenant is responsible to the tenant and the landlord for rent. Typically when I propose that the tenant be given the right to sublease, the final agreement allows the tenant to sublease, subject to the landlord’s approval, which cannot be withheld unreasonably.

Keep in mind that a sublease is different than an assignment. Under an assignment, the subtenant steps into the shoes of the tenant, and the tenant’s obligations under the lease agreement are terminated. However, under a sublease, the landlord can go after the original tenant in the event that a subtenant does not pay; the tenant is still obligated under the contract.

For practical purposes, however, a sublease can have the effect of a tenant substitute and keep the original tenant from incurring increased rental debt month after month.

Kick-Out Clause

A kick-out clause allows the tenant to terminate the lease if after a specified time revenue has not exceeded a specified amount. Sometimes the right of the tenant to exercise its rights under the clause includes the application of a penalty. Despite such a penalty, kick-out clauses are almost always worth it. Again, if you’re having to get out a of a lease agreement, you’re most likely going to be behind on payments. The goal, then, is to avoid the piling on of even more debt month after month (which accumulates compound interest as it remains unpaid). Anything that can stop the piling on, even if accompanied by a short-term increase in debt, can save you tens of thousand of dollars.

Construction Period

Frequently, there is a fair amount of interior construction that must take place before a tenant’s business can begin. It’s reasonable and advisable then to ask for a discounted rental fee for the first month or two during which the tenant completes its necessary construction. The landlord typically will counter-propose slightly higher rental fees for the months thereafter to offset this discount. This is usually a good deal for the tenant, who will be cash strapped in the revenue-less first months of the lease.

Repairs

Commercial lease agreements, more so than most residential leases, allocate significant amounts of repair and maintenance responsibility on the tenant. Usually, the tenant is responsible for repair and maintenance inside its walls and the landlord is responsible for repair and maintenance outside the walls and in the common areas.

Two things should be insisted upon. First, the tenant should not be responsible for repair to damages caused by the landlord or by a co-tenant. Second, there are certain exterior repairs that should be non-discretionary. The lease agreement should impose an affirmative covenant on the landlord to repair and maintain things such as electrical systems, plumbing, heating and air, and so on. It is not enough to merely say that the tenant is not responsible for such repairs—SOMEONE NEEDS TO BE RESPONSIBLE.

Summary

In summary, commercial lease agreements tend to be abundantly landlord friendly. For a tenant to minimize its risk of financial catastrophe, commercial leases require serious negotiating. To that end, I hope this article provides helpful information on some of the more consequential lease terms.