How to Negotiate a Commercial Lease Agreement
Are you preparing to enter into a business lease? Before signing a commercial lease, consider the following terms commonly found in commercial real estate agreements and take the necessary steps to negotiate the terms of your lease.
Operating Expenses (Common Area Maintenance): It is common for commercial leases to include a provision requiring the tenant to pay for operational and maintenance expenses. However, landlords may also include language specifying that tenant pay for insurance and tax-related expenses for their leased building space – expenses the property owner should handle. By reviewing the history of the building’s operating expenses for the last several years, you will be able to determine a trajectory of future expenses. It is important to negotiate the terms of the operating expenses and limit them to legitimate common area expenses. It is also important for the tenant to retain the right to audit and review property owner’s expenses and calculations. A tenant should attempt to insert a clause setting a maximum threshold for operating expenses and insert a “kick out” clause allowing termination of the lease if the threshold is exceeded.
Damages Provisions: Several provisions and clauses frequently found in the commercial lease deal with potential damage and destruction to the leased property. Landlords usually require indemnification and subrogation clauses to be included to cover themselves from incurring additional expenses. The tenant should negotiate limitations on responsibility for expenses incurred from damages, especially those occurring outside the control of the tenant.
- Force Majeure: It is important for tenants to be aware of the weather patterns in the area where they intend to lease. For example, if the leasing area is prone to flooding, hail storms, high winds, wildfires, falling trees, or power outages then the tenant should ensure that the lease contains a Force Majeure clause that covers these weather conditions. Additionally, a major event out of the tenant’s control can include items unrelated to weather such as labor union strikes.
- Damages: Several clauses can be included within a commercial lease addressing damages. These clauses require careful review and may require adjusting the language to be more favorable to the tenant. Typically, the damages clause will address how the landlord and tenant will handle damage to the property, repair, and if there is a need to terminate the lease early due to the extent of the damage to the leased property. There are two common types of damages resulting from a breaching party and providing resolution:
- Liquidated Damages (LDs): A default clause requiring a breaching party to pay a per diem amount for each day of default. Not a favorable clause for the tenant and one that should be amended or removed entirely from the lease agreement. Amendments should include language setting a cap for total damages that the breaching party is liable to pay.
- Consequential Damages (CDs): Include implied damages, such as reputation and name. It is ideal to add a waiver of CDs to the lease agreement and to include language for loss of profits, loss of business opportunities or goodwill, loss of property and/or equipment, and the expense of unforeseen costs.
Subrogation: A waiver of subrogation provision is one of the most critical, yet misunderstood provisions in a commercial lease. This clause allows the insurance company paying the claim to sue a third party it deems responsible for the damage. In terms of leases, the tenant is the third party. Without a clause of waiver of subrogation from the landlord’s insurer, the tenant may be obligated to pay the landlord’s insurer for the damage to property. Landlord and tenant should negotiate whether the waiver of subrogation will be mutual, or only benefit one party.
Additional Insureds: In some cases, landlords will require the tenant to add them to their Comprehensive General Liability (CGL) insurance policy as an additional insured. In this case, if a claim is made for damage, the tenant’s insurance will be required to pay for the claim. Instead, the tenant should attempt to have the landlord named as a Named Insured under a separate policy outside the CGL.
Indemnity: An indemnity provision is a hold harmless agreement involved in a process to assume risk. It is the transference of risk from a third-party claim to the party best able to bear the risk. The claim will arise from damages incurred from the negligent party—party best able to bear the risk, the tenant in this case because he has direct oversight of the rented property space. Indemnity clauses must adhere to strict terms in Texas. The ultimate negotiation of the indemnity clause will determine the tenant and the landlord are responsible for their own actions.
Repair and Maintenance: Tenant should carefully review this clause to determine if the landlord included language that would require the tenant to maintain an area that is the responsibility of the landlord. Typically, repair and maintenance is limited to the interior of the leased premise. However, the tenant should stipulate the exclusion of HVA, sprinklers, heating, and structural elements repair from the clause. The landlord is responsible for the upkeep and repair of said items.
Provisions Relating to Real Property Tax: It is important to ensure language within this provision stipulates the tenant is responsible only for defined real property tax specified within this provision and that these taxes end at the termination of the lease/tenancy. Additionally, it is vital to exclude state and federal income tax. The lease should specify the tax implications in the event the landlord sells his property; specifically stipulating a maximum threshold the tenant will pay for property taxes resulting from a change in ownership.
Compliance with Laws: It is important to thoroughly review the language within the lease agreement to ascertain who is responsible for maintaining the building/property’s compliance with state and federal laws. The tenant should include language specifying they will only be required to maintain compliance with laws regarding their particular use of the leased space. Furthermore, the tenant should include a cap amount they are required to pay per year to limit their yearly exposure.
Assignment and Subletting: It is imperative that you understand what areas within the agreement require consent from the landlord. Within most lease agreements, the tenant is required to obtain permission to sublet or assign their lease. Prior to signing your lease, negotiate this clause to include language for assignment in terms of business reorganization and for space-sharing. In instances of subletting, a provision should be included regarding “excess” rent obtained from subletting. The tenant should attempt to retain part of the excess rent. Additionally, if the lease contains a recapture clause allowing the landlord to terminate the lease at a request by the tenant to sublet, you need to counter with a stipulation allowing you, as the tenant, to withdraw the request if it triggers termination.
Eminent Domain and Estoppels: Tenants should ensure the lease addresses what will happen if a casualty loss damages the premises or eminent domain threatens the leased premise. Provisions addressing this issue can allow termination rights for the landlord and/or the tenant to navigate eminent domain. Effectively reducing risk and loss for the tenant and addressing whether the tenant will continue to lease the premise. The inclusion of an estoppel clause within the lease binds the tenant to factual statements concerning their actions within the lease. Estoppels provides information concerning tenant lease terms to lenders or potential purchasers of the premise. Tenants can negotiate the types of questions that can be asked within the estoppel clauses and set a response time that is convenient for the tenant.
- Subordination, Nondisturbance and Attornment (SNDA) Provision and Lenders: It is important to include a provision for subordination and nondisturbance if the landlord does not hold the deed of trust to the leased premise. The SDNA provision will protect the tenant in the event the landlord defaults on their loan and the property reverts to the lenders. In this case, the tenants lease will continue as is, with the lender being viewed as the new landlord.
- Termination and Abatement Rights: Tenants should include provisions addressing abatement rights relative to the proportion of the affected area of the premise. The abatement should provide additional remedy to the tenant in the event the landlord fails to resolve the affected premise issue and the issue continues to affect the business of the tenant. Including termination rights within the clause, allow the tenant to vacate the premise and terminate the lease without further obligation to the landlord.
- Cross-Default: Tenants who operate within a chain of businesses, should strike the cross-default clause from any lease agreement at their locations. The cross-default clause places all business within the chain in default if one premise location defaults. This is not fair to the other locations who are paid through. Additionally, the tenant should include language for a cure period to remedy the default locations lease.
Termination: Termination clauses cover a broad range of items. Tenants should be aware of provisions addressing relocating the tenant to a different location, landlord’s rights for expansion into the leased space and/or relocation consequences.
- Alternative Dispute Resolution (ADR): It is now common to include ADR provisions in lease agreements. However, tenants should ensure that the ADR provision is non-binding and allows the tenant to seek further remedy if they are unhappy with the results attained by mediation or arbitration. This provision should require a mediator or arbitrator be in compliance with the American Arbitration Association or the International Institute for Conflict Prevention and Resolution and to ensure full neutrality. The tenant may also wish to specify that ADR to take place in their premise location.
- Holdover Provision: Holdover provisions require attention and amending, prior to signing a lease. Tenants should be aware that such a provision will require them to pay a premium for their property upon the expiration of the lease with neither the tenant nor landlord, insisting on vacating the premise. Tenants should negotiate an amendment specifying the conclusion of the lease agreement, the rent will be month-to-month, at a specified amount. Additionally, such month-to-month rent is subject to the Termination for Convenience clause that either party can initiate without risk. The holdover provision can be included to activate in terms of the termination of the lease, but not for a lease expiring.
- Default: Termination for Convenience The tenant should ensure that a Notice clause is included within the lease providing a remedy to the tenant in the event a default is triggered against the tenant or the landlord invoked the Termination for Convenience clause. Thereby, allowing the tenant time to remedy the default before termination procedures are invoked by the landlord or allow the tenant additional time (depending upon what is negotiated within the Notice Clause) to obtain a new location. Additionally, a Net Book Value Protection clause should be included within the lease to protect the tenant’s financial interests if a Termination for Convenience clause is included within the lease. This will allow the tenant to recoup part of their losses for investments put into the property/property.
Conclusion: Prior to signing a commercial lease, it is important to review each clause within the lease with an experienced attorney to protect your business and financial interests. Failure to carefully review your commercial lease could result in increased insurance premiums, unnecessary expenditures for leased space upkeep, liability exposure to state and federal taxes, and unfavorable one-sided termination clauses.
Is your business about to enter a commercial lease? As a rule, never sign a commercial lease agreement without a lawyer’s review and approval. The attorneys at FILIPPOV LAW GROUP, PLLC have the experience and answers to the questions you face when reviewing a commercial lease agreement. Contact us today for a no-obligation assessment of your overall legal needs. Call us at (832) 305.5529 or email us at email@example.com to schedule your appointment.
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