By Juanita R. Ingram, Esq.[1]

A. The Parties and the Plans

Every commercial lease transaction, at a minimum, involves two primary parties — the landlord and the tenant. There also will be a lender involved in some capacity as it relates to the transaction; however, this article will focus on the two primary parties to these lease transactions. Each party will have its own agenda, set of concerns and perspectives. Naturally, a tenant’s goals and objectives will be different than those of the landlord. Depending on the market, the negotiation power that each party possesses will vary. An important initial step in the leasing process is understanding your client’s underlying business and their plans for the potential lease location. Although the basic “business terms” of the lease agreement are not ordinarily determined by attorneys, having a well-developed understanding of “the deal” and the multiple business variables affecting it will greatly aid in your ability to discern which statutes and drafting techniques need to be explored and employed. This will ensure that the original basic “business terms” are effective, functional and, most importantly, enforceable.

B. Term/Duration of the Lease

Although there are situations in which landlords and tenants will prefer a longer lease term in order to ensure rental income or continuity of business, there are times when a longer lease duration can be problematic. Traditionally, a landlord is able to evict a tenant who is not paying the agreed rent, regardless of the stated duration of the lease. In cases where the landlord has entered into a long-term lease based upon underestimates of future increases in rental values, the landlord may face a greater risk with a tenant who is paying his rent on time. In such a case, a landlord could end up locked into a lease with a tenant who has a legal right to continue renting for less than fair rental value.

In addition, most landlords will require the personal guarantees of the business owners before leasing to a newly formed LLC. Therefore, the new business owner generally will be forced to forego the limited liability protection he might otherwise enjoy in running a business through a corporation or limited liability company. It is a universally accepted reality that small start-up businesses have a high failure rate. Many commercial leases will last longer than the businesses that sign on to them. Unfortunately, when this happens, the small business owner can wind up owing rental payments to the landlord long after the business has ceased occupancy of the building. The smart tenant should seek to have a specific requirement that the landlord make affirmative efforts to re-let the premises after the tenant defaults.

Another issue that arises in connection with the term of the lease is the issue of establishing an actual commencement date for the term of the lease. Typically, the term of the lease should begin or commence on or before the date of delivery of possession of the leased premises to the tenant. Often, delivery of possession will depend on what responsibilities the landlord and tenant have for constructing tenant improvements. Issues that arise in connection with this consideration revolve around determining the point in time when the premises are “substantially complete” and what penalties are associated with late delivery. In order to define “substantial completion,” the parties may need to engage an architect to certify “substantial completeness” for the purposes of determining the commencement date.

C. Rent and Operating Expenses

Regardless of whether your client is the landlord or the tenant, issues arising in connection with rent are always critical and worthy of adequate consideration. It is important from a landlord’s point of view to ensure that the tenant’s obligation to pay rent is unconditional without any right to set-off or abatement. A landlord also will need to decide how to structure the rental terms for the lease transaction in a manner what will not only allow the landlord to recoup its investment, but also realize some profit. In this respect, the landlord will need to be certain that it has adequate rental income to cover the operating expenses, which include taxes, insurance, utilities, maintenance and any debt on the property. This is typically done by providing for “base” rent supplemented by “additional” rent. Also, “percentage” rent will routinely be utilized which allows the landlord to share in a percentage of the tenant’s profit over a specified threshold income amount.

The tenant will want to carefully analyze and negotiate which expenses will be included, as well as excluded, from the “additional rent” or “operating expense.” Special attention should be given by both parties when crafting the definition of “operating expenses” and tenant’s “proportionate share.” From a tenant’s perspective, the tenant will want to make sure that the denominator includes all leaseable areas and not just the leased areas. The tenant will not want to pay for more than its share, and, thus will want the landlord to pay the operating costs for any unoccupied space. From a landlord’s perspective, the landlord will want the trusting tenant to stipulate to the percentage that represents tenant’s proportionate share of operating expenses. This approach is beneficial to the landlord since it does not require the landlord to justify how the tenant’s “proportionate share” is determined.

Most well-drafted commercial leases, at least, will provide the widely accepted definition of tenant’s “proportionate share,” which typically is calculated as a fraction, whose numerator is the total rentable square footage of the leased space and whose denominator is the total rentable square footage of the project. Some landlords, however, will want to set the denominator as the total square footage of the occupied portion of the project. In this situation, landlords will argue that such a method of calculation is fair because it is based on the actual square footage leased.

With regard to costs that are excluded from the definition of operating expense, tenants will desire exclusions for costs incurred in connection with the construction, improvement or remodeling of the property, including the cost of resurfacing parking areas, correcting design or construction defects, repairing things that are beyond the scope of routine repairs that tenants regularly performed, and any other costs that are capitalized under GAAP. Tenants also will desire that the costs of selling, syndicating or mortgaging any interest in the property be excluded from operating expenses.

Conversely, the list of costs and operating expenses an aggressive landlord may attempt to pass thru to project tenants is sometimes only limited by the imagination of the landlord or its accountant. For example, the following provision is a landlord-oriented operating expenses provision: Operating expenses may include, without limitation: tenants proportionate share of all costs and expenses of every kind and nature and may be actually paid or incurred by landlord relating or indirectly relating to the operation, replacement, maintenance, management, or repair of the property, including common areas. The foregoing type of provision is so broad that a tenant would be hard pressed to challenge the appropriateness of any expense or cost that the landlord passed through to the tenant.

D. Assignment and Subletting

Understandably the tenant will want as much flexibility as possible regarding assignment. At the very minimum, a tenant will want a landlord to agree not to unreasonably withhold, delay or condition the landlord’s consent to an assignment of the lease. From a tenant’s perspective it is best to set out specifically the criteria that the landlord can consider. Typically, a landlord can refuse to consent to a sublease or assignment if the lease allows him to do so and ordinarily has a duty only to consider the request.

A well-written lease, from the landlord’s perspective, will stipulate a laundry list of factors which will be “reasonable” for a landlord to consider in connection with a sublease or assignment request. Some of those factors would include whether a proposed assignment or sublease would cause the landlord to violate an exclusive granted to another tenant, whether the proposed assignee or subtenant has “sufficient” financial stability or net worth to discharge the monetary obligations of the lease, and whether the proposed subtenant’s or assignee’s use of the property would be inconsistent with the types of uses engaged in by other tenants.

Most landlords understand that a sophisticated corporate tenant may attempt to effectively assign a lease thru a corporate reorganization of the tenant entity and that an assignment could be deemed to occur in connection with the purchase of the tenant’s assets by a third party. Consequently, a landlord-oriented lease would expressly provide for circumstances or transactions that would be deemed an assignment. Most landlords would typically agree that certain inter-company changes in control or assignments to corporate affiliates of a tenant may not be considered an assignment for the purposes of the lease.

References

[1] Mrs. Ingram is an in-house staff attorney with Simon Property Group, Inc. where she practices in the Legal Development group. Simon, the largest publicly traded retail real estate company in North America, is engaged in the ownership, development and management of retail real estate, holding interests in the United States, France, Italy, Poland, Japan and Mexico.

Mrs. Ingram received her JD/MBA from the University of Memphis and her BBA in accounting from Tennessee State University. She is also an adjunct Professor of Business Law at Butler University, past president of the S. L. Hutchins Bar Association (NBA affiliate chapter), as well as a member of the International Council of Shopping Centers, the National Coalition of 100 Black Women and Delta Sigma Theta Sorority Inc.