Practical Considerations in Leasing

By: Daniel S. Schleck

Schleck & Associates PA 505 Hwy 169 N, #260
Minneapolis, MN 55441
763-404-8800
dschleck@schleckpa.com
www.schleckpa.com

Assignment and Subleasing Provisions

Landlord consent is likely to be a pivotal factor and should be negotiated early on in the process.

Express assumption of obligations by Assignee/Subtenant. Prime Landlord will want to confirm that Assignee/Subtenant expressly assumes certain obligations under the Prime Lease. 

No modification of Prime Lease. 

Further assignment or sublease. Prime Landlord will want to reserve its rights to consent to any further assignment or sublease. 

Reimbursement for expenses. Prime Landlord may want to be reimbursed for its costs of subleasing.

Brokerage commissions. Prime Landlord may want to be indemnified against any claim for brokerage commission

Assignee/Subtenant’s concerns:

Landlord’s express written consent. Assignee/Subtenant will want to obtain express written consent of Prime Landlord. 

Estoppel Certificate. Assignee/Subtenant will want an estoppel certificate or its equivalent, namely acknowledgment by Prime Landlord that the Prime Lease is not in default and is in full force and effect. It may be advisable for Prime Landlord to certify true and correct copy of lease.

Assignment can be partial or total, but partial assignment has numerous substantial drawbacks and is almost never used intentionally (Under Minnesota Law a sublease or partial assignment is considered an assignment).

The issues to consider in an assignment are:

Effective date.  Specify the effective date the assignment commencement.

Credit risks. Assignor will want to consider and address the credit risks. 

Warranties.  Assignee will want warranties of good title and lease is in full force and effect.

Negotiation Considerations.  In most respects, the issues in a sublease are the same as the issues in a lease. The issues for which the Prime Leasesublease relationship creates special considerations are:

Promise to comply with Prime Lease. 

Sublandlord will want to create remedies directly between Sublandlord and Subtenant. 

Additional rent for Operating Costs. In cases where the Prime Lease contains a requirement for monthly payment of estimated operating costs with a yearend reconciliation, the parties should pay some attention to the mechanics of passing these through the sublease. 

Insurance and Indemnity

Sublandlord  will want Subtenant to be obligated to provide insurance and give indemnity per the Prime Lease.  

Sublandlord.  Subtenant should obtain a waiver of subrogation/claim

Express assumption of obligations by Assignee/Subtenant. Prime Landlord will want to confirm that Assignee/Subtenant expressly assumes certain obligations under the Prime Lease. Prime Landlord will want an Assignee to assume all obligations. A Subtenant will want to assume only to the limited extent that is consistent with the terms of the sublease. 

Bankruptcy

As in most things, bankruptcy can significantly modify the contractually established agreements of the parties to a sublease. Operating Expenses

Most landlords believe that all expenses in connection with the leased property are borne by the tenants, either directly or as operating expenses. In many retail and commercial leases these are some of the most heavily negotiated provisions of the lease.

What are these costs

In addition to the required rental payments, lease agreements usually require tenants to pay their pro rata share of the property’s operating expenses. These additional payments may include the tenant’s pro rata share of property taxes, property insurance, common area maintenance expenses and utility expenses but not leasing and property management expenses. The tenant’s pro rata share normally is calculated as follows:

Area leased/Building’s gross leasable area= Pro rata share

Pro rata share ´ total expense = Tenant’s share

The tenant should review the demised premises clause to confirm how the number of square feet included in the area leased (i.e., the demised premises) and the building’s gross leasable area are to be measured. Usually, the leased area is measured to the center of partition walls and to the outside of exterior walls with no reduction for interior partitions, stairwells or similar areas. For properties with multiple tenants, the analyst also must determine how the building’s gross leasable area is measured; the description of this measurement is usually in this section of the lease.

When tenant pays: Lease is called:

• No additional payments Gross lease
• Property taxes and insurance Double net lease
• Property taxes, insurance and common area maintenance Triple net lease
• Property taxes, insurance, common area maintenance and utilities Quadruple net lease

Typically, each of the foregoing expenses is carefully defined in separate sections; these sections usually contain considerable detail, and the analyst must review them carefully. When all operating expenses are paid by the tenants, the property’s estimated NOI is essentially equal to the property’s estimated rent collections; for such leases, the property’s NOI may be forecast with greater certainty. However, the lease agreement may limit the annual increase in operating expenses that the tenant pays to a specified percentage of the previous year’s operating expenses. This is known as an expense stop. Vacancies and expense stops may require the owner to pay some portion of the operating expenses.

Typical Negotiations of Operating expenses include:

• Costs that are attributable to marketing and leasing the property or improving leaseable space.
• Costs of enforcing leases against other tenants.
• Management fees to the extent that the fee exceeds the range of fees customarily charged for similar buildings in our community.
• Charges for services performed by an affiliate of the landlord to the extent those charges exceed market rate.
• Charges related to defects in design or construction of the improvements on the leased property.
• Charges related to additions to the property.
• Charges for interest or penalties that arise as a result of the landlord's failure to pay real estate taxes or any other operating expenses.
• Charges incurred as a result of the negligence of landlord, its agents, employee or contractors.
• Debt service and/or ground lease payments.
• The cost of repairing damage caused by other tenants (however, such items are probably better dealt with through appropriate insurance).
• Insurance "deductibles" to the extent in excess of some agreed upon amount.
• Reserves for maintenance or repair.
• Expenses for which the landlord is reimbursed by insurance or otherwise.

Installments of special assessments to the extent (i) they represent the payment by a municipal or other governmental authority for infrastructure or other improvements to the leased property that would ordinarily have been paid for by an owner; or (ii) in excess of the amount that would have been payable if the special assessment were spread over the longest period permitted under law. Perhaps the most controversial operating expense issue is inclusion of capital expenditure items. There may be no correct answers here. From the landlord's standpoint, the landlord wants to properly maintain the quality of the leased property (which is also a goal of the tenant). Consider agreeing to permit costs that must be capitalized for federal income tax purposes to be amortized over their useful lives if necessary to replace a component of the leased property, reduce operating expenses, or comply with applicable laws.

Note: It makes little sense to exclude items from operating expenses if the tenant does not have some right to audit the operating expenses in order to make sure that only permissible operating expenses are being included.

Defaults and Remedies

Defaults and Remedies- This provision of the lease is extremely important. It sets forth specific conduct or actions on the part of the tenant that trigger a default under the lease. Some examples include: failure to pay rent, the filing of a mechanic's lien against the property as a result of tenant's failure to pay for work performed, abandonment of the property by tenant, filing a petition in bankruptcy, failure to pay all required taxes, etc. The landlord's remedies in the event of a default are also clearly defined. Tenants should pay special attention to a "Confession of Judgment" clause. In some states, a Confession of Judgment clause permits the landlord to go to court in the event of tenant's default and obtain a judgment of possession to take back the property without any prior notice to tenant. This essentially speeds up the process for the landlord to regain control of the property if the tenant has defaulted under the lease.

What are some typical Defaults

• Events of default
• Non-payment of rent
• Non-performance of covenants and obligations
• Misrepresentation
• Vacating or abandoning premises
• Bankruptcy or assignment for creditors
• Repeated defaults
• Typical RemediesLandlord Remedies
• Right to repossess (vs. obligation to mitigate)
• Right to terminate
• Right to accelerate
• Injunction
• Right to hold Tenant responsible for costs
• Right to sue for damages
• Landlord lien
• Tenant’s Remedies (Landlord Default)
• Self-help
• Right to offset against rent
• Cancellation clauses
• Right to sue
• Constructive eviction

Drafting Considerations - When drafting a lease, the first priority of the landlord's counsel is to fully protect the landlord. A landlord that fails to ensure its interests are protected can easily be saddled with an undesirable tenant. In the event of default, the focus should be to facilitate the expedient reclamation of the leasehold, with as little delay as possible

Some important considerations include:

It is important that landlords not implement excessive penalties and late fees. Any damages imposed upon the tenant must bear a relation to the harm that may have been caused.

Another important guideline is to avoid ambiguity, leaving no room for interpretation.

It is also more difficult to prove the validity of a dollar amount derived from multiple sources outside of the lease. Landlords can avoid such a pitfall by incorporating a flat rate for CAM, as stated in the lease.

The lease should also include "additional rent," or fees that are collectible within the framework of a summary nonpayment proceeding.

Additional rent items can include common charges, late fees, utilities, and real estate tax escalation charges, which permit a landlord to pass along a prorated share of annual taxes assessed on the building. With regard to utilities, it is generally advisable that landlords have tenants billed directly for electric, water, and the like, to prevent delinquencies from the tenant.

Provisions in the lease should explicitly state when the landlord has the right to terminate the tenant's lease prior to the expiration of its term. The governing principles should be clarity and expedient reclamation of the leasehold.

A good default provision provides a mechanism that will permit the landlord to quickly and conclusively prove that the tenant has violated the terms of the lease and is subject to eviction. As a final recourse, the landlord should be able to pursue the commercial tenant's principal for any monies due.

Guarantors are commonplace in commercial leases and give the landlord "teeth" in the collection of arrears or damages arising from a lease violation.

Properly drafted clauses are extremely attractive to developers that can purchase the building and serve termination notices rather than resorting to expensive buyouts of tenants with long lease terms.

Other Tips

NEGOTIATING

Some simple negotiating tips:

Be prompt and respond promptly (even if its to set a time to discuss the lease later), but don’t negotiate when you’re not prepared, because that can lead to changes in position that poison discussions.

“Headers” or “footers” that specify the date of a draft are helpful in telling drafts apart.

If you revise a draft, send a blackline. Remember, a blackline that doesn’t show all of the changes is regarded as highly unethical behavior.

It isn’t about “keeping score.”

Understand that the market and your client’s special circumstances play a big part in the negotiations.