1. Read the lease, no matter the length or the small print.
2. Ask. If you do not understand certain terms, ask for clarification.
3. Negotiate. Depending on supply and demand, some terms may be negotiable.
The following are some common provisions in commercial leases and the signifance to the tenant. It is not an exhaustive list or explanation. Look for a followup post for an analysis of terms for the landlord’s benefit, plus two practical reasons why landlords should carry their own insurance even if the tenant also carries casulty and liability insurance.
Who is the tenant?
It is commn for the named tenant to be a corporation or limited liability company. However, in this instance it is also common for the landlord to also require that an individual personally guarantee the lease. For small businesses, that usually means that the owner of the company. So, whether the business owner is the named tenant or the personal guarantor, it is important to know that his or her personal assets are at risk if there is a default on the lease. Wishful thinking that the landlord will walk away from unpaid rent is not a realistic business plan and jepoardizes the guarantor’s home, bank account and other assets.
Make sure that the premises are adequately described. Usually a municipal address, including suite number, is sufficient.
Use and Non-Compete
The lease also includes a general description of the type of business allowed in the leased space. If the space is in a shopping center, it might be in a tenant’s best interest to request that a non-compete clause be added so that the landlord cannot, from that date forward, lease other space to a competitor. Be mindful, however, that a non-compete clause will not bind existing leases and subleases. Finally, to gain the best advantage of a non-compete clause, be sure to describe in detail the type of businesses to be excluded.
The rent may be constant throughout the lease or it may increase each year. The increase may be a stated amount or may be calculated based on a standard of measurement such as the Consumer Price Index.
Monthly rent may be a flat rate, or may also include a percentage of the tenant’s sales.
It is also common for the tenant to contribute monthly a prorata share of the insurance, property taxes and/or common area maintenance expenses. Sometimes this obligation is set out separate and apart from the base rent. In that instance, the tenant must combine the base rate and all additional monthly charges to determine the total monthly expense. No matter the rent structure, each tenant should carefully review the lease before signing for a clear understanding of the total financial commitment.
Just as with residential leases, commercial leases also generally require a deposit equal to one month’s rent.
Commercial leases are usually 3-5 years. If you want a shorter term, ask for it. In addition there may be an option exercisable by the tenant to extend the lease.
Be careful though, some leases have an automatic renewal clause that puts the burden on the tenant to give the landlord considerable advance notice that it will NOT renew the lease. If the lease you sign has an automatic renewal clause, make sure you tickle the notice deadline so that you can timely terminate the lease, if that is in the best interest of your business. Otherwise, inaction may lead to an automatic renewal of the lease.
Hold Harmless and Insurance
The parties usually agree to hold each other harmless for liabilities arising from the negligence of just one of them. For example, if a customer slips and falls on the premises due to negligence of the tenant, this clause says that the tenant will indemnify the landlord for any sums the landlord may be called upon to pay arising from the accident.
The lease will likely require that you carry insurance to cover yourself and the landlord in these types of accidents. You should consult with an insurance agent to find out what insurance is available and which best suits your needs.
The lease should also include a waiver of subrogation for the protection of the tenant and the landlord. With this provision, the insurance policies will cover the damage and the paying insurance company cannot seek reimbursement from the party at fault.
The most common ground for default is non-payment of rent. However, the grounds for default are broader; violation of almost any requirement of a lease is an actionable default. Whether the landlord would seek to terminate the lease is a different issue.
Some leases require that before the landlord can take action on a default, notice of and time to cure the default must be first given to the tenant. If the proposed lease does not include a cure provision, this may be an item subject to negotiation. For example, the lease may provide that before the landlord can declare the tenant in default for not paying rent, the landlord has to give notice of the default to the tenant and give the tenant 5 days to cure the default, or in other words, the tenant gets another 5 days from the notice of default to pay the delinquent rent. This may not be an unlimited right; some leases cap the number of times the landlord has to extend the notice and cure period.
Generally attorney’s fees are not awarded in contract disputes unless the contract says so. Leases generally include this clause, but sometimes it is only in favor of the landlord. So, if the landlord files a lawsuit alleging a default and is successful, the tenant will also be cast to pay the landlord’s attorney’s fees and court costs. The tenant should make sure the attorney’s fees provision goes both ways.
Recordation of Leases
Inherent in each lease is a promise by the landlord that the tenant will not be dispossessed of the premises, assuming the tenant is not in default. However this promise of peaceful possession is not binding on new owners of the property, unless the lease is recorded in the land records. So if the landlord sells the property, the new owner is technically not obligated to honor the lease, UNLESS the lease is recorded in the public records.
Recording the lease or a memo of it puts all third parties on notice that a lease exists and any future owner must honor the recorded lease.
In practical terms, many new owners purchase the property based on the leases in hand. But if you have any concerns, you will need to record a memorandum of the lease and make sure the lease gives you the right to do so. Recordation of the lease also protects the tenant’s trade fixtures from becoming an improvement to be owned by the landlord.
Repair and Maintenance
Perhaps the most significant difference between commercial and residential leases is that commercial tenants are responsible for a considerable portion of the repairs and maintenance. Generally, the landlord is responsible for making repairs only to the roof, foundation and other structural parts of the building, and the tenant is responsible for all other repairs. For example, that means the tenant is responsible for repairing the air conditioner when it fails. Furthermore, if the pipes burst and damage your property or inventory in the leased space, the landlord is not responsible for replacing furniture, replenishing inventory or remedying any other damages.
In essence the tenant accepts the premises in its current condition, accepts responsibility for keeping it in good condition and is obligated for making repairs when the condition fails.
Therefore, before signing the lease, it is important that the tenant make inquiries as to the age of such things as the air conditioning and heating systems, plumbing and roof.
Ownership of Improvements
If you make improvements to the premises, the improvements will become those of the landlord. Sometimes, tenants invest substantial funds preparing the premises for occupancy, all to the ultimate benefit of the landlord.
While the lease may look like a daunting document, many pages in length and containing a lot of small print, it is essential that tenants read and understand it before signing. That’s a true axiom for any contract.
Practical tips before signing a lease
- Read it
- Ask questions about provisions you do not understand
- Negotiate terms
- Ask for the personal guaranty to be waived
- Ask for an accounting of the prior year’s property taxes, insurance and common area expenses
- Be mindful that investments in the buildout will be to the landlord’s benefit
- Find out the age of the roof, air conditioning and heating systems, plumbing, etc.
- Consider requesting a non-compete clause
- If the lease has an automatic renewal clause, tickle a reminder date to let the landlord know you will not be renewing the lease.
- Consider recording a memorandum of the lease
- Ask for a default cure period
- Make sure there is a waiver of subrogation clause