Issue: April, 2008
Author: Scott W. Meier
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Issues to Consider in Drafting of Commercial Leases
Leasing premises is a major investment decision, whether your client is a landlord or a tenant. In fact, it is highly unlikely that any single transaction will affect the lives of more businesspeople more than the real estate lease. Unfortunately, many attorneys do not understand the complexities of a commercial lease and how a commercial lease can be fraught with potential problems. These leases have broad implications, not the least of which is the prospect of your client losing a business should something go wrong.
Issues Regarding Both Parties
It is extremely important that the lease agreement properly state the correct names of the legal parties. All too often counsel (and perhaps brokers) relies on the letterhead, a business card or worse yet, a verbal statement of the party’s representative for the correct name of the party. Reviewing the organizational documents or checking with the Secretary of State may save considerable embarrassment.
Specific Issues for Landlord’s Counsel to Consider
In representing a landlord, you should consider several issues. First, you need to ensure the lease documentation meets your client’s needs. You must be able to explain to your client, preferably in plain English, how the lease operates and his or her rights and obligations under the lease. Since boilerplate language rarely fits, you may also need to adapt any special requirements your client may have into the lease agreement.
In drafting the lease agreement, you may need to consult with other advisors working with your client such as his or her banker (if the property is subject to a mortgage) or the client’s architect or builder (if your client’s needs involve construction and/or modification). Involving additional advisors will help ensure that the commercial terms incorporated into the agreement are appropriate.
Third, you should discuss with your client the importance of not only finding the right tenant with whom he or she is comfortable, but also one that your client is confident can pay the rent and leave the premises in a satisfactory condition. Other considerations you will need to take into account include:
- How to ensure adequate security for the lease. For example, you may want to advise your client that he or she needs to obtain personal guarantees from the directors or shareholders of the company leasing the premises or a bank guarantee or cash deposit. By doing so, in the event the company fails to meet its obligations under the lease, your client has recourse.
- Who is responsible for the finish-out of the premises, who will own the improvements at the end of the lease and who is responsible for refurbishing the premises at the end of the lease?
- With respect to alterations to the premises, the lease agreement should also discuss the possibilities of liens on the property. Your client may want to require the tenant to post a bond before any alteration to the premises.
- You may need to obtain the consent of your client’s banker for the lease. The bank may have different requirements for a short-term lease than for a lease that exceeds three years. You should also make sure the mortgagee understands the many options to renew the lease.
- Finally, in representing a landlord, you will also want to consider the maintenance terms and what party shoulders the costs and burdens of maintenance. With respect to commercial property with more than one tenant, your client will want to incorporate in the lease agreement access to common areas, elevators, toilets, etc.
Specific Issues for Tenant’s Counsel to Consider
When you consider that one of your client’s most important business assets is the lease, it becomes critical that your client understands the implications of the lease as well as his or her rights and obligations under the lease. In fact, your client’s premises may very well be the most tangible component of his or her business. Because the term of the lease and the financial effect can be significant, tenant’s counsel should carefully review and fully negotiate the lease agreement. If not, your client risks losing much over a lease dispute.
The recitals should set out the ownership of the premises as well as the parking and common areas of the building. Careful tenant counsel will review the property owner’s title, review any title exceptions and, especially where the tenant is making a large investment in the leased premises, consider obtaining leasehold title insurance.
When your client has found the right premises, in the right location for his business, some specific issues you will want to consider when negotiating the lease include:
- How and when the parties will review the rent payment. Does the rent increase over time? If so, is the increase a fixed dollar amount or is it a percentage? Is the amount of any increase predetermined or is the increase based upon the Consumer Price Index? In today’s market, the value of real property can change dramatically. If the value of the leased property changes materially, does that affect the rent? Is your client obligated to pay late charges if the rent becomes past due? If so, how much are those late charges?
- Who pays real estate taxes and utility payments? How does the lease agreement allocate these types of expenses?
- Your client’s lease may be as much an asset as it is an obligation. Does the lease agreement allow your client to record the leasehold interest? Is your client obligated to record the leasehold interest?
- What are your client’s obligations and responsibilities regarding repairs, cleaning and upkeep of areas shared with other tenants? The industry generally refers to these types of expenses as common area maintenance (CAM) charges. If the lease agreement requires your client to pay a monthly CAM charge, how often does the landlord reconcile what the landlord has expended verses what the landlord has collected? Who audits these expenses and how often are they audited? You may also seek to impose caps on these CAM charges.
- The lease agreement should define the tenant’s rights and obligations regarding alterations of the premises. These would include who pays for the alterations, what restrictions, if any, does the tenant have regarding the alterations, who owns the alternations after the lease term expires and does the tenant need to return the premises to its original condition after the lease expires?
- Does the lease agreement require the tenant or landlord to carry insurance? If so, what kind and how much? Does the lease agreement require the tenant to list the landlord as an additional named insured? Under the lease agreement, who has the obligation to pay such insurance? Does the lease agreement require the insurance to cover common areas? If so, is the cost of such insurance covered under the CAM charges?
- The lease agreement should discuss what happens in the event the premises are destroyed. Does the landlord have an obligation to rebuild? If so, under what time frame?
- What does the lease agreement provide regarding assigning or sub-letting? Does the landlord need to give his consent before the tenant can assign or sublease?
- What is the term of the lease and when is your client able to exercise any options for renewal? You and your client may need to calendar these dates to ensure your client meets the relevant requirements for exercising these options.
With any commercial lease, regardless of the party you represent, a variety of unique issues will arise. Whether a tenant wants to install wall-to-wall shag carpeting or a landlord wants to evict a tenant because of strange barnyard noises in a downtown office space, the key is to memorialize an agreement that accurately and clearly expresses the intent of the parties and provides guidance on the rights and duties of the landlord and tenant through the lease term and beyond.
Scott W. Meier attended the University of Wyoming where in 1982 he received his B.S. in Accounting. He worked as a CPA in Dallas and Denver before returning to the University of Wyoming, College of Law to earn his J.D. in 1996. Scott is a partner with the firm of Hathaway & Kunz, P.C. in Cheyenne, Wyoming.
* The author acknowledges assistance by Lucas Buckley, an Associate with Hathaway & Kunz, P.C.
Copyright © 2008 – Wyoming State Bar