Business Owner's Guide to Commercial Lease Terms
JAKE HOLLY | Associate Attorney | Foulston Attorneys at Law
Approximately 70% of businesses lease commercial space. Leasing is such a common practice that it may be easy to lose sight of how important negotiating your lease is. For most companies, commercial space is one of its most crucial operational components and a major cost. If you’re in the business of leasing, the rental income received from the tenant is a significant revenue stream.
Below is a high-level listing of things to consider when negotiating your next lease, from either side of the aisle.
TENANT’S PERSPECTIVE
As a tenant, you likely know the key terms of your lease and are comfortable with them, such as the monthly rent, term or security deposit. But several other significant items often go unnoticed.
Escalation Clauses. These clauses permit or sometimes mandate annual increases in rent. For accurate budgeting and projections, you should know whether and how your rent may increase during the term of your lease and act accordingly, such as considering negotiating for caps or a set percentage increase.
Operating Expenses. In a “net” lease, tenants are often responsible for some or all of the “operating expenses,” which can be uniquely defined from lease to lease. Tenants should understand how their lease defines the parameters of operating expenses, so that you can negotiate for certain limitations. For example, I have seen leases in which the operating expenses include roof repairs or other capital expenditures. This could lead to a nightmare situation if an unexpected and significant expense is passed on to the tenant as an “operating expense.”
Late Fees & Defaults. Leases can sometimes include exorbitant late fees, administrative fees or both. No one plans to pay rent late, but sometimes it may happen, even through no fault of the tenant. Consider negotiating for reasonable grace periods in the event of late rent. Even more important, negotiate for explicit notice from the landlord with a grace period to cure before a default under the lease could occur. If your bank’s automatic clearing house (ACH) payment fails for some reason and goes unnoticed, it should not give the landlord an opportunity to hold you hostage with the threat of a default and termination of your lease.
Maintenance Obligations. Often the landlord is responsible for some maintenance and repairs. Depending on your lease, some of these responsibilities may have significant operational impacts if not diligently and timely performed (e.g., a broken elevator or leaky ceiling). Your lease should ensure you have suitable remedies if the landlord is negligent or does not otherwise diligently perform their obligations under the lease. Otherwise, you could be stuck in a scenario where the condition of property is unacceptable, but from a practical perspective, there is nothing you can do because the lease does not provide any remedy. In some cases, the lease may even explicitly release the landlord from liability if they did not cause the problem.
Flexibility. Often, leases will prohibit any changes to the use of the space without the landlord’s consent. Sometimes, the consent procedures can be overly burdensome, such as requiring legal or professional opinions, imposing flat “administrative” fees or requiring hundreds of days of advance notice to the landlord. If you believe you may change or expand your business operations, alter or make improvements to the space or perhaps sublease part of the space at any point in the future, then the onerous procedures in the lease will present a problem. Make sure you push for reasonable terms regarding any potential changes throughout the lease term.
LANDLORD’S PERSPECTIVE
As a landlord, the primary concern is to ensure payment and limit liability. Additionally, if you do have an unreasonable tenant, you will want to have clear remedies and options available to remove the tenant and recoup losses.
Security Deposit/Guarantee. All landlords should typically seek a deposit and a guarantee whenever they can. In the commercial context, most of your tenants will be businesses with limited liability. Therefore, a guarantee helps mitigate the risk of nonpayment and gives the landlord another pocket to seek in the event the tenant goes belly up.
Dispute Resolution Clauses. Former tenants suing their landlords is bad for business and the landlord’s reputation. An arbitration clause can preclude a lawsuit in a public forum and require private arbitration if there is a dispute under the lease. Often, it is in the landlord’s interest to handle any disputes confidentially.
Remedies Upon Default. A good lease will include several choices of remedies in the event of a tenant default and provide clear procedures for enforcing those remedies. For example, as a practical matter, the landlord will want the right of reentry upon termination coupled with the ability to seize control of any personal property left by the tenant. Poorly worded remedies can inadvertently cut off the ability to pursue other damages, such as rents owed after the date of the default and termination but prior to the natural expiration of the lease.
Indemnity Clauses. A strong indemnity clause is essential for every landlord because it gives the landlord the right to recoup from the tenant any damages caused by the tenant’s use of the lease. This could include a litany of problems such as legal violations, third-party injuries and other unique situations. Without a broad indemnity clause, the landlord may be on the hook for the actions of the tenant without any way to mitigate those losses.
There are far fewer protections available to the tenant than in residential leases because the Kansas Residential Landlord Tenant Act does not apply to commercial leases. Thus, the terms of the lease will generally exclusively govern. That’s all the more reason to review, familiarize and be comfortable with those terms — they may come back to bite you.
This article is not a comprehensive listing of all negotiation points, but a handful of areas where landlords or tenants may have regrets. Chances are your commercial lease is one of your most important business assets. Make sure you treat it that way!
