How to avoid the most common mistakes when negotiating your company’s new lease Featured

9:01pm EDT August 31, 2011
How to avoid the most common mistakes when negotiating your company’s new lease

Business owners might avoid bringing an attorney to the table when negotiating a lease, but the advantages of having an advocate in their corner far outweigh the cost.

“In my experience, when you see a lease where an attorney was not involved on behalf of the tenant, you get a lopsided, landlord-favoring lease,” says Jesshill Love, a partner with Ropers Majeski Kohn & Bentley PC. “The attorney’s job is to think ahead to what happens if something goes wrong to make sure the tenant will be treated fairly.”

Smart Business spoke to Love about the pitfalls a tenant can avoid by partnering with an attorney before signing a commercial lease.

Why should an attorney be present in the negotiations?

Any smart businessman or woman is going to employ both an attorney and tenant broker, because they have different roles. A broker is going to be more focused on lease rates, market factors, square footage allocations and tenant improvement allowances. An attorney is going to focus on protections for the tenant from the point of view of the ‘legalese’ of the lease. This can include indemnification, attorney fees, arbitration and mediation issues. Sometimes an attorney has to interpret multiple provisions together in order to get to the conclusion that the lease actually pushes more of the obligations and expenses onto the tenant than it should. The role of the tenant’s attorney is to make sure that the tenant is well represented and receives the benefit of the bargain in the negotiation process.

What is the role of the letter of intent?

This is often where tenants misstep: they start talking to the landlord about deal points or even move to a draft lease before considering the letter of intent (LOI). The LOI is what will set the tone for future negotiations, and if you don’t drive a hard bargain at the LOI stage, then you’re leaving money on the table when the lease is signed. Once the LOI is established, it’s going to serve as a framework for the actual drafting of the lease itself.

There’s a tremendous amount of standard language thrown into a lease, such as forum selection clauses, attorney fee provisions and indemnification and insurance provisions. All of this is fairly standardized in the industry, but the framework of the main deal points from the LOI is what’s going to set the tone for the lease when it comes to flexible items like tenant improvements, common area maintenance (CAM) expenses and operating expenses, and how they’re defined.

What are some provisions a tenant should push for in a lease?

These can change every couple of years as the market changes. Also, as new case law is handed down, attorneys on both sides of the negotiation will angle to push off certain costs or obligations on the opposing party. The big ticket items now are tenant improvements, free rent, environmental concerns, termination provisions and risk of loss provisions.

It’s still a tenant’s market, so negotiating for free rent up front is something you want to try to do, if possible. Also, try to negotiate a cap for any structural improvements with an absolution period and landlord indemnification of the tenant for any pre-existing structural or environmental problems. Mediation and arbitration as well as attorneys’ fees provisions are additional issues to look out for.

Landlords on triple-net leases will try to define everything as a tenant responsibility: roof, plumbing, sewer line, heating, ventilation and air conditioning (HVAC) and electrical problems. A tenant attorney should push back in an effort to make a major structural problem involving the building envelope the responsibility of the landlord.

Another thing you’ll definitely want to have is a clear definition of default, particularly if you have a letter of credit. You don’t want the landlord to be able to draw down on the letter of credit for something that’s an immaterial default under the lease. Also, when lease rates start to increase, landlords are going to be looking for any type of breach they can in order to cancel the tenant’s lease so they can lease to somebody else at a higher rate. Landlords will attempt to define default broadly to effectuate this purpose. We have seen multiple over-reaching default definitions, such as violation of local zoning and use laws and operating hour violations. The attorney’s job is to make sure that a breach of a lease for which the landlord can actually terminate is material; this should be limited to non-payment.

What should tenants avoid in a lease?

First, tenants should avoid personal guarantees when possible, as well as excessive security deposits. Relocation provisions should also be avoided or, at a minimum, limited. Relocation provisions are common in leases with multiple commercial tenant or office spaces. They allow the landlord to move a tenant if the landlord wants to incorporate the tenant’s space with adjoining spaces for a prospective tenant. The tenant has no choice but to move upon notification from the landlord. Relocation could result in a tenant being buried in the back of the office building, or the franchise in the shopping mall could end up tucked away in a space with little foot traffic. This is obviously not what the tenant initially negotiated for when the lease was signed. The tenant must negotiate relocation preferences and safeguards prior to signing that lease.

Further, some lease agreements require a tenant to continue to pay rent even if the space is rendered unusable. For example, if there’s a fire in the building, and the tenant cannot continue to operate the business, the tenant is still required to pay rent. Although the tenant’s lost business can be covered by business interruption insurance, it is not in the tenant’s best interests to have an open-ended time period for the landlord’s repair of the premises. Most large commercial leases are drafted that way — even if it’s not the tenant’s fault, the tenant is not allowed to terminate the lease pending the landlord’s repair of the premises. Litigation surrounding these matters between landlords and tenants can be company killers. There have to be provisions in the lease that say, if this can’t be fixed within a reasonable time period, the tenant gets to walk.

Jesshill E. Love is a partner with Ropers Majeski Kohn & Bentley PC. Contact him at (650) 780-1611 or jlove@rmkb.com.