Leases:A "Quick Look"

Saturday, April 1, 2006 - 01:00

Clients, and sometimes our partners on behalf of their clients, often ask us to take a "quick look" at a lease and let them know if there are "any problems." Every real estate attorney with any leasing experience has heard this request. Many office leases exceed 40 pages and 100+ page leases are not extraordinary. Short of not reading the whole lease - not recommended - it is difficult to take a proverbial quick look at a long lease. Self censorship is hard for lawyers.

Clients asking for a quick look at a lease often will have given little thought to the deal beyond the basic terms. It is, of course, essential to confirm that the lease reflects the basic business agreement, but the key to an efficient lease review is to probe the client about matters that the client may not have considered but may be very important. The relevant questions differ from deal to deal and many will be dictated by the client's earlier replies, but here are some of the basics:

When does the tenant need to be out of its current space and into the new space? Tenants often assume the new space will be ready when promised and they will be able to move on time. However, most leases absolve the landlord from liability for delay in delivering possession of the premises to the tenant. If timing is important to the tenant, the clause may be negotiated to seek delay penalties and cancellation rights. Delay penalties often take the form of free rent, often one day for each day of delay (after which rent would otherwise be due and payable). Cancellation rights are usually strongly resisted, especially if landlord is incurring costs in improving the leased premises. In any case, landlord will want an extension of time for unavoidable delays before any penalty or cancellation rights accrue in favor of tenant.

How will tenant use the premises now and in the future? Clients are usually satisfied if their planned use of the premises is permitted by the lease, without considering the possibility that their operations may change or expand into other areas over time, or that they may need to assign the lease or sublet all or part of the premises. A use clause allowing general office use is acceptable. A clause limiting the tenant to a specific kind of office use, and allowing no other use, is not. The obvious concern is that the tenant's use may change over time. Less obvious is the impact of a restricted use clause on assignment and subletting, because the universe of potential assignees and subtenants has been drastically reduced to companies whose use is identical to tenant's use.

Are substantial initial tenant alterations contemplated? With regard to initial alterations that are very minor such as painting and re-carpeting, there should be few issues or concerns. If the initial tenant fit-up is substantial, there will be many questions.

Most importantly, who is doing the construction work, landlord or tenant? In either case, if landlord is paying some or all of the cost (often referred to as the "TI Allowance"), how and when will landlord's payment be made, will there be any security to insure payment, what expenses can the TI Allowance be used to pay and if there is any excess money left after paying for the tenant fit-up, can it be used by tenant and how? If landlord is doing the tenant fit-up, does tenant have any input on the contractor and subcontractors, how will tenant control the use of the TI Allowance, if the work costs more than the allowance, how and when will tenant be obligated to pay the excess, when will landlord have to complete the work and will the work be warrantied in any way by landlord? If the work is to be done by tenant, in what condition will the space be delivered to tenant, what is the process for landlord's approval of the contractor and subcontractors and will landlord be entitled to a supervisory fee or other compensation in connection with the work? Whether the tenant fit-up is undertaken by landlord or tenant, what are the restoration obligations at the end of the term?

What are the tenant's plans for growth or, alternatively, is it possible the tenant will not need the space, or all of it, over time? This is a central question. Tenants often sign leases for terms beyond a few years but cannot answer the following question: several years from lease inception, when you still have a number of years left on the term of your lease, what is the likelihood your space needs will be unchanged from your requirement at the beginning of the term? Unless a tenant is fairly certain that its space needs will remain static, assignment and subletting provisions are critically important to allow a contracting or expanding tenant the ability to exit the space for lesser or greater space and mitigate its costs in doing so.

Some additional comments are in order because of the importance of assignment and subletting as tenant's most likely exit strategy. Short of a simple "consent not unreasonably withheld," it will take some hard work to get an assignment and subletting section into acceptable condition, and there are a number of traps for the unwary.

First, make sure so-called corporate transactions are allowed with relative freedom. This includes mergers and asset sales. In the case of public companies, or private companies where there is any thought of going public, trading of stock must be an exception to anti-assignment provisions.

Recapture provisions are not necessarily problematic except when a tenant anticipates warehousing space for its future anticipated use. If that is a possibility, recapture should exclude interim subleases.

Many landlords will negotiate a profit-sharing arrangement. Whether or not landlord is willing to allow profit-sharing, there is hidden exposure to tenant in such clauses unless tenant is allowed to recover its reasonable subletting or assignment expenses out of the rent paid on a subletting or consideration for an assignment. Many landlords, if pressed, will agree to reasonable expense reimbursements to tenants.

Tenants allowed to assign or sublet often must operate within a series of rules intended to prevent tenant from competing with landlord. Such clauses prohibit tenant from subleasing at a rental rate below the building standard rate or language to that effect, and prevent tenant from negotiating with any current or prospective tenant of landlord.

Minimum rent clauses are very problematic. Subleases tend to be for rental rates below direct space rental rates. The effect of a clause barring tenant from subleasing below direct rental rates is to bar subleasing altogether. Many landlords will agree to remove such restrictions, to be replaced, instead, by prohibitions against advertising sublet space at below market rates. This is acceptable as most space is subleased without advertising.

Anti-competition clauses can be very broad, more than necessary for the protection of landlord. Only when landlord has comparable space available to lease directly to a prospective subtenant should tenant be barred from subleasing to the prospective subtenant.

What are the tenant's parking requirements? How does the tenant expect them to be addressed? Allocated parking, represented by clauses promising a given number of parking spaces to the tenant, is not the same as reserved parking. Reserved spaces have to be specified and identified.

How important is signage? What is expected or needed? Clients sometimes expect the same signage rights that have been afforded to other tenants, evidenced by the signs the client saw when the property was inspected. Tenants have no right to signage unless specified in the lease.

What are the tenant's operating times, and when will the tenant need access to the premises? These are separate but related questions. Many leases state business operating hours, and impose charges for heat and air conditioning during non-business hours. A tenant needing to operate during non-business hours must be assured, first, that services will be available (not only HVAC, but also elevators, where applicable, and security), and second, must understand the charges that will be imposed for such services. Overtime HVAC can be expensive, but rates can sometimes be negotiated or the stated business hours can be expanded.

Many leases allow tenants access beyond normal business hours. However, access may be limited to the tenant's employees (or those issued access cards). You have to find out from tenant if access by customers, clients or third parties during non-business hours is important. This could become a threshold issue with the landlord if third party access during non-business hours is prohibited or severely limited because, by way of example, there is no access to parking facilities.

Does the tenant have any special needs? For example, does the tenant need back up or additional power supply, or access to the roof for microwave or other communications devices? Tenants have no right to appropriate areas outside of their premises for their exclusive use, unless the lease specifies otherwise. If such rights are granted, it is important to provide a means of accessing such areas for repairs and maintenance of tenant's installations, and also for running cabling to and from such areas.

There are many other questions which can be asked that relate to the condition of the property, its operating costs and expenses and the like, most of which do not relate to your client's particular needs and concerns. In an expedited lease review, you will have served your client well if you have discerned the issues that matter to your client and focused on them.

Russell B. Bershad chairs the Real Property and Environmental Department of Gibbons, Del Deo, Dolan, Griffinger & Vecchione.

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