The best tenant representation starts with the term sheet

Do you want to take the service you provide as a tenant representative to the next level? The first step might be incorporating the lease terms below into your next term sheet or letter of intent. While these items are sometimes viewed as “legal issues” and left to the attorneys to resolve down the road, tenants almost invariably benefit when these issues are addressed early in the negotiation process, when landlords are more likely to offer meaningful concessions to close the deal. Moreover, both parties will benefit by saving time and money if an agreement can be reached on these points prior to involving counsel to document the transaction.

1. Request a non-disturbance agreement

A non-disturbance agreement (i.e., when a lender agrees to recognize the lease in the event of foreclosure) will protect a tenant against the lease being extinguished in the event of a default under an existing loan. It is especially important to protect your client’s investment by obtaining non-disturbance agreements from senior lienholders when significant expenditures are made to improve the premises.

When negotiating transactions involving large, up-front expenditures, inquire early in the negotiation process about whether the property is encumbered by third-party debt. If applicable, require that the landlord commit to provide a non-disturbance agreement from each lender with a lien on the property. Also, be sure the term sheet provides for meaningful remedies (such as offset rights or the placement of tenant improvement funds into a third-party escrow) to be exercised by the tenant in the event the landlord does not obtain the required agreements. To expedite the process, consider asking the landlord to provide the preferred form of the non-disturbance agreement from each of its lenders and provide it to your client’s attorney to be reviewed and negotiated concurrently with the lease agreement.

2. Pursue Proposition 13 protection

Most tenants of commercial property will be obligated to pay a pro rata share of the real estate taxes levied against the property. Article 13A of the California Constitution (aka “Proposition 13”) caps real estate taxes at 1 percent of a property’s assessed value, and limits annual increases to the lesser of 2 percent or the increase in the cost of living for the year. But when property is sold or is otherwise subject to reassessment, the cap on property taxes does not apply. As a result, tenants of a building with a low tax basis benefit from the cap on real estate taxes as long as the building is not reassessed, but they may experience an unexpected spike in their share of taxes if the building changes ownership during the term of their lease.

Protect your client by evaluating the current tax basis of the contemplated property and the financial impact that reassessment would have on their property tax obligation. If applicable, consider requesting some form of Proposition 13 protection from the landlord. Although full protection against reassessment during the lease term may be obtained only by tenants with the greatest bargaining strength, landlords may be more willing to offer some level of protection that diminishes throughout the term of the lease.

3. Define the outside date and remedies for untimely delivery of premises

Term sheets frequently provide that a lease will commence on the date on which the landlord “substantially completes” the tenant improvements to be constructed in the premises. When negotiating a deal with a floating commencement date, consider setting an outside date for the landlord’s delivery of the premises. Take into account the termination date of your client’s existing lease, holdover rent obligations, etc. If an outside date is important to your client, negotiate a meaningful remedy (e.g., a rent credit or landlord’s payment of the tenant’s holdover rent) that will motivate the landlord to complete the tenant improvements on time and protect your client in the event that the premises are not timely delivered.

4. Discuss tenant improvements and other work letter items

Parties frequently overlook the importance of discussing and agreeing upon the particulars of the tenant improvement construction process and other items typically addressed in the work letter. Addressing these details head-on, however, will likely expedite the lease negotiation process and lead to a more pleasant construction period.

Often neglected issues include the selection of (or process by which to select) a space planner and contractor; the time periods for each party to review and approve plans, specifications and other documents requiring consent; whether the landlord will be entitled to charge a construction management fee, and if so, how the fee will be calculated and whether it will be subject to a cap; and whether a build-out is a true turn-key delivery with no exposure to the tenant for cost overtures (other than those due to tenant delay or tenant-requested change orders). Term sheets for deals with an improvement allowance should also indicate how the allowance will be distributed; whether the allowance may be applied toward expenses, such as cabling/wiring costs or moving expenses; and whether the tenant may use any excess allowance to offset the rent obligations. If not addressed in the term sheet, the default resolution of many of these issues tends to favor the landlord.

On a final note, consider creating your own form term sheet or letter of intent addressing these issues and others that are important to your clients. Use your own form as the starting point or checklist for negotiations whenever possible, and you (and your clients) may be pleasantly surprised by the results.

Siler is senior counsel in the real estate practice group of Gordon & Rees LLP. She represents regional and national building owners and tenants and public and private companies in a variety of real estate transactions.

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