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Know the law: Lease negotiation and drafting for commercial properties

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Robert Thorn

Careful lease drafting and negotiation can reduce the potential for future legal problems.

Property description

Conflict may arise between the parties from almost any lease provision, even from something as basic as the property description. Cases have been hotly litigated over what is included in the “premises,” as this determines the areas controlled by each party and may also have an effect on repair and maintenance obligations.

Cases have also been litigated over a discrepancy between the square footage of property specified in the lease and actual square footage. Landlords can avoid these types of disputes by avoiding using square footage descriptions in the lease, and instead, describing the space only by address and suite number and/or a drawing or plan attached as an exhibit.

Lease commencement

The lease commencement date should be stated, but the lease should provide that the landlord is not in default if the landlord is unable to deliver possession of the premises by that date. The lease may specify that the tenant will not be liable for rent until possession is delivered to it.

Termination date

Under the case of Ramona Convalescent v. Care Enterprises, a tenant who fails to vacate in a timely manner may be liable for damages both to the landlord and the new tenant caused by the old tenant’s failure to vacate when required. The lease should provide that, time is of the essence and that if the tenant holds over at the end of the term, the tenant will be responsible for any damages incurred by the landlord and the successor tenant. A tenant who is informed of these financial responsibilities in advance may be more likely to return possession without a lawsuit.

Renewal options

Commercial leases often provide for a long lease term or for renewal options. The parties need to be very specific when addressing these areas. A long term can be an advantage or disadvantage depending on economic conditions and the landlord’s future plans for the property. If there is a marked upswing in the economy, and the lease doesn’t provide for increases to market rent, the landlord could lose money every month for a very long time. On the other hand, a long-term lease at market rate with appropriate periodic increases, may appeal to buyers and lenders and increase the property’s value.

The option should identify how the parties will establish the rental rate during the option period. The most common ways to establish the rent are to specify a fixed increase amount, an increase tied to the consumer price index (CPI), or a market rate increase. Because the landlord and tenant can disagree regarding the market rate, a well-drafted lease will describe a prompt, cost-effective process for determining the market rate if the parties don’t agree. It is also important for landlords to specify increases annually during the option period; this is sometimes overlooked.

Options can be non-transferable as personal to the original tenant, but only with careful drafting.

Renewal options should state the conditions under which they can be exercised. Many landlords have been surprised to learn that unless specifically stated otherwise, a tenant may be able to exercise an option even if the tenant has breached lease obligations. Well-drafted leases eliminate this possibility and numerous other common disputes.

Assignment and subletting

Assignment and subletting rights should be clearly addressed, along with any use restrictions that limit the tenant’s right to conduct certain types of business. In the absence of lease provisions on these issues, a tenant may use the premises for any “reasonable” use and freely assign or sublet the lease without landlord consent. If specified in the lease, a commercial landlord can absolutely prohibit or restrict assignment, subletting or change in use. However, an absolute prohibition against assignment or subletting will invalidate a landlord’s right to sue for damages under California Civil Code §1951.4. Because this remedy is rarely pursued, loss of this remedy may not be significant.

Rent amount and increases

The parties must negotiate the rental amount. Will the lease be gross, triple net or a hybrid? Will there be rent increases (fixed, CPI, or adjustments to market)? Will all monetary obligations be deemed additional rent (late charges, property taxes, etc.)? If the tenancy is terminated because of non-payment, all of these issues will be material to the parties’ rights and responsibilities.

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Know the Law” is a service for commercial property owners and managers from the law firm of Kimball, Tirey & St. John LLP. This article is informational only and should not be used as legal advice. For more information, please call (619) 231-1422.

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