© Goulston & Storrs 2010. All rights reserved.

III. DEMYSTIFYING THE GROSS-UP PROVISION

(OR WHY THIS ACTUALLY MAKES SENSE

FROM the perspective of BOTH LANDLORD

AND TENANT)

Assumptions

1. Building is 100 square feet.

2. Tenant XYZ occupies 50 square feet, and its percentage share is 50%.

3. Annual cleaning costs are $1.00 per square foot.

4. Empty offices are not cleaned.

5. Gross-up provision in lease reads: “With respect to those elements of Operating Costs

which vary based upon occupancy, if the Building is less than 95% occupied, the

amount of such variable costs to be included in Operating Costs shall be “grossed up”

to the amount that such costs would have been had the Building been 95% occupied.”

(Note that a gross-up provision should only apply to costs, such as cleaning, that vary

based upon occupancy.)

Analysis

1. Since cleaning costs $1.00 per square foot and XYZ occupies 50 square feet, it utilizes

$50.00 worth of cleaning services (50 square feet x $1.00).

2. If the Building is 100% occupied, cleaning costs are $100.00 (100 square feet x $1.00).

Since XYZ’s percentage share is 50%, XYZ pays for $50.00 of cleaning. This matches

the amount of cleaning that XYZ actually uses.

3. However, if the Building is 75% occupied, then total cleaning costs are $75.00 (since

empty offices are not cleaned). Absent an adjustment, XYZ will pay for $37.50 in

cleaning services ($75.00 x 50%), but will still utilize $50.00 in cleaning services. This

is a windfall to XYZ of $12.50.

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© Goulston & Storrs 2010. All rights reserved.

III. DEMYSTIFYING THE GROSS-UP PROVISION

(OR WHY THIS ACTUALLY MAKES SENSE

FROM the perspective of BOTH LANDLORD

AND TENANT)

4. Without an adjustment, Landlord collects $37.50 from XYZ and $18.75 from the

occupant(s) of the remaining 25% of the Building that is occupied ($75.00 x 25%), for a

total of $56.25. But since Landlord has to pay the actual cleaning costs of $75.00, this

represents a shortfall of $18.75 ($75.00 - $56.25). This is a penalty to Landlord (since

Landlord must pay it, but none of it is properly attributable to the 25% of the Building

that is vacant and not being cleaned).

5. The effect of the gross-up provision above is to gross up cleaning costs to what they

would have been had the Building been 95% occupied, or $95.00 (95% occupancy = 95

square feet, x $1.00 per square foot). XYZ pays 50% of this, or $47.50. Since XYZ is

still using $50.00 worth of cleaning services, it is actually still getting a windfall of $2.50

(which is 5% of $50),and Landlord is still incurring a penalty, but in both cases the

amount is reduced to 5% (the imputed vacancy factor) rather than reflecting the actual

vacancy factor (25% in our example).

6. Thus, rather than harming tenants, the gross-up provision in fact usually leaves them

ahead of the game -- with a 95% gross-up provision, tenants still get a windfall of 5% of

the cost of the variable cost items which they utilize. The windfall/penalty will only be

completely eliminated by a gross-up to 100%, which is a less common provision -- but

even at 100%, the gross-up provision is merely neutral to tenants and not a penalty.

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© Goulston & Storrs 2010. All rights reserved.

IV. YOUR FRIENDLY NEIGHBORHOOD

LAWYER’S LOI WISH LIST

Key Practice Points: In addition to the things mentioned above, there are several things that

you can do in the LOI to make the lease drafting process smoother and more efficient (and

therefore faster).

1. Specific things lawyers always want to know:

a. All of the items listed above

b. Is the space currently vacant?

c. Does any other tenant have prior rights in the space?

d. What is the exact name of the Tenant entity? Remember, unless you have seen

financials for the exact Tenant entity named in the lease (not something that is

similar, such as IBM Corp. vs. IBM Co., and not a parent or affiliate of the Tenant

entity), then you have no assurances that the Tenant entity has any assets

whatsoever. Knowing that its parent is rich isn’t good enough; a subsidiary

corporation is like a child who over 18 -- the parent is not legally obligated to pay

its debts.

e. If there is free rent, specify whether the term (e.g., five years) runs from the

Commencement Date or the Rent Commencement Date. Ditto for when the rent

bumps occur -- the anniversary of the Commencement Date or the Rent

Commencement Date? Does free rent include base rent only, or also OpEx, Taxes

and/or electricity?

f. If there is a security deposit of X months’ rent, specify whether it is based on the

initial rent, the ending rent or the average rent.

g. State how electricity will be handled. Is it included in Operating Expenses?

Does Tenant pay a separate electricity charge to Landlord, and if so, is it subject

to increase? Is the space to be separately metered (Tenant pays directly to the

utility company) or sub-metered (Tenant pays to Landlord based on actual usage),

and if so, is the meter already in place? If the meter is not already in place, who

will pay for it? Note that how electricity is handled can go by different

terminology, so please spell out what you mean. In other words, instead of saying

the lease is “full service” say “electricity is included in OpEx.”

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© Goulston & Storrs 2010. All rights reserved.

IV. YOUR FRIENDLY NEIGHBORHOOD

LAWYER’S LOI WISH LIST (cont’d)

h. If this is an extension and there is a TI allowance, state whether it can be

used immediately or only after the new term begins.

i. If this is an expansion and there is a TI allowance, state whether it can be

used anywhere in the premises, or only in the expansion space.

j. Lawyers understand the desire to see a date certain for a commencement

date in the LOI. However, if the Tenant is doing the work, they are not going

to accept this – they want XX days after Landlord delivers the space to do their

buildout, not a commencement date of February 1. While you may get away

with February 1 in the LOI, it won’t stay in the lease. Tell your lawyer how

many days Tenant's build-out period will be.

k. If Tenant has antenna rights, what is the maximum size of the antenna, and

how much rent will there be?

2. Feel free to call your lawyer BEFORE the LOI is signed if there is language or

concepts you are not sure of or want to run past them. This can make a huge difference

later. Most leasing lawyers understand that the LOI needs a big-picture focus and will

not raise unnecessary issues at this stage. (Contrary to the widespread urban legend,

lawyers almost never actually charge by the word.)

3. If there are fees or other economic terms, disclose them up front and put them in

the LOI. This particularly includes construction management fees and parking fees,

both of which Tenants have balked at paying if they are not specified in the LOI.

Similarly, if there is an extension option, the LOI must state if there is to be a floor of

“not less than current” on the extension term rent. Otherwise, Landlord probably won’t

be able to get this point. In general, ambiguity or silence in the LOI on key issues does

not benefit anyone, and can in fact greatly delay lease signing.

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© Goulston & Storrs 2010. All rights reserved.

IV. YOUR FRIENDLY NEIGHBORHOOD

LAWYER’S LOI WISH LIST (cont’d)

4. Always leave room for change in the future. Rather than say that the Building has a

fitness center, say that it “currently” or “presently” has one -- otherwise, Tenants can

insist (and have done so) that Landlord be obligated to keep the fitness center

throughout the lease term. Similarly, be sure to say that the current monthly parking

charge is $XXX, and/or that $XXX is subject to change. Be especially wary of

specific language about security procedures in the LOI since these change often. If

you do include this language, be sure to state that this is what Landlord is “currently”

or “presently” doing.

5. Understand that certain things cannot be drafted in the alternative. If the amount

of the security deposit has not been decided, the lawyer can insert TBD and send out

the lease. If you don’t know if the electricity will be separately sub-metered or

included in Operating Expenses, the best the lawyer can do is include one option in

the lease with a note that it may be changed in a later draft. If you don’t know if

Landlord or Tenant is doing the work, as noted above the lawyer can’t do any drafting

until the decision is made.

6. Don’t be afraid to make suggestions to the lawyers you deal with about how they

might handle things better, either at the LOI stage or at the lease stage. You have a

perspective on lease deals that they don’t, so help them to help you.

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