Negotiating theCommercial Lease

Peter Collins, Kevin Schouten, Katherine Kowalchuk

Seminar Focus

• Review of major areas of offer to lease and lease with a view to identifying common issues and typical solutions

• Viewed from both Landlord and Tenant perspectives

Know Your Limitations

• Your ability to get the lease deal you want depends mostly on factors out of your control:– Leasing market conditions– Importance of tenant to the development– Strength of tenant’s covenant

The Offer and the Lease

• Two main steps in most lease negotiations:– Offer to lease/Agreement to lease– Lease– (a.k.a. Beauty and the Beast)

Offer to Lease

• An “outline” document of essential terms• Can act as an interim lease if it has the five

essentials:– Parties– Place– Term– Commencement Date– Rent

Bridge to Lease

• The offer might compel tenant to sign landlord’s standard lease

• Landlord will want to preclude Tenant from negotiating changes to Lease

• Tenant will want ability to negotiate change

Bridge – Common Stepdowns

– “Sign standard lease, amended to include terms of Offer”

– Stepdowns “ And amended to include”– Changes agreed to by both parties– Changes of a non-financial nature requested

by tenant, acting reasonably– Changes of a non-financial nature requested

by tenant– Changes requested by tenant

Offer to Lease, cont’d.

• Might permit landlord to terminate if tenant doesn’t sign lease

• Might deem landlord’s presented form to govern:– Until lease actually signed, or– If tenant goes into possession

The Tenant Covenant

• Goal of landlord: have maximum ability to recover against Tenant and its principal(s)

• Financial statements of corporation• Security agreement• Personal guarantees from principals• Security against assets of principals• Letters of credit• Security deposit• Prepaid rent

The Tenant Covenant, cont’d

• Goal of Tenant: • Avoid personal liability, if possible• Use a corporation (preferably single

purpose) • Avoid guarantees/indemnities, if possible

– Or limit by time– Or limit by amount

• Letter of credit as alternate security

Lease

• Lengthy formal comprehensive agreement• Usually heavily weighted in landlord’s favour• May carry over construction and lease

startup provisions from Offer/Agreement• There is no government or CSA approved

“standard” lease– REALPAC has an approved form of office

lease – favours landlords

Developing the Space

• Tenant should:• Review landlord’s development criteria

– Theme/design restrictions• Review insurance requirements for

construction/fixturing period• Review contractor requirements

– Who chooses contractor?• If landlord, must the contractor’s prices be competitive?

(Beware “Cousin Bob’s Construction Co.”)

– Union affiliation

Developing the Space, cont’d.

• Landlord’s work v. Tenant’s work– Landlord’s work – base building (what is

included?)– Tenant’s work – plans approval process

• Fixturing period– Fixed v. open for business– Pay for utilities only

Term, Extensions and Renewals

• Initial term usually 5 years for retail, office and commercial

• Longer initial term on full building build-to-suit

• Monetary risk of longer term lease – tenant is “locked in”

• Shorter term lease - tenant can reduce relocation risk through extension/renewal options

Rent

• Three basic types:– Gross rent– “Net” rents + additional costs– Percentage rents

Gross Rent

• Read the definitions carefully• Should be all inclusive• Landlord should pay all operating and repair

costs and taxes• Tenant should pay only rent and GST

Net Rent

• “Net”/ “triple net” etc.• Landlord shifts some portion of ownership

and operating costs into tenant• Most leases require Tenant to pay

– Landlord’s operation costs– Landlord’s insurance– Property taxes

Net Rent, cont’d

• If multiple tenants – pay only proportionate share– Floating proportionate share is more

accurate than a fixed/stated percentage• Landlord might exclude some tenants

– Anchor tenants– Separate pad tenants

Percentage Rent

• Often found in retail premises leases• Landlord charges a percentage of tenant’s

gross revenues• Definition of gross revenue is flexible• Tenants should beware cash flow inclusions

– Lotteries– Vending machines

Percentage Rent, cont’d

• Usually subject to a (high) floor amount of base rent

• Tenant should seek to make it adjustable for revenue fluctuations

Operating Expenses

• Three main categories• Operating/administrative cost recovery• Property taxes• Insurance

Operating/Admin. Cost Recovery

• Typically is limited to recovery/ reimbursement of actual costs – tenant should avoid surcharges

• Typically limited to operating, not ownership, items

• Typically excludes capital costs recovery• Difficult to negotiate changes to Op Costs

clauses with larger landlords

Operating/Admin. Cost Recovery

• Management fee – tenant should ensure value for fee, or negotiate reduced fee– Retail - typically 15% of operating costs (or 4

or 5% of Rent)– Industrial/commercial properties - 0 to 5%

• Tenant should seek to exclude admin charges if management fee charged– Or, only payable when tenant is defaulting

Audit Provisions

• Tenant should seek to include right to audit the landlord’s Statement of Operating Costs

• If Landlord grants audit right, Landlord should limit the exercise period

• Tenant should seek right to audit at least one year back

Audit Provisions – cont’d.

• Procedure:– Selection of auditor– Compensation of auditor– Confidentiality– Audit cost – who pays

Financial Inducements

• Three common major types– Free rent - base or all rent?– Straight inducement - cash payment on

opening– Tenant improvement allowance - linked to

construction costs• “Excluding GST”

Financial Inducements - cont’d.

• Notion of Net Effective Rent• Is landlord’s financing rate better than bank’s

lending rate?• Might ease cash flow - especially on startup• Potential ability to expense capital items• Landlord usually wants security to recover

cost of inducements

Use of Premises/Conduct of Business

• Landlords define “permitted use” narrowly• Change of use might require consent – can

affect tenant’s ability to sell business• Controls on “classiness” of use• Landlord will usually set hours of use, for

retail leases• Landlord may require “continuous use” -

esp. in retail

Exclusivity

• Landlords are reluctant to grant exclusivity• Exclusivity might be critical to tenant’s

success• Exclusivity is usually narrowly defined• Major tenants are often excepted• Tenant should ensure it applies to

renewals/extensions

Insurance

• Landlord and tenant each insure. Typically:– Landlord insures building– Tenant insures own (interior) premises and

contents• Landlord will require extensive insurance by

tenant– Fire/damage– Liability– Rental payment/business interruption

Insurance, cont’d.

• Tenant should protect itself by obtaining– Waiver of subrogation– Waiver of cross claim

• Tenant should always review insurance requirements with tenant’s insurance broker

• Change in insurability can permit landlord to cancel lease

Maintenance and Repairs -Landlord

• Landlord only liable as expressly set out in lease

• Landlord usually responsible for structural repairs– Should not be recoverable as an operating

cost• Landlord usually responsible for general

non-premises repairs/maintenance – Recoverable as operating cost

Maintenance and Repairs -Tenant

• Usually limited to the (interior) premises• Tenant should ensure no obligation to repair

structure• Restoration obligation on lease

expiry/termination– Improvements – tenant should avoid

defixturing obligation– Trade fixtures usually removable if tenant not

in default– Permanent fixtures usually not removable

Transfer

• Assignment v. sublease• If lease silent, no restrictions• Most leases tightly control lease transfers• Can affect ability to transfer lease as part of

sale of business

Transfer - cont’d.

• Typical transfer control provisions include• Landlord’s consent• Approval of financial strength and character

of assignee• Review and approval fee• Original tenant remains liable after transfer• Change of corporate ownership triggering

transfer clause

Transfer - cont’d.

• Tenants should beware:• “Unreasonable and arbitrary withholding” of

consent• Long list of tests to meet• Take-back right by landlord• No change of use on transfer

Default and Termination

• Landlords have extensive common law rights

• Most leases expand on common law rights• There is no commercial tenancy legislation

in Alberta• Tenants should ensure written notice of

default and right to cure default• Match default events to lease rights (ex.,

continuous use/abandonment)

Default and Termination, cont’d.

• Right of entry on default• Default will not necessarily result in

termination• Landlord has no obligation to re-lease• Landlord can claim rent for balance of lease• Distress rights (unless/until lease

terminated)

Subordination and Non-Disturbance

• Mortgage lender wants top priority• Tenant wants security of tenure• Lease usually requires tenant to subordinate

to lenders• Quid Pro Quo – get a Non-Disturbance

Agreement– Lenders agree to not evict, so long as tenant

not in default– Landlord – covenant to obtain NDA

Estoppel Certificates

• Tenant certifies facts to the landlord/lender/potential buyer

• Can result in tenant waiving claims against landlord

• Tenant should limit scope of certificate during lease negotiations

• Tenant should compare requested certificate to lease obligation

• Nothing in it for tenant – tenant shouldn’t give more than tenant contracted to give

Lease Renewal

• Limits on right to exercise/timing of exercise• Ensure rent is set or there is a rent-setting

mechanism• Definition of “fair market value”

– Improved space?– What comparables?

• Tenant should avoid “floor” on renewal rent– Variance from market– Net effective rent issue

Bells and Whistles

• Option - expansion space• Right of first refusal - expansion space• Co-tenancy and right to terminate• Arbitration/Mediation

After Lease is signed…

• Tenant should register a caveat– Not required if lease term < 3 years

• Landlord should ensure all initial deliveries:– Lease commencement certificate– Proof of insurance– Measurement

Summary

• Leases are usually heavily weighted against most tenants

• Your ability to negotiate improvements to your position is limited by many factors out of your control

• Keep your perspective– Small tenant = small changes – Small landlord + big tenant = big changes

• Good luck! You’ll need it……

Questions??