Negotiating The Commercial Lease(Slides)

Negotiating the Commercial 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……

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Negotiating The Commercial Lease(Slides)

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