For many businesses that are trying to rent space, negotiating a commercial lease is a major decision that involves hours of research and planning. You may think that once you find the perfect space and negotiate all the key details such as rent, term, and renewal options, all of the hard work is done. However, there may be pitfalls lurking in your lease agreement that could turn your dream space into a nightmare. Paying attention to these details now can prevent costly mistakes that could impact your business later on. Before you sign on the dotted line, make sure you know whether your lease contains any of these hidden traps.
Many tenants are dismayed to learn that the space they painstakingly found and thought they had negotiated for may not be the space that they end up with. Landlords often include a “relocation” clause in their form leases which gives the landlord the right to move the tenant to a different space in the building, or even to a different property in some cases! Landlords include relocation options in their leases because they like to maintain maximum flexibility for themselves to reallocate the space in the building and to attract new tenants who may want more space or offer better terms. For tenants, however, the exercise of relocation option is rarely a good thing. The tenant could end up with a less desirable space, or lose tens of thousands of dollars that the tenant paid for improvements to the original space. If the location and/or layout of the space is critical to the tenant’s business model, a relocation could have a devastating effect on business. For retail businesses, in particular, the loss of frontage and visibility could dramatically impact sales.
If your lease contains a relocation clause, we recommend asking your landlord to delete it completely, eliminating the possibility that you could be moved to another space without your consent. If your landlord is unwilling to completely remove the relocation clause, there are still steps you can take to protect your interests. At a minimum, the lease should state that the landlord is responsible for paying for all of your moving costs, and that the move will be coordinated with you to minimize any impact on your business. In addition, you may want to consider including language in the lease that requires the replacement space be comparable in size, layout, or location. If you or the landlord made substantial improvements to the original space, you may also want to require that the new space to be finished to a comparable standard at the landlord’s expense, or for the landlord to provide you with an allowance for building out the replacement space yourself.
In the excitement of signing a new lease, most tenants never consider that a day might come when they want to transfer the lease to someone else. Eventually, however, you may want to sell your business, or transfer the lease to another entity as part of a corporate reorganization, for estate planning purposes, or because you want to close your business. Most landlord-friendly lease forms prohibit tenants from assigning the lease without the landlord’s consent. As a result, you may find yourself unable to achieve your goal of selling the business, reorganizing, or getting out of the space because the landlord refuses to approve the assignment of the lease to the new tenant, or takes so long to approve the assignment that the new tenant walks away. Even if the landlord is willing to approve the assignment, it might be on conditions that you are not willing to accept, such as your agreement to remain personally liable for any defaults by the new tenant. Many of these problems can be avoided or minimized by carefully reviewing the language in your lease and negotiating these provisions with your landlord before the lease is signed.
When it comes to operating costs, leases come in all shapes and sizes. Some leases are all-inclusive, and utilities, taxes, insurance and all other costs of maintaining and repairing the premises are included in the monthly rent. At the other end of the spectrum, some leases are true triple-net leases, in which the tenant is responsible for directly paying all of these costs themselves. Most leases fall somewhere in the middle; the tenant is responsible for directly paying some costs, while the landlord may pass through other operating costs to the tenant as additional rent.
When negotiating a new lease, make sure you understand exactly what expenses will be your responsibility, and the kind of expenses the landlord can pass on to you. Most landlord-friendly leases include a broad definition of “operating costs,” which can result in disputes later on when you are asked to reimburse the landlord for expenses that you believe are excessive or improper. Careful attention should be paid to the language in the lease to prevent the landlord from charging you for things like disproportionately high management and administrative fees, interest on the landlord’s financing, costs which are attributable solely to other tenants, and promotional costs for marketing to new tenants, to name just a few, resulting in significant potential cost savings over the life of the lease.
Removal of Alterations
Many tenants spend a great deal of time negotiating the buildout of the leased space with the landlord without realizing that a very expensive surprise may be waiting for them years down the road when the lease ends. Many leases provide that at the end of the lease term, the tenant must remove any alterations to the leased space upon the landlord’s request. In some cases, this means removing all of the interior improvements and returning the space to an empty shell, which may cost thousands or tens of thousands of dollars in unplanned demolition costs. If your lease requires you to remove the alterations to the premises at the end of the term, we recommend asking your landlord to delete this provision. If your landlord is unwilling to remove it altogether, there may be other ways to make this requirement less onerous and to control this future expense, such as by requiring the landlord to determine at the time the alterations are made whether they must be removed at the end of the lease. In any event, being aware of this provision will allow you to plan accordingly and to avoid any unpleasant surprises.
Never assume that a commercial lease is just a “standard” form or that its terms can’t be negotiated. For many business owners, signing a lease is one of the business’ most significant obligations. The provisions described in this article are just a few of the many traps that may be hidden inside what seems like an otherwise innocuous lease. Taking the time to have your lease reviewed by a qualified real estate attorney can avoid unwelcome surprises and regrets later on.
Catherine Robinson is an attorney with the Business and Transactional practice group at Davis, Agnor, Rapaport & Skalny LLC. If you have questions about this article or other business or real estate related matters, please contact Catherine at 410.995.5800.