Four non-economic factors that should be kept in mind when negotiating leases.
When entering into a lease agreement, the single most important factor is usually the rent. Unfortunately, both landlords and tenants can often overlook the non-economic factors that can adversely affect their cash flow and impact their bottom line. So when negotiating a commercial lease, protect your business interests by paying attention to four key non-economic considerations: exit strategies, expansion rights, alteration requirements and repair obligations.
Exit Strategies
Negotiating an exit strategy is important because the last thing a struggling business needs is to default on its lease obligations and be saddled with long-term lease debt.
Exit strategies take several forms. For instance, a tenant can negotiate a termination right after a typical three- or five-year lease term. The tenant that exercises its “termination right” is likely to be asked to reimburse the landlord for its share of build-out costs. The landlord also may request reimbursement for the unamortized cost of improvement allowances and brokerage commissions. In addition, the timing of termination will be factored into determining the reimbursement amount.
Expansion Requirements
Just as the tenant should plan ahead to protect itself in case its business declines, landlords should also prepare for the possibility that the tenant might outgrow its space. If possible, negotiate expansion rights in the form of a right of first refusal or a right of first offer if space becomes available in the building or complex. While a right of first refusal gives a tenant the option to match a current offer or proposal that the landlord has for the vacant space, the price is often at market rates. A right of first offer, on the other hand, requires a landlord to offer vacant space to the existing tenant first, before going to market, and the offer is typically at the same rental the tenant is then paying for its existing space.
Alteration Provisions
A careful review of lease alteration provisions may ultimately save a tenant both time and money. A tenant should be permitted to make interior, decorative, non-structural alterations that do not affect mechanical systems without landlord’s consent. Landlords may require tenants to use a particular contractor. This requirement should only apply if the proposed construction could impair the roof or building system warranty. Landlords also may require: completion bonds to be posted, plan review fees to be paid, the right to charge for inspecting tenant’s work and reimbursement for costs related to disabling the fire system so that a tenant can connect to a building-wide system.
Repair Obligations
Finally, landlords are generally responsible, at their sole cost and expense, for roof and structure replacement, but repair costs are passed down to tenants. Relevant lease provisions are drafted narrowly to limit the scope of landlord’s repair responsibilities so that the cost is shifted to tenants. Therefore, it is very important to review the operating expense provisions of a lease in conjunction with a landlord’s repair obligations to ensure that both the tenant and landlord are bearing responsibilities equally.
Also, a thorough inspection of the premises, the HVAC and other systems, by the tenant should be conducted to determine if the tenant is likely to encounter unexpected repair or replacement costs. It is important to specify the condition in which the premises is to be delivered to tenant. For instance, “broom clean, free of tenants or other occupants, in compliance with law and with all mechanical systems in good working order” is generally sufficient.
Although exit strategies, expansion rights, alteration requirements and repair obligations are common considerations in commercial leases, individual leases vary, and other provisions and clauses may be problematic. Also, you may not be able to negotiate everything to your advantage. A skilled and experienced legal advisor can help you determine what will benefit you the most over the long term.
— Iryna Lomaga Carey, Esq. is a partner at Kurzman Eisenberg Corbin & Lever LLP, where she focuses her practice on commercial real estate transactions. She can be reached at [email protected] or 914-286-6372.