By Ho-El Park, Esq.
One of the biggest expense items for most business owners is probably rent. Yet, many keep their lease agreements buried in a file cabinet, only to take it out when trouble arises. The fact is, most leases don’t receive a thorough review and if trouble arises, the five words I hear the most are, “I never agreed to this!” For the small business owners, they have too many things on their plate in launching and running their businesses so lease negotiation and review is not on their priority list. Many assume that these are just standard “take it or leave it” deals. Be that as it may, a lease has an economic value, especially when selling a business. While I cannot discuss every issue that comes my way during my representation of either landlords or tenants, here are the top 5 contested issues that commonly arise in a commercial lease setting:
1. Maintenance and Repair: When a pipe bursts, the air conditioner stops working, or if the ceiling leaks, who is responsible? While this is negotiable between the parties, generally, the landlord is only responsible for exterior and structural portions of the leased premises. Tenants are usually stuck with everything else. However, many times, parties are in dispute with regards to “who” caused the problem. For example, when there is a leak in the ceiling, tenants blame the landlord for not waterproofing/sealing the roof while the landlord points to the lease and say they are not responsible for the interior ceiling (especially if tenant is taking the premises in “as-is” condition). Disputes like this can get ugly, expensive, and lengthy. Business judgment should play a pivotal role in these situations. It really all boils down to damages, since even if there is a leak, there may not be any damage to the business operations, inventory, fixtures, or other items. Best thing for the parties to do is to resolve any small items efficiently by working together instead of blaming each other. Of course, this would only happen in a perfect world. Therefore, it is imperative to make sure detailed discussions and disclosures are made before signing the lease as to who maintains what part of the leased premises. Otherwise, the parties should use more business judgment than trying to play the “blame game” and put the problem under the rug until it resurfaces or exacerbates. However, any problems that are resolved between the parties should be documented and if necessary, the lease should be amended to reflect the new agreement.
2. CAM Charges. Most commercial leases require tenants to pay the base rent and their portion of the Common Area Maintenance (“CAM”) charges, Landlord’s insurance and property taxes (i.e. NNN lease). Normally, in these situations problems arise when the NNN charge increases drastically. For example, when the landlord decides to re-roof the building or repave the parking lot, or hire a security guard, they usually foot the bill on the tenant. The tenant who has a set budget for monthly rent is dumbfounded by the sudden increase and eventually suffers losses. In such situations, the tenant should review what constitutes “Common Area” and what charges are allowable as CAM. Some leases don’t necessarily have repaving and re-roofing as CAM but are classified as capital expenditures. Some leases have a cap on the CAM. Some parties dispute over electric bill if there is no separate meter for the leased premises since the landlord calculates it. Some leases have CAM calculations based on a complicated formula. Again, as mentioned, business judgment and the market should come into play. Landlords should realize that if “everything under the sun” would be a CAM charge, then eventually tenants would have difficulty in paying rent, resulting in the rise of empty units. Even if the “form language” of the lease allows for these charges, in lease negotiations, landlord should disclose all current CAM charges and itemize any potential charges in the future to prevent disputes. Tenants, on the other hand, if not negotiated prior to signing the lease, and if the charges are complicated or hard to calculate/understand, should request for itemized statements showing all the CAM charges (along with calculation and supporting documents) and diligently monitor the charges.
3. Withholding Rent. Most leases prevent tenants from withholding rent (no offset/deduction clause). In general, tenants should not withhold rent and risk an eviction. Yet, too many tenants ask if they can withhold rent when landlord refuses to comply with the lease. If tenants have a genuine good faith dispute as to any charges (including any repair and maintenance costs or CAM charges as referenced above), then at the very least, tenants should deposit the rent in a separate escrow account in timely manner per lease terms and notify the landlord that this is being done in light of the pending good faith honest dispute (of course, supported by evidence). This may safeguard the tenant at eviction trial where the Judge may find that tenant was in compliance of the lease terms in light of the circumstances. Tenants should also keep records of their rent payments instead of relying on landlord’s rent statements. Landlords too make mistakes in rent calculations.
4. Assignment. When tenants desire to sell their businesses for whatever reason and several years remain on the lease term, the assignment provision in the lease can act as a “bump on a road” because the right to assign is not absolute. Usually, the landlord has a final say in approving the new tenant (the buyer of the tenant’s business). Some harsh restrictions to assignment are when; a) the right to assign applies only to the original tenant and not its successors; b) the option to renew provisions are nullified if the lease is assigned; c) the landlord’s right to terminate the lease is triggered by assignment; and d) a hefty transfer premium is charged as consideration for assignment. The process of assignment itself can appear to be a restriction, such as when the landlord requires tenant to submit numerous documents from a potential assignee-tenant that would prove financial strength of such tenant and pay an assignment review fee. Landlord can also assert that a corporate tenant has triggered its right of assignment when it sells most of its shares to another person. Hence, if the tenant wants a way out of the lease by way of assignment, it should negotiate this term thoroughly before signing the lease.
5. Options to renew. Most tenants want to “feel out” the location for a few years and if their businesses thrive, they would want to have an option to renew the lease for several more years. For those tenants with options to renew, they should not assume that their lease terms would be automatically extended if they stay beyond the initial term. Many tenants forget to follow the specific notice procedures in exercising their option and if the rental market favors the landlord, the landlord would use this against them. For instance, most leases require tenants to give landlords a written notice to exercise their options to renew. Many tenants forget to send this notice within the requisite time period or fail to follow the method of sending notice as permitted under the lease (i.e. certified mail or overnight courier, etc.). While it may not be a big deal for some tenants, it can become a landlord’s weapon if the tenants fail to strictly follow the process in exercising their options to renew. Also, many times, the parties dispute over the rental amount during the renewal period if the lease does not specify a number but presents a vague formula in calculating a new rent amount (i.e. “based on fair market value”). Thus, unless otherwise negotiated prior to signing the lease, again, business judgment should dictate what rent amount is reasonable and appropriate during the renewal period.
Both landlords and tenants have a common goal of making profit, and I believe if the parties can come to a sound business judgment, most of their disputes can be resolved. However, in situations where two minds cannot agree, the lease provisions will be critical in dictating the parties’ rights and obligations and can act as further leverage in future negotiations.
For further questions about commercial lease negotiations, landlord/tenant issues, or real estate transactions/litigation, please feel free to contact Mr. Ho-el Park, Esq. directly at (714) 523-2466 or firstname.lastname@example.org.
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