In the wake of the COVID-19 pandemic, commercial leases are being scrutinized by landlords and tenants for flexibility and negotiation opportunities. If there is any uncertainty, review by a professional contract attorney is highly recommended. Whether you are reviewing a current lease or negotiating a new lease, below is a brief overview of 10 key clauses that are typically included in a commercial lease.
The general purpose of the term clause is to specify timing and dates. In addition to the start and end dates of the initial rental term and the date that the tenant can take possession, this section may also dictate the due date of the security deposit, the day of the month that the rent is due, and effective dates for required business insurances. The lease should also address whether rent will be abated or there will be any other penalty to landlord in the event the property will not be ready by the noted date of possession.
A specific description of the premises the tenant will occupy should be included in a commercial lease, including any right of the tenant to use any areas to be used in common with other tenants.
The description of the premises typically also included the square footage of the leased premises. It is important that the parties understand how the size of the leased premises is calculated (rentable vs. usable square feet) if rent is based upon a price per square foot and/or if the tenant will be obligated to pay a proportionate share of common area maintenance (CAM) charges or operating expenses based upon the amount of square footage occupied by the tenant in relation to the entire building.
The rental clause of a commercial lease dictates the base amount a tenant will pay for occupying space in a commercial building as well as a portion of the common area expenses, and other expenses such as taxes, insurance and maintenance and repair.
The lease will typically include any future rent escalation during the term of the lease. It is common to tie future rent increases to variable indexes like the Consumer Price Index; however, tenants often try to cap the amount of rent increases over the term.
4. Improvements and Alterations
Most tenants will seek to make some changes to the leased premises during the term of the lease. Those changes could be as minor as a new coat of paint or as major as an expansion or addition. The improvements and alterations clause defines the type and scope of alterations allowed by the tenant to the property, when and how those alterations require permission from the landlord, and their subsequent effects on the rent. For example, improvements to the property could result in a rent decrease while expansions could increase the rent due to the resulting increase in usable space.
Some landlords will even provide a tenant improvement allowance (TIA) for the purpose of customizing the space to their specific needs. However, if the improvements exceed the amount of the TIA, the tenant is generally responsible to pay the overage. Some leases permit the tenant to make minor alterations without landlord permission while other landlords require permission for any alterations. It is common for landlords to agree not to unreasonably withhold or deny permission for tenant alterations.
5. Use, Exclusivity, and Continuous Operation
- Use: The use portion of this clause defines how the tenant may or may not use the rental property. It can include a broad range of conditions in the areas of products or services being offered, and the type of business that can be operated on the premises, and even the type or manner of advertising allowed. In the aftermath of the COVID-19 pandemic and resulting government shutdowns, additional flexibility in the usage clause has been a common point of negotiation between tenants and landlords.
- Exclusivity: An exclusivity clause states that the landlord has granted exclusive rights to a one tenant for a specific action, thereby prohibiting additional tenants from the same action. The addition of an exclusivity clause to the lease might be considered by a landlord for a premium tenant looking to limit local competition.
- Continuous Operation: Some leased require tenants to continuously operate its business throughout the terms of the lease. Although such clauses initially were used primarily for retail spaces within shopping malls, these clauses have become more common in all types of commercial leases as landlords do not want the leased premises to be vacant, even if the tenant is still paying rent.
6. Operating Expenses
If the lease is a “triple net” lease, then operating expenses which are not included in the base rent but will instead be “passed through” from the landlord to the tenant tend to be heavily negotiated points of commercial leases. These expenses fall into several categories.
- Maintenance and repairs: This section should not only detail who pays for maintenance and repairs, but which party is responsible for any necessary replacements of the structural components or material building systems. The responsibility for maintenance, repair and replacement of HVAC systems is a commonly negotiated item.
- Taxes/Insurance: If the lease requires tenant to pay property taxes and property and casualty insurance during the term, the lease should identify whether: (i) the landlord will pay the taxes or insurance premiums directly with the tenant reimbursing the landlord for such costs; or (ii) the tenant will be responsible for paying the taxes and insurance premiums directly.
- Utilities: One reason that utilities may be added to a tenant’s rent instead of individually contracted is whether or not the construction of the building allows for the installation of separate meters. If the building does not have separate meters for each usable unit, the lease will usually be written to allow the landlord to divide utility bills between multiple tenants. A provision which allows the tenant to audit the division of the utility bills should also be included in the lease.
7. Assignment and Sublease
Negotiating flexibility into a commercial lease should be a priority for the tenant and is usually in the best interest of the landlord as well, especially when it comes to long-term contracts. A tenant’s right to sublease or assign the rights and obligations of a contract to another party can help provide this flexibility.
- Assignment: The assignment clause allows the original tenant the right to grant or “assign” the rights and obligations of the current lease to another party; however, it is common that the landlord require the tenant to request the permission of landlord for any assignment. If a landlord is going to consider allowing an assignment to a new tenant, disclosure of the newly assigned tenant’s financials, credit history, and background will usually be required.
- Sublease: A sublease clause offers the original tenant the option to rent out all or a portion of the contracted space to another company, but the right to sublease is also usually subject to the landlord permission as well.
Even if the lease allows for assignment or subleasing, however, the original tenant typically remains legally obligated to the terms of the lease unless specifically released by the landlord
The renewal clause is important not only because it gives the tenant the option to continue occupying the rented space past the expiration of the lease, but also because it usually defines changes in rent and notification deadlines associated with the lease extension. The renewal clause also may address the amount of rent payable during any renewal term or may include an agreed upon method (fair market value appraisal) for determining the rent in future terms.
The tenant should keep the lease expiration and extension notification deadlines in mind and provide timely written notification to the landlord if the intention is to renew. A tenant risks losing its right to renew the lease term if it does not timely notify the landlord.
If the intention is not to renew and the lease lacks a renewal notification deadline, the tenant should make sure to vacate the property by the date of the lease expiration to avoid potentially having to pay rent at an increased, renewal rate.
9. Remedies Upon Default
A lease typically includes a clause that explains the various options that a landlord may have if the tenant defaults. One remedy that is frequently negotiated is whether or not the landlord has the right to accelerate the rent payments for the balance of the lease term or collect some other type of liquidated damages penalty from tenant. This is another provision that has gained increased relevance as a result of the COVID-19 pandemic. A tenant may attempt to reduce the potential damages due upon a default by requiring a landlord to attempt to mitigate its damages by finding another tenant to occupy the premises.
10. Force Majeure
A force majeure clause identifies unavoidable and unforeseen circumstances and their effects on the legal obligations of the tenant and the landlord. This clause has become a point of focus for many tenants seeking to reduce or fail to pay rent without penalty due to the negative effects of the COVID-19 pandemic on their businesses. However, a force majeure clause does not normally allow for the abatement or untimely payment of rent by a tenant in the event the tenant’s business has been impacted by a pandemic.
Strobl is a team of experienced and trusted lawyers that can advise on all legal matters relating to business law, including commercial leases. For more information, visit Strobl online at www.stroblandsharp.com or on LinkedIn.