Commercial Leases
Although office and manufacturing leases are generally recorded on the books as a liability, they are in fact critical business assets. Substantial investments are made in preparing an office or manufacturing center for occupancy. Also, a company generates good will associated with its location.
When leasing office or manufacturing space, an initial matter to consider is the difference between rentable and usable square footage. Prices are usually quoted on an annual square foot basis, so it is important to know whether the quote is based on actual useable space. Tenants should verify the square footage number provided by the landlord before signing the lease.
It’s also important to make sure that the uses planned for the space are permitted under the lease. The permitted uses should be broad enough to allow possible changes in the business, or to allow for a possible assignment or subletting of the space to a third party. The best use description is “any lawful use.” If the owner’s consent must be obtained to a change in use, it should be given readily unless there is a reasonable objection.
The commencement date of the lease is often different than the signing date to allow for necessary improvements in the space. What happens if the space is not ready on the commencement date? At a minimum, rent should be abated, and if the problem continues for a period of time, the lease should be cancelable at the option of the tenant. The termination date must also be spelled out clearly.
The base rent for the primary term is usually clear enough. What about escalations during the term of the lease, such as annual increases? Are there other escalations, such as cost of living increases? Leases often add a supplemental charge for the expenses of maintaining common areas, heating and air conditioning and operating costs. Care must be taken to make sure that any expenses are directly related to the occupancy of the space (excluding the owner’s overhead expenses). The owner should be required to account for the expenses and justify any requested increases. There should also be provisions for audits of expenses. It is prudent to negotiate clear provisions on any escalations or increases and even to cap any such increases.
The owner generally demands a security deposit for the lease. Sometimes a letter of credit can be substituted for a cash deposit. If cash is required, the interest should accrue to the tenant.
Tenant is generally responsible for the cost of the utilities that it uses when occupying the space. There should be separate utility meters so that the tenant doesn’t end up paying for other occupants or common area utility charges.
It is usually necessary to make certain improvements to the space before the tenant can move in. What will be the cost of these improvements and who will pay them? The owner will sometimes provide a work letter for improvements as an inducement to secure a long-term lease. If so, the owner sometimes wants to specify the company that will provide the contractor services. If that’s the case, it is important to prepare a detailed construction letter setting out all the requirements of the renovation, as with any contractor. Whoever is the contractor should be responsible for obtaining any necessary permits and approvals. At the end of the lease term, the owner will generally own the improvements, but if there are any special fixtures that the tenant wishes to take away, these should be specified in the lease.
If something goes wrong with a structural element of the space or one of the mechanical systems, whose responsibility is it to fix the problem and who pays? It is important to detail these responsibilities, and to factor them into the cost of the lease if the tenant is forced to assume responsibility for them. Leases generally contain a requirement that the space be returned at the end of the lease in the same condition as at the beginning, subject to ordinary wear and tear. Is this consistent with the use that tenant intends to make of the space? The tenant should consider the costs of returning the facility to its original condition if major modifications were made during the course of the lease.
The tenant should have the right to sublet or assign the lease, as long as the new tenant is reasonably acceptable to the owner. The lease will generally spell out the standards of what is an acceptable subtenant or assignee. The tenant should be allowed to assign to an affiliate without the consent of the owner, as long as it remains primarily liable under the lease. The assignment clause should be read carefully to determine if there is a deemed assignment in the event of a change in control of the tenant. If the assignment or sublet is at a higher rental, the owner will often try to keep all or most of the increase.
The owner should warrant certain basic conditions, such as quiet enjoyment, ownership and class of building, if appropriate. If the building is destroyed or rendered unfit for occupation, the tenant should of course have the right to cancel the lease.
Tenants should generally negotiate for options to renew the lease at the end of the basic term. The tenant may also want to secure rights of first refusal on contiguous space in case the space becomes available and the company is outgrowing its initial quarters. Attention should be paid to the rules and regulations of the building as well as things like weekend and evening access, security and exterior lighting, signage and parking spaces.
