Negotiating the Commercial Lease

Peter Collins, Kevin Schouten, Katherine Kowalchuk

Seminar Focus
Review of major areas of offer to lease and lease with a view to identifying common issues and typical solutions Viewed from both Landlord and Tenant perspectives

Know Your Limitations

Your ability to get the lease deal you want depends mostly on factors out of your control:
Leasing market conditions Importance of tenant to the development Strength of tenants covenant

The Offer and the Lease

Two main steps in most lease negotiations:
Offer to lease/Agreement to lease Lease (a.k.a. Beauty and the Beast)

Offer to Lease
An outline document of essential terms Can act as an interim lease if it has the five essentials:
Parties Place Term Commencement Date Rent

Bridge to Lease
The offer might compel tenant to sign landlords standard lease Landlord will want to preclude Tenant from negotiating changes to Lease Tenant will want ability to negotiate change

Bridge Common Stepdowns

Sign standard lease, amended to include terms of Offer Stepdowns And amended to include Changes agreed to by both parties Changes of a non-financial nature requested by tenant, acting reasonably Changes of a non-financial nature requested by tenant Changes requested by tenant

Offer to Lease, contd.

Might permit landlord to terminate if tenant doesnt sign lease Might deem landlords presented form to govern:
Until lease actually signed, or If tenant goes into possession

The Tenant Covenant

Goal of landlord: have maximum ability to recover against Tenant and its principal(s) Financial statements of corporation Security agreement Personal guarantees from principals Security against assets of principals Letters of credit Security deposit Prepaid rent

The Tenant Covenant, contd

Goal of Tenant: Avoid personal liability, if possible Use a corporation (preferably single purpose) Avoid guarantees/indemnities, if possible
Or limit by time Or limit by amount

Letter of credit as alternate security

Lease
Lengthy formal comprehensive agreement Usually heavily weighted in landlords favour May carry over construction and lease startup provisions from Offer/Agreement There is no government or CSA approved standard lease
REALPAC has an approved form of office lease favours landlords

Developing the Space

Tenant should: Review landlords development criteria
Theme/design restrictions

Review insurance requirements for construction/fixturing period Review contractor requirements

Who chooses contractor?
If landlord, must the contractors prices be competitive? (Beware Cousin Bobs Construction Co.)

Union affiliation

Developing the Space, contd.

Landlords work v. Tenants work
Landlords work base building (what is included?) Tenants work plans approval process

Fixturing period
Fixed v. open for business Pay for utilities only

Term, Extensions and Renewals

Initial term usually 5 years for retail, office and commercial Longer initial term on full building build-tosuit Monetary risk of longer term lease tenant is locked in Shorter term lease - tenant can reduce relocation risk through extension/renewal options

Rent
Three basic types:
Gross rent Net rents + additional costs Percentage rents

Gross Rent
Read the definitions carefully Should be all inclusive Landlord should pay all operating and repair costs and taxes Tenant should pay only rent and GST

Net Rent
Net/ triple net etc. Landlord shifts some portion of ownership and operating costs into tenant Most leases require Tenant to pay
Landlords operation costs Landlords insurance Property taxes

Net Rent, contd

If multiple tenants pay only proportionate share
Floating proportionate share is more accurate than a fixed/stated percentage

Landlord might exclude some tenants

Anchor tenants Separate pad tenants

Percentage Rent
Often found in retail premises leases Landlord charges a percentage of tenants gross revenues Definition of gross revenue is flexible Tenants should beware cash flow inclusions
Lotteries Vending machines

Percentage Rent, contd

Usually subject to a (high) floor amount of base rent Tenant should seek to make it adjustable for revenue fluctuations

Operating Expenses
Three main categories Operating/administrative cost recovery Property taxes Insurance

Operating/Admin. Cost Recovery

Typically is limited to recovery/ reimbursement of actual costs tenant should avoid surcharges Typically limited to operating, not ownership, items Typically excludes capital costs recovery Difficult to negotiate changes to Op Costs clauses with larger landlords

Operating/Admin. Cost Recovery

Management fee tenant should ensure value for fee, or negotiate reduced fee
Retail - typically 15% of operating costs (or 4 or 5% of Rent) Industrial/commercial properties - 0 to 5%

Tenant should seek to exclude admin charges if management fee charged

Or, only payable when tenant is defaulting

Audit Provisions
Tenant should seek to include right to audit the landlords Statement of Operating Costs If Landlord grants audit right, Landlord should limit the exercise period Tenant should seek right to audit at least one year back

Audit Provisions contd.

Procedure:
Selection of auditor Compensation of auditor Confidentiality Audit cost who pays

Financial Inducements
Three common major types
Free rent - base or all rent? Straight inducement - cash payment on opening Tenant improvement allowance - linked to construction costs

Excluding GST

Financial Inducements - contd.

Notion of Net Effective Rent Is landlords financing rate better than banks lending rate? Might ease cash flow - especially on startup Potential ability to expense capital items Landlord usually wants security to recover cost of inducements

Use of Premises/Conduct of Business

Landlords define permitted use narrowly Change of use might require consent can affect tenants ability to sell business Controls on classiness of use Landlord will usually set hours of use, for retail leases Landlord may require continuous use esp. in retail

Exclusivity
Landlords are reluctant to grant exclusivity Exclusivity might be critical to tenants success Exclusivity is usually narrowly defined Major tenants are often excepted Tenant should ensure it applies to renewals/extensions

Insurance
Landlord and tenant each insure. Typically:
Landlord insures building Tenant insures own (interior) premises and contents

Landlord will require extensive insurance by tenant

Fire/damage Liability Rental payment/business interruption

Insurance, contd.
Tenant should protect itself by obtaining
Waiver of subrogation Waiver of cross claim

Tenant should always review insurance requirements with tenants insurance broker Change in insurability can permit landlord to cancel lease

Maintenance and Repairs Landlord

Landlord only liable as expressly set out in lease Landlord usually responsible for structural repairs
Should not be recoverable as an operating cost

Landlord usually responsible for general non-premises repairs/maintenance

Recoverable as operating cost

Maintenance and Repairs Tenant

Usually limited to the (interior) premises Tenant should ensure no obligation to repair structure Restoration obligation on lease expiry/termination
Improvements tenant should avoid defixturing obligation Trade fixtures usually removable if tenant not in default Permanent fixtures usually not removable

Transfer
Assignment v. sublease If lease silent, no restrictions Most leases tightly control lease transfers Can affect ability to transfer lease as part of sale of business

Transfer - contd.
Typical transfer control provisions include Landlords consent Approval of financial strength and character of assignee Review and approval fee Original tenant remains liable after transfer Change of corporate ownership triggering transfer clause

Transfer - contd.
Tenants should beware: Unreasonable and arbitrary withholding of consent Long list of tests to meet Take-back right by landlord No change of use on transfer

Default and Termination

Landlords have extensive common law rights Most leases expand on common law rights There is no commercial tenancy legislation in Alberta Tenants should ensure written notice of default and right to cure default Match default events to lease rights (ex., continuous use/abandonment)

Default and Termination, contd.

Right of entry on default Default will not necessarily result in termination Landlord has no obligation to re-lease Landlord can claim rent for balance of lease Distress rights (unless/until lease terminated)

Subordination and NonDisturbance

Mortgage lender wants top priority Tenant wants security of tenure Lease usually requires tenant to subordinate to lenders Quid Pro Quo get a Non-Disturbance Agreement
Lenders agree to not evict, so long as tenant not in default Landlord covenant to obtain NDA

Estoppel Certificates
Tenant certifies facts to the landlord/lender/potential buyer Can result in tenant waiving claims against landlord Tenant should limit scope of certificate during lease negotiations Tenant should compare requested certificate to lease obligation Nothing in it for tenant tenant shouldnt give more than tenant contracted to give

Lease Renewal
Limits on right to exercise/timing of exercise Ensure rent is set or there is a rent-setting mechanism Definition of fair market value
Improved space? What comparables?

Tenant should avoid floor on renewal rent

Variance from market Net effective rent issue

Bells and Whistles

Option - expansion space Right of first refusal - expansion space Co-tenancy and right to terminate Arbitration/Mediation

After Lease is signed

Tenant should register a caveat
Not required if lease term < 3 years

Landlord should ensure all initial deliveries:

Lease commencement certificate Proof of insurance Measurement

Summary
Leases are usually heavily weighted against most tenants Your ability to negotiate improvements to your position is limited by many factors out of your control Keep your perspective
Small tenant = small changes Small landlord + big tenant = big changes

Good luck! Youll need it

Questions??