Transcript Commercial Leasing Issues

Trevor Adler
Stroock
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Commercial lease basics
Issues to consider before negotiating the
lease, including an exit strategy
Negotiating the commercial lease
What the terms of the lease mean
Lease violations and court proceedings
Lease Strategy “Dos and Don’ts”
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A contract is an agreement between two or
more parties to do something.
A contract may be oral or written, implied or
express, and legally enforceable or not.
In a commercial setting, a written contract
that clearly states the terms of the agreement
is the best protection for a business.
Oral agreements may be enforceable, but
what is agreed to is often disputed.
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A residential tenant has significant protections
under law, including the right to have repairs
made by the landlord and requiring the
landlord to provide heat.
A commercial tenant’s rights are governed
almost entirely by the lease (whether for retail,
office or industrial use), meaning that unless
the lease requires the landlord to make repairs
or provide heat, the landlord will not be
obligated to do so.
 For this reason, it is very important to negotiate a lease
carefully, with the assistance of an attorney if possible.
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Is the space suitable for the business?
– Check the Certificate of Occupancy and zoning law
– Determine what the space was previously used for and
whether the space may be used for a variety of
purposes, in case the business needs to change.
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Have you partnered with real estate
professionals?
– Real estate brokers and local business development
initiatives (Business Improvement Districts) may help
identify space and assess business conditions.
– Legal counsel helps navigate potential minefields and
hidden costs in a lease such as taxes and insurance fees
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Determine the type of business entity that will
be named as the tenant on the lease.
◦ Sole Proprietorship, Partnership, Corporation,
Limited Liability Company
◦ The type of entity can impact the exit strategy by
possibly insulating the business from personal
liability and by making it easier to sell the business
◦ Naming an entity as the tenant on the lease may
result in the landlord requiring a lease guaranty
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Consider lease terms that will limit personal
liability if the lease has to be terminated.
Provide a realistic opportunity for sublet or
assignment.
Exit strategy is not just for negative events .
– Downturns can be an opportunity for expanding a
business, if commercial rents drop.
– Selection of a location is an important factor in the
success of a business
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Oral agreements will not protect a business
Request and negotiate a letter of intent or
term sheet, which lists the key terms of the
lease, including:
– Name of Landlord and Tenant
– Building address
– Description of property
– Use of Premises
– Rent
– Security deposit
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Leases are drafted by landlords.
The standard “form” lease favors landlords.
A form lease usually has a rider that is many
pages long, is drafted by the landlord, and
contains provisions that the landlord wants
and may insist on.
Leases may not reflect the letter of intent.
– Do not sign the lease if it does not accurately reflect
the letter of intent. Oral agreements are not
enforceable when there is a written lease.
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Building address
Name and notice address of tenant
Name and notice address of landlord
Description of the premises
Basic rent
Security deposit
◦ Can it be reduced/eliminated over the course of the
term?
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Term of the Lease (start and end dates)
Additional charges/additional rent
◦ Real estate taxes
◦ Operating expenses / common area costs
◦ Utilities
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Security deposit
◦ Can it be reduced/eliminated over the course of the
term?
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The “standard” lease often limits use of the
space to a very specific purpose—this can be
fatal to an exit strategy.
Keeping the permitted use general will allow
for sublet or assignment to a variety of
businesses.
It is unlikely that the party who takes over
your lease will have the same type of
business.
– For example, a book store may have a hard time
subletting only to another book store.
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The lease will require casualty (property damage)
and liability (damage to persons or property of
others) coverage, at a minimum.
Ask your insurance agent to review the insurance
provisions in the lease and to regularly review the
policy to ensure compliance. Obtain a certificate
of insurance as proof of the current coverage –
DO NOT ALLOW COVERAGE TO LAPSE!!!.
Make sure any indemnity obligations are covered
(indemnity: obligation to cover a third party,
such as the landlord).
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Free rent periods
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Renewal option
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Signs
– Important if making alterations before opening – avoid
paying rent before receiving any income from the business.
– Start-up business may want a shorter initial term with
renewal options to allow for an exit strategy.
– Renewal options provide more flexibility than a long lease
term and limit the tenant’s obligations if the business fails.
– Businesses must have the right to use interior or exterior
signs.
– Signage restrictions may hinder the types of use or exit
strategy.
– If there is an exterior sign or awning, make sure that the
landlord cannot erect scaffolding or otherwise cover it for
an extended period of time.
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Who will do the construction?
Who will pay for it?
Who will own the fixtures after the lease is
over?
Who has to remove furniture or other items at
the end?
Limit the fees that Landlord can charge to
review plans or supervise work.
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Landlord’s repair obligations must be written—there
is no “implied” duty to repair in commercial leases.
Landlord should maintain and repair the structure of
the building (including the roof), building systems
(including plumbing and electrical at least until those
systems enter the premises), lobby and common
areas.
Landlord should be obligated to minimize
interference with your business by performing repairs
after hours.
Request rent abatement and/or termination rights for
circumstances in which the landlord fails to repair or
maintain the premises for an extended period of
time.
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Events that may trigger a default (a violation
of the lease) include:
– Failure to pay rent
– Failure to perform obligations
– Vacating or abandoning the space
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Tenant must receive written notice and be
given an opportunity to cure the default
Resist an acceleration of rent provision
Understand that a default that is not
corrected may lead to termination of tenancy
and eviction.
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Landlords will resist language that permits
the tenant to terminate the lease before it is
over if landlord defaults or the tenant’s
business fails, but it is often worth asking
because it opens up the door to further
negotiate the issue (and receive a rent
abatement if a termination right is off the
table).
Cost will probably be less than the remaining
rental obligation.
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A continuous use covenant requires a business to
remain open and should therefore be avoided if a
business shuts down at certain times of the year.
If the landlord insists upon a continuous use
covenant, you need to provide exceptions for
closure for renovations or sale of the business.
If you operate a seasonal business, specify when
the business is allowed to close. For example, an
ice cream shop may be closed during the winter.
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These are powerful strategies to get out of
the lease or permit someone else to use it.
Typical sublet and assignment provisions in a
lease give the tenant no meaningful rights.
Negotiate these terms at the outset and
incorporate them into the term sheet.
Certain events should not require the
landlord’s consent:
– Mergers, acquisitions and the sale of the business
– In an office lease, occupancy by affiliates
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Limit net worth tests as condition of
Landlord’s consent.
Limit the ability of Landlord to share in
profits and make sure you get your costs
back.
Permit “sharing” arrangements, licenses and
concessions.
Permit the substitution of the old guarantor
for a new guarantor in the event of a sublet of
assignment.
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Some lease terms make it even more difficult
for the tenant to assign or sublease the
space. For example:
◦ Landlord may recapture the space, rather than
consent to sublease or assignment.
◦ Limit recapture rights to a termination of the lease
rather than permit the landlord to sublet the space
back from the tenant, which keeps the Tenant on
the hook for its obligations under the lease.
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Other lease provisions to watch out for:
– Landlord has a right to share in the tenant’s profit
from subleasing the space or assigning the Lease
– Landlord need not reply in a reasonable period of
time to tenant’s request to sublet or assign the
space
– Landlord is not required to be reasonable in
granting its consent to sublet or assignment.
– The space may only be sublet or the lease assigned
for the “permitted use”: for example if the
permitted use of the space is only as a café,
assignment or sublease is limited to another café.
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Landlord should be required to return the
security deposit quickly.
If the last month’s rent was paid upon
execution of the lease—do not pay it again.
Avoid agreeing to restore the space to its
original condition or to remove fixtures or
other improvements.
Avoid high “holdover” rent penalties and
consequential damages.
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Landlord has the right to terminate the lease
or move the tenant to other “equivalent”
space.
◦ This can be a death blow to a budding business.
◦ Say no. If you absolutely cannot say no, then:
– Build in long notice periods – landlord must give the
tenant plenty of time to move.
– Landlord should pay all costs associated with moving.
– Limit termination to specified conditions, which may
include demolition, gut rehab of the building, or a
vacate order.
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Landlord may require a personal guaranty from
individual owners, which puts the individual owners’
personal assets at risk of seizure.
– It is not unusual for landlords to require a guaranty if
tenant is a limited liability company or corporation
– Ask for a “good guy” guaranty to limit liability to rent
– Director and Officers of not-for-profit entities should
strongly resist any personal liability
– Provide for substitute guarantors in the case of lease
assignment or retirement - or provide for increased
security deposit if substitute is not available.
– Limit extent of liability to the estate of the owner
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What is a “Good Guy” Guaranty?
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Limiting Renewal and Expansion Options
– Not a full lease guaranty
– Only responsible for rent up to surrender of lease by
tenant (or certain period after surrender)
– Expressly exclude any “acceleration” of rent upon lease
termination
– Landlord’s often try to limit renewal and expansion
rights to the original “named” tenant
– The ability to transfer these options to a party you sell a
business to may increase the value of the lease
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If you fail to pay rent or violate the terms of your
lease, your landlord may sue you in the
Commercial Part of the Housing Court.
You will receive eviction papers (sometimes
called the “dispossess notice”) called a “Notice of
Petition” (like a “Summons”) and a “Petition” (like
a complaint).
The two types of Housing Court commercial
tenant eviction cases are a “nonpayment”
proceeding and a “holdover” proceeding.
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In a nonpayment case, the Landlord claims
that the Tenant has not paid its rent on time.
– The court may require the tenant to pay the rent
within five days, and a tenant that fails to pay may
be evicted.
– Tenant must receive a “rent demand” (a written or
oral statement that the rent is due and that the
tenant may be sued in Housing Court) at least three
days before the commencement of the nonpayment
case.
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In a holdover case, the Landlord usually
claims that the Tenant has violated one or
more of the terms in the lease.
◦ If the court finds in the Landlord’s favor the tenant
will be evicted—there is no opportunity to “cure”
the violation
◦ In most cases (unless the lease has expired), the
Landlord must first provide the Tenant with written
notice of the claim.
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The tenant must file a written answer to the
landlord’s court papers.
If the tenant is a corporation or LLC, it will not be
permitted to file an answer without a lawyer.
If the tenant fails to file an answer, the court will
enter judgment for landlord.
– Once judgment is entered, the tenant may be evicted
from its space, and my have to pay the landlord’s legal
fees and other costs.
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The tenant’s possible defenses to a rent claim:
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Payment
Actual eviction of the Tenant
Constructive eviction of the Tenant
Breach of the covenant of quiet enjoyment
Apportionment under the casualty provision
Counterclaims against the Landlord
Improper service of process
• Landlord must serve Tenant with court papers in hand (if
feasible); or by posting at the premises and by mail.
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If the premises are damaged by fire, building
collapse, flood, or other disaster (a “casualty”) to the
extent that the tenant cannot use all or a portion of
the premises for the permitted use, the tenant’s
obligation to pay rent is typically suspended until the
space is repaired.
Most leases require that the tenant give the landlord
written notice as soon as the casualty occurs.
A tenant who fails to give the landlord notice will be
required to continue to pay rent until the notice is
given – even if the landlord is aware of the casualty.
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If a tenant receives a default notice, the tenant
must immediately file for an injunction (TRO)
from the Supreme Court to stop the landlord
from terminating the lease. The Court will
consider the following factors:
– Did the tenant received a Notice to Cure, Notice of
Default or other notice to terminate the lease.
• Did the tenant apply for a temporary restraining order (TRO)
prior to the termination of the lease.
• Tenant is ready, willing and able to cure the violation of the
lease.
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Do carefully assess your needs in terms of
growth and down-turns.
Do get an attorney and community business
development group involved at an early
stage.
If you use a broker, Do remember:
◦ the broker’s commission is typically paid by the
landlord
◦ the broker should not get paid until a lease is
actually signed.
◦ to consult an attorney before signing any
agreements
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Do require assignment and subletting
flexibility and sharing rights
Do review your existing agreements
frequently to know your rights
Do try to limit extent of guarantees and
amount of security deposit
Do permit the right to terminate or “go dark”
if the business fails (paying rent but not
opening)
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Do have a business plan before negotiating
the term sheet.
Do get everything agreed upon in writing.
Do try to limit the initial out-of-pocket costs:
◦ Persuade landlord to build-out space or to provide
allowances for build-out during the free rent period
◦ Preserve your lines of credit and savings for
possible down-turns
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Do identify all “hidden” costs in the lease.
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Don’t overlook the necessity of getting
necessary licenses and permits and budget
time and money to get them
Don’t be in a hurry
◦ There are many good locations to consider
◦ Be aware that it can take many weeks or months to
complete between negotiating terms, the lease and
construction
◦ Build this time frame into the business plan
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Don’t hesitate to talk to the landlord about
concessions during lease negotiations or
even after your lease has been signed.
◦ The landlord may prefer to have occupied space
versus vacant space even at a reduced rent.
◦ Understanding your exposure with respect to
security deposits and/or guarantees can give you
significant leverage during negotiations.
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