FEATURE ARTICLE, JUNE 2005

LEASES: WHAT TO KNOW BEFORE SIGNING
Leases are complex documents that require viligance — here is an introduction to a few things to keep in mind.
Shepard A. Federgreen

A lease, of course, is the contract between a property owner and a tenant defining the relative rights and obligations of the parties concerning the use of the premises being leased. The virtually universal procedure is that once the basic business terms are struck, the landlord has these terms inserted into its form lease — except for major retailers, which often insist on using their form lease. These forms are sometimes relatively even-handed, but much more often than not are written to be advantageous to the landlord in any number of ways. These are complicated documents addressing many issues. If that wasn’t the case, leases would not have grown to their current typical length of 40 to 60 pages. A complete lease review is a lengthy and complicated process. However, here is an introduction to some of the provisions both landlords and tenants should be thinking about — and making sure are set forth clearly — when drafting or reviewing a lease.

• Parties: The parties should be properly identified from a legalistic standard.

• Premises: The premises should be clearly defined, as should any rights to use common areas (and the landlord’s right to use, alter or eliminate common areas), any parking rights, any roof rights for communication or other equipment, and any other ancillary rights such as access to a gym.

• Initial Build-Out: Any work to be performed by landlord, and the time in which it is to be completed, should be clearly defined. The implications of the work not being completed on time should be thought through. If municipal approvals such as a certificate of occupancy are required, the lease should define who is responsible to obtain said approvals. If the tenant is to receive a dollar allowance from the landlord, not only the amount of the allowance but the timing of its delivery and the circumstances, if any, under which it might be forfeit should be clearly defined. Any responsibilities for punch list items should be defined. If the tenant is doing the work, the need for landlord approvals should be defined, in addition to the timing and delivery of such approvals. If the tenant needs access only for cabling or installation of fixtures or communication devices, that should be defined, and if necessary coordinated with the landlord’s work.

• Term: Commencement of the term and the obligation to pay rent should be tied to either a certain date or delivery of the completed premises as defined by any build-out terms. Extension and early termination rights, if any, should be addressed.

• Rent: Rent encompasses not only the basic monthly payment but tenant’s obligations for its own costs of occupancy, such as utilities, trash removal and overtime HVAC charges, and its obligations to share in the costs of property-wide operating expenses, such as maintenance of common areas and real estate taxes assessed against the property. A constant area of tension between landlords and tenants is the breadth of expenses that may be passed through to tenants, and how to deal with capital expenditures. There is also the need to clearly define rent abatements and whether any abatement is permanent or subject to forfeiture and repayment by the tenant should there be a tenant default at any time during the initial or any extended term.

• Tenant’s Obligations: In addition to paying rent, tenant will have some or all of the following obligations: to maintain and repair its premises; to maintain insurance in defined amounts and forms; to comply with law, including environmental laws; and to indemnify the landlord from any problem arising out of or related to the tenancy. From the tenant’s perspective, it does not want to inadvertently accept a boiler-plate obligation that is disproportionate to the magnitude of its tenancy — and should work to eliminate or reduce these obligations to only include risks that are commercially acceptable under the circumstances.

• Landlord’s Obligations: Landlord’s obligations, in addition to any initial build-out, might include providing access to utilities; HVAC; building security; maintenance and repairs; landscaping; snow and ice removal; cleaning services; trash removal; and door, floor, and building signage. In retail facilities additional responsibilities might include marketing the project. Leases often include provisions that virtually release landlords from failing to meet their respective obligations.

• Use/Operating: Leases will often define for what the tenant may use the premises and add “and for no other purpose.” So it is important to the tenant that the permitted use is broad enough to allow for all that is contemplated. This is a much more complicated topic when dealing with retail properties. Things to be addressed include exclusives granted to tenants, radius restrictions imposed on landlords, continuous operating covenants, the right to “go dark,” signage, the inter-relationship of all these topics with the assignment clause, and whether any rights that are granted are “personal” to the named tenant.

• Assignment/Subletting: Whether the premises proves to be too big, too small or too expensive, all tenants want the ability to get out. Tenants want as broad a right as possible to assign the lease or sublet all or a portion of the space to whomever is willing to take it. Landlords want as much control over that process as possible. In addition to defining when landlord consent will be required in connection with any such activity, there are the issues of recapture — the landlord’s ability to take back whatever space is to be sublet or to terminate the lease; what constitutes “reasonableness;” and the split on profits, which is often hotly debated, and exceedingly difficult to define — even though profits are very seldom realized by a tenant in an assignment or sublet scenario.

• Subordination: Landlords need the right to compel tenants to subordinate their leasehold estates to the liens of future mortgages, and boiler-plate forms invariably provide for this. Tenants — especially tenants who make a large upfront investment of capital to build out the premises — need to know that if they perform they can remain in occupancy notwithstanding a foreclosure of the landlord’s mortgage. Tenants should not accept the concept of subordination without receipt of a non-disturbance agreement from the holder of superior estates, that is, an agreement that so long as the tenant performs, the tenant can continue in occupancy.

• Landlord Defaults/Tenant Remedies: Interestingly, leases almost never discuss landlord defaults or remedies that are available to tenants. Sometimes a tenant with sufficient economic clout can obtain a “self-help” right should the landlord fail to perform. What leases often do specify, however, is that any liability of landlord shall be limited to its equity in the building — meaning that but for the spread between the value of the building and any lien thereon, the tenant has no other assets against which to realize upon a judgment.

• Tenant Defaults/Landlord Remedies: In contrast to landlord defaults and tenant remedies, leases often go on for pages defining tenant defaults and landlord remedies. The definition of damages available to the landlord often includes the present value of the remaining rent due under the lease less some sort of credit for the then-rental value of the premises, which is not terribly surprising, but also almost always includes all costs incurred by the landlord — including brokerage fees — in procuring a new tenant. A related topic is whether the landlord has a duty to mitigate the tenant’s damages, that is, must the landlord work to reduce the tenant’s exposure arising out of the tenant’s default. Historically in leases the answer was no. However, it is now a question the answer to which varies in different jurisdictions. In New Jersey, for instance, there is a so-called “duty to mitigate.”

This article is an introduction only. It is not meant to be an exhaustive list of the significant topics addressed in leases or an exhaustive discussion of the highlighted topics. It is meant to provide an introduction to some of the more critical topics to be addressed in a lease, and mostly to highlight how complicated a document a lease can be.

Shepard Federgreen is a director at Gibbons, Del Deo, Dolan, Griffinger & Vecchione, P.C. in the New York City office and is a member of the real estate and environmental department and the real estate practice group.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.