COMMERCIAL LEASES - TIPS & TRAPS

Commercial leases are minefields for the unwary. This article attempts to point out some of the major concerns that a business owner should watch for. Finding the right place to do business is an important challenge. Settling and documenting the terms of the lease is also very important.

While a month's rent may not seem like a lot of money, try adding up all of the rent and expenses payable over the term of a ten-year lease. It adds up to a lot of money. A prudent business owner will want to limit the downside when getting into a new lease. Although every new business owner is optimistic, experience teaches us that many new businesses fail, and it is important to build in protection from the beginning.

Commercial leases tend to be very long documents and almost all of the words are for the benefit of the landlord. In this economic client, it is a tenant's market and a lot of lease provisions are negotiable.

Set out below are a number of hints and warnings. The list is not exhaustive, and a tenant should always get legal advice before signing a lease or an offer to lease. The advice of a good accountant and an experienced real estate agent is also invaluable.

OFFER TO LEASE:

Many landlords want you to sign an Offer to Lease first. It is usually a shorter agreement, setting out the bare bones of the deal. BE CAREFUL, because this is a binding agreement and contains many of the important provisions that will go into the lease itself. Get legal advice before signing it or you may be locked into unfavourable lease terms without realizing it. An offer to lease often says that the terms of the landlord's standard form of lease will apply. Unless you look at this in advance, you do not know what you are agreeing to!

GROSS OR NET RENT?

Leases can be gross leases (where the landlord pays all the extra costs), net leases (where the tenant pays all the extra costs) or something in between. These costs, sometimes called "common area expenses" or "additional rent", can include property taxes, fire insurance, utilities, maintenance, and other costs, for both the premises you are renting, and (in a multi-unit complex) for the common areas. They sometimes include everything, right down to the cost of the landlord's employees and accountants.

In some cases, these extra expenses are as much as the base rent!

The Offer to Lease, and the lease itself, will generally set out which costs you pay. It is important to read this carefully and make sure that you understand what your obligations as tenant are. If in doubt, spell it out!

WHO IS THE TENANT?

Unfortunately, many businesses fail. A prudent business owner will try to insulate himself personally from the effects of this. Operating your business through a corporation can protect you from the liabilities of the business, if it goes under. If you intend to incorporate, but have not yet done so, make it clear in the Offer to Lease and the lease that you are signing on behalf of a corporation to be incorporated, and not personally.

GUARANTEES

Even if the tenant is a corporation, a landlord will often ask for personal guarantees from the shareholders. Try to negotiate your way out of this. In the current market, many landlords are happy just to have someone paying the rent. If the landlord provides a lot of inducements, such as free rent or improvements, the landlord is more likely to ask for a personal guarantee, to ensure that he gets his money back. If a guarantee is required, try to limit its scope so that it expires after, for example, the first year of the term.

LANDLORD'S WORK AND TENANT'S WORK

The Offer to Lease is the place to spell out what work, if any, the landlord has to do to get the premises ready for you. Generally, if it is not spelled out, the landlord does not have to do it. The tenant will normally have to do all the additional work to get the premises ready for occupancy.

TERM OF THE LEASE

Landlords like to negotiate lengthy lease terms. It helps them with their financing. Tenants also like long terms, so that the rent is locked-in, and they know they will not be out on the street in two years. However, the longer the lease term, the more exposure the tenant has, if the business does not work out. To get the best of both worlds, try to negotiate a short lease term, with several renewal options. Try to set the rent in advance for the renewal options. If the landlord will not nail down what the rent will be for renewal options, make sure that there is an arbitration clause for the renewal rent, so that if the landlord and tenant cannot agree a neutral third party will set a fair market rent at the time. If there is no set rent, and no arbitration clause, the renewal clause is not enforceable, and therefore worthless to the tenant.

REPAIRS & MAINTENANCE

Most commercial leases require the tenant to pay for routine maintenance of the premises, and also a share of the maintenance costs for the common areas. Some leases also try to pass on the costs of the landlord's major capital repairs and replacements. These can be significant, particularly in an older building. Try to negotiate the removal of these clauses, or at least put in a requirement that the landlord amortize the cost of any improvements over their useful life, so that you don't end up with a huge repair bill in the last year of your term.

RESTRICTIONS ON USE, ASSIGNMENT AND SUBLETTING

A landlord likes to know whom he is dealing with, and likes to have some control over what tenants are doing in the premises. This is especially true in retail malls. A landlord, therefore, will want to restrict what you can do in the premises and whom you can assign the lease to. A tenant wants to have maximum flexibility, so that if the original business fails, the tenant can assign the lease to somebody else, and the new tenant will be able to change the use of the premises. The landlord will still want the right to approve, but it is important that the lease not permit the landlord to unreasonably withhold consent.

WHAT TO DO WITH IF THE WHEELS COME OFF

If your business is doing badly and you can't pay the rent, get some good legal advice quickly. The landlord has some special rights to seize and sell the tenant's assets in certain circumstances, and the tenant may want to make sure the bank gets there first. This is a very complicated area of law and good advice at the right time can be very important.

CONCLUSION

A properly drafted lease can be of great advantage to you. Make sure you know what your rights and liabilities are before you sign, and you will reduce the chance of unpleasant surprises later.

These articles are provided as general information only, and should not be considered to be legal advice. For advice on a specific situation, please see one of our lawyers.