What Legal Issues to Watch For When Negotiating Your Commercial Lease

As I reviewed another commercial real estate lease this week, I was reminded that negotiating a commercial lease is often a challenge for tenants because each one is so different.  And there is often a difference between negotiating business terms and legal ones.  But the differences can be important.  This is why:

Of course, tenants naturally will focus on the business terms that you would expect to find there: the amount of rent payments and whether they are "gross" or "net", the use of the property, the length of the initial term of the lease, a description of the premises (which must be clear and exact).  Each of these are laden with traps in their own right, but the parties generally expect to negotiate these with every lease.

But some other items are less negotiated but equally as important.  Without being able to address all of the lease's issues here, here is just a sampling of the complex issues involved in negotiating a commercial lease.

  1. Determining the Lease Commencement Date.  Many leases will provide a rent commencement date, which may or may not be the same as the lease commencement date.  Either way, pay careful attention to how much control the tenant has in actually taking possession then.  Often, the landlord will perform some type of buildout to ready the space for the new tenant, which could involve moving some walls, finishing the space with painting or carpeting, or customizing for a particular use.  In any event, date certain for rent commencement in the lease could be problematic for a tenant that is still waiting on a landlord to finish the work.  That tenant certainly does not want to be paying for space that cannot be occupied because the landlord's contractors are still working.  It is best to put into the lease either a non-specific date (i.e. the commencement date is the date that the landlord actually delivers the premises to the tenant), or build in a trigger mechanism that either penalizes the landlord or gives an additional benefit to the tenant like moving into other space temporarily, or even gives the tenant the right to terminate the lease.  Either way, the provision will compensate the tenant and reflect the true intent of the parties - that tenant will pay rent while it occupies the space.
  2. Understanding Lease Renewals.  The initial term of a commercial lease is typically measured in a period of a few years - typically three to five - but can be upwards of ten.  Locking in long terms is good for the landlord's bottom line, but can be very daunting for a tenant, especially one with a new business.  A tenant may be able to negotiate for a shorter initial term with options for extensions at the end of the term.  This gives the tenant some flexibility if it needs to break the lease after a couple of years.  But no matter how long the term lasts, a tenant must clearly understand what is required in providing notice for exercising the option to extend or for terminating the lease.  Often, the tenant must give notice to the landlord more than 90 days before the end of the term, so plan ahead.  And the tenant must understand what is required to extend: Does the landlord have to give consent?  Is renewal automatic without notice of termination?  Can the landlord object to an extension?  Finally, recognize that on an extension, the terms of the lease will generally stay the same, but there is room for the renegotiation of rent and other fees.
  3. Negotiating Assignment and Subletting.  As noted before, most commercial leases last for a period of years.  A tenant who is locked into an economic responsibility for that long wants to have flexibility.  What if you are a startup with a five-year lease and you outgrow the space after three years?  Or you decide that the business is not working out and you want to transfer the lease to another business?  Landlords have an interest in keeping you in the property because they have already qualified you and worked with you for a period of time - they don't necessarily want the extra hassle and expense of qualifying another tenant.  In such cases, the tenant will typically try to negotiate for the right to assign the lease while the landlord generally prefers a sublease.  The assignment transfers all of the rights to the new tenant and now that new tenant is responsible to the landlord.  In many cases, the old tenant walks away.  A sublease on the other hand keeps the lease in tact, and the tenant merely gives away some of its rights while remaining ultimately responsible under the lease.  This is better for the landlord because it allows the space to be used efficiently while keeping the original tenant on the hook.  While the landlord may not give up full unilateral assignment rights to the tenant, landlords are generally willing to allow a reasonable standard to be included (i.e. the landlord's consent to an assignment or sublease "will not be unreasonably withheld").  Massachusetts law, as an example, does not assume a reasonableness standard here, so landlords can refuse to allow an assignment arbitrarily.  So this is a provision that should be visited by all tenants.  Also make sure that any provisions personal to the tenant (e.g. a personal guaranty) will be terminated if an assignment is granted.
  4. Subordination and Nondisturbance Rights.  Much of the attention in negotiating a commercial lease is on the tenant and the ramifications if the tenant defaults or otherwise does not comply with the lease.  But what if the landlord does not comply?  Particularly these days, landlords are at risk of foreclosure just as much as tenants if the property they are leasing to you is mortgaged.  If the mortgage company forecloses on the landlord, your lease is at risk because the landlord the mortgage is superior to the lease.  You can find out if this is the case for your property with a quick search of the state's public records database, many of which are now online.  If you see that the mortgage company or another party has a superior claim to yours, you should negotiate for a "nondisturbance agreement".  This says that if the mortgage company or superior rights holder forecloses on the landlord, it will not disturb your possession and will continue to recognize the lease as long as the tenant continues to perform its responsibilities according to the lease.  That could save you both serious time and money.
  5. Recording a Notice of Lease.  If you have a long-term lease, you should record a memorandum of lease in the public records or your state in order to put other creditors on notice.  Here's why.  Your lease is a claim on the property in a similar way to a mortgage.  But in addition to the mortgage situation described above where you can find the notice in the public records, there may be other creditors making claims against the landlord that you don't know about.  For example, if someone purchases the property from the landlord and you have not filed notice of your lease, the new landlord can refuse to recognize your lease and force you to vacate immediately or re-negotiate the lease on terms favorable to the new landlord.  Having your lease or a memorandum of your lease recorded puts those subsequent purchasers or lien holders on notice of your lease and helps protect your rights in it, particularly if you have negotiated some specific rights.

So what issues have you run into with your leases?  Are there any mistakes you have made that drive your negotiations now?