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An attorney’s role in a commercial lease transaction is dependent upon several factors including the parties, the size, the location and the intended use of the Leased Premises (e.g., office or retail) and the letter of intent or term sheet that contains key terms that were drafted prior to involving counsel. However, it is helpful, not only to the parties to the Lease, but also to counsel, to have counsel involved from the beginning, especially during negotiations of key Lease terms and conditions.
For attorneys representing landlords, a key area of concern is protecting the value of tenant’s business interests with respect to the intended use of the Leased Premises. To address this issue, the landlord or landlord’s counsel may have a certain preferred base form for the Lease which includes covenants by tenant intended to maintain its overall business and financial interests. Depending on the type of Leased Premises, this base form is customarily prepared and revised by landlord’s counsel as an initial draft of the Commercial Lease Agreement. For attorneys representing tenants, their role may involve assisting clients in assessing the type of lease that will best serve the individual tenant’s interests and concerns. Tenant’s counsel should review the initial draft of the Lease from landlord’s counsel and prepare comments based upon counsel’s experience with similar leases and on conversations and potential concerns raised by the client as well as key terms and conditions provided in the agreed upon LOI.
Although not required, if utilized, the Letter of Intent serves as the beginning step in negotiations between landlord and tenant. Upon agreement by all parties, the initial draft of the Letter of Intent should include a brief description of the potential leasing transaction, as well as agreed upon and negotiated key terms (either negotiated by the parties, their counsel or a third party (e.g., broker)). It is customary for tenant, tenant's broker or tenant’s counsel to assume the initial responsibility of providing the first draft of the LOI. The drafting of the LOI and its key terms by tenant could greatly influence tenant’s bargaining power and play a critical role in future Lease negotiations if tenant unknowingly cedes potential leverage early on.
In Texas, there have been a few instances in which a Letter of Intent has been found to be a binding agreement over a conflicting Commercial Lease Agreement by a court of law. Texas courts tend to look to the parties’ original intent as reflected in the LOI to determine the enforceability of terms not covered in the LOI. To ensure that the Letter of Intent is treated as a non-binding agreement, counsel should include express, clear and concise language to such effect.
Due Diligence is a process, typically conducted by tenant’s counsel, to assess the condition, the value and other aspects of the proposed Leased Premises and surrounding premises. Tenant may want to conduct due diligence on (1) whether its intended use of the premises is permissible under local laws and ordinances, (2) what permits may be required to allow tenant to construct improvements on the premises, and otherwise conduct business there, and (3) whether the premises and the surrounding areas are suitable for office, retail, or whatever other purpose the tenant is proposing. Depending on the specialized nature of the proposed use, counsel for tenant may want to conduct additional due diligence as well.
Some of the most important concepts to include in a lease agreement are (1) limitations to a tenant’s use of the premises, (2) the amount of rent a tenant must pay to landlord for its use of the premises, and (3) how rent payments will be adjusted/escalated in the future.
Use of the Premises
A landlord will want to carefully look at the tenant’s intended use of the premises prior to entering into a lease agreement. The landlord may want to allow the tenant broad latitude to use the premises for “any use allowed by law,” or the landlord may want to limit the tenant’s use to only a specific purpose. Similarly, a lease may not allow a tenant to change uses during the course of the lease, or may not allow tenant to sub-lease space to a sub-tenant for a different use. Landlord will also want to ensure that the intended use is in compliance with local ordinances and regulations. Landlord may also insert exclusivity provisions to protect retail tenants, and continuous operations clauses to govern when an establishment must be open to the public.
Unlike in a residential context, commercial rent comes in several forms. A base (or fixed) rent is a set dollar amount calculated on a rentable square foot basis, due on a monthly or annual basis and fixed for a specific period of time. Although base rent is the simplest and most common form of rent utilized for certain commercial spaces (e.g., office or retail), other forms of commercial leases may charge a variable rent. A variable rent is based in whole or in part on a percentage of tenant’s gross receipts or net profits. Landlord’s operating expenses play a major role in the calculation of tenant’s share of costs and expenses under a Commercial Lease Agreement. In most commercial leases, tenants reimburse landlord for their proportionate share of operating expenses and other associated costs related to the Leased Premises. This reimbursement can be embodied in a form of lease called a gross lease, a net lease (or a double or triple net lease) and a base year/expense “stop” lease which separately allocate how/when expenses must be paid by tenant.
Rent Adjustments and Escalations
Typically, provisions related to possible rent adjustments and escalations are included in a Commercial Lease Agreement. In most cases, rent is periodically increased throughout the term of the Lease and may be dependent upon a number of factors such as the current economic real estate market, increases in landlord’s operating expenses, or formulas tracking consumer price indices used to calculate initial base rent. Most rent adjustments have a variety of factors associated with calculating the amount of the rent increase. If rent adjustments should occur within the term of the Lease, it would be prudent for tenant to include provisions covering both rent adjustments and rent allowances. Tenant should always include a provision within the Lease entitling it to a periodic right to audit landlord’s books, including inspection of all escalation statements. Any such audit is generally at tenant’s expense, and should be conducted in accordance with generally-accepted accounting principles.
Other Important Provisions
Other important issues that should be addressed in a lease may include (1) allocation of operating expenses, (2) issues surrounding common areas, (3) services provided by landlord, (4) repairs to the premises, (5) tenant improvements and alterations, (6) parking, (7) the right of first refusal for additional vacant space, (8) indemnity provisions, (9) assignment and subletting of premises, (10) choice of law provisions, (11) default provisions, (12) insurance, and (13) commissions and estoppel certificates.
If the building is subject to a mortgage, the lease will also need to include a clause making it expressly subject to a separately-negotiated subordination agreement. If a landlord insists on a tenant signing such a subordination agreement, it is wise to include a clause in the lease stating that any new owner (or the bank, in the event of a foreclosure) will not disturb the tenant’s occupation of the premises during the term of the lease. It is also wise to include a form of subordination agreement as an attachment to the lease in such instances.
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