What are some key considerations for tenants when negotiating a commercial lease? Posted onJune 21, 2023June 21, 2023 Stephen Sforza Tenants must carefully consider a variety of factors in the process of negotiating a commercial lease in order to protect their business, maintain the landlord-tenant relationship and avoid unexpected costs. This article outlines some key factors and considerations that tenants should consider when reviewing and negotiating the terms of a commercial lease. More Than Just Base Rent—Operating Costs & Additional Rent Most commercial leases today are net leases, wherein a tenant is responsible for some or all of the costs associated with the property in addition to paying the base rent, such as costs for utilities, property taxes and insurance. Additionally, landlords incur a multitude of other expenses in order to operate, maintain, repair, replace and manage the common areas of the commercial property. These are called operating costs. Most landlords will attempt to transfer some of these operating costs over to the tenants by using broad or unspecific language in the lease. These operating costs are paid by the tenant as additional rent. When negotiating the lease, a tenant should fully understand and be very clear about what operating costs they are responsible for and how those costs are calculated. The tenant might also consider implementing specific language in the lease that limits or prevents the landlord from charging certain costs back to the tenant that both parties agreed the tenant would not be responsible for. A tenant can include a positive obligation on the landlord in the lease to annually provide an estimate of additional rent on a per square foot basis, respond to any and all questions relating to calculating operating costs, along with an obligation to produce substantiating documentation for those calculations. A tenant should also always negotiate to include in the lease an obligation on the landlord to provide an annual statement (ideally audited) setting out the additional rent for the property/project for that fiscal year and the tenant’s proportionate share of the additional rent. The lease should stipulate how discrepancies between the amounts in annual statement and the amount of additional rent paid in such fiscal year by the tenant will be handled. Repair and Maintenance Where a lease requires that a tenant assume responsibility for repairs, restoration and maintenance, the tenant should negotiate the terms of the lease to limit the extent of its responsibility in this regard. For example, the tenant’s repair and maintenance obligations should exclude reasonable wear and tear, structural and capital repairs and repairs arising due to the negligence of the landlord or its contractors. Furthermore, if a landlord requires the tenant to repair or replace mechanical and electrical systems in the leased premises, the tenant might want to add the condition that it will be assigned any of the landlord’s current warranties with respect to such systems, and that the landlord provide its own warranty as to the good operating condition and repair of such systems on the commencement of the lease. Hazardous Material and Environmental Liability A landlord might require a tenant to remove any hazardous material from the premises, but this requirement should be limited to only those hazardous materials brought onto the premises by the tenant during the lease. A landlord might also attempt to hold the tenant liable for environmental contamination regardless of whether the contamination was caused by the tenant or another source during or before the tenant’s occupancy of the premises. The tenant should negotiate provisions in the lease that would protect them from being held liable for environmental contamination that was not caused by them. End-of-Term Restoration Tenants need to pay special attention to requirements at the end of the lease term, where the landlord might impose an obligation on the tenant to return the premises to its original, pre-occupation condition. The removal of leasehold improvements can be an onerous and highly expensive process. A tenant’s goal, in turn, might be to limit their obligation only to removing its own trade fixtures and chattels, and not any leasehold improvements (especially if not installed by the tenant, but rather a previous tenant). Aside from the lease itself, a helpful tip to tenants would be to take photos and videos of the premises as soon as the tenant takes possession. This media would provide a clear point of comparison for the condition of the premises at the end of the lease term. Redevelopment There are times when landlords may wish to decide to make significant improvements and changes to their property that could directly impact their tenants and cause them to terminate their lease. Examples of these improvements can include major renovations, reconfigurations, and building residential units above a mall. Landlords usually include redevelopment clauses in their leases to give them the flexibility to make these decisions at their discretion. Tenants, however, prefer to remove or limit redevelopment clauses because of the potential disadvantages to their business’ success and stability. There are various ways that tenants can negotiate a redevelopment clause. Ideally, a tenant should ask that the redevelopment clause be removed altogether, even if the odds of the landlord accepting that demand are slim. A tenant might also restrict the landlord from enacting such a clause until a specific date is reached or subject the landlord to a mandatory notice period that is long enough for the tenant to find new suitable premises before the lease is terminated. Furthermore, the tenant should require that all its costs and expenses incurred in the moving process be paid by the landlord. Relocation Like redevelopment clauses, a tenant should attempt to remove relocation clauses altogether because relocating to a new premises could disrupt the goodwill that the tenant established at its current premises. Nevertheless, relocation could be used as a solution in favour of the tenant when a landlord requests to redevelop. That is, a tenant could negotiate to implement an obligation on the landlord to relocate the tenant to similar premises in the development, rather than terminate the lease when redevelopment occurs (if the redevelopment clause provides the landlord with the option to terminate the lease). If the landlord has more properties in close proximity to the current property that is to be redeveloped, the tenant could require the landlord to relocate them to one of the nearby properties, thereby limiting the disruption to its business. A tenant can also ask the landlord to pay for any expenses related to the improvements. Where the landlord insists on the option to relocate the tenant, the relocation clause in the lease should be carefully drafted to ensure minimal interference with the tenant’s business. Extending the Lease Term Tenants are often interested in ensuring that they have the option to renew or extend their lease beyond the original term. This would allow for the continuation of the tenant’s business operations at the premises. It is important that this option to renew/extend that is granted to the tenant speaks to the manner in which notice of the tenant’s intention to exercise this renewal option must be provided (e.g., written notice to be provided no earlier than twelve months and no later than six months before the end of the current term), and the terms of the lease during the renewal period (e.g., all terms remain the same, except for base rent, which would be negotiated by the parties and based upon the then market rent). Where the rental rate for the renewal period is to be negotiated by the parties, there must always be an arbitration clause included that provides for an arbitration procedure in the event the parties cannot agree on such market rent. Transfer Provisions Sometimes a tenant needs a way out of a lease for a variety of reasons, or the tenant sells its business to a third party purchaser. For these reasons, it is critical the lease contains a transfer provision that deals with transferring the lease to another person, including by way of assignment or by subletting the premises. Leases typically limit a tenant’s ability to transfer the lease to another person without the landlord’s prior written consent. The landlord may also impose conditions that must be met by both the tenant and prospective transferee prior to the landlord granting its consent to the transfer. Some of these conditions can be onerous, unnecessary or unduly intrusive. The landlord may require further deposits, detailed financial records of the prospective transferee, and impose a consent fee along with a requirement that the tenant pay the landlord’s legal fees with respect to such transfer. Some leases even provide the landlord the option of terminating the lease upon receiving a request for a transfer of the lease. A tenant would be prudent to negotiate these transfer provisions in the lease to ensure they are reasonable and that they include certain transfers where obtaining the landlord’s consent is not required. Events of Default Leases will list the types of events that will constitute a default by the tenant, such as failure to pay rent or comply with a non-financial obligation. The rights and remedies of landlords upon such tenant defaults need to be reviewed and considered carefully by tenants. Most leases will allow the landlord to terminate the lease, accelerate rent, lock out the tenant, seize the tenant’s property, and continue to hold the tenant liable for all rent obligations for the remainder of the term of the lease. The tenant should ensure that these default provisions are coupled with an obligation on the landlord to provide adequate prior notice in writing to the tenant with respect to any default committed. Such notice of default should also allow for a reasonable cure period, so the tenant can work to remedy the default within such cure period and thereby avoid the landlord exercising its aforementioned rights and remedies. Personal Indemnifiers If the tenant is a corporation, most landlords will require one or more personal indemnifiers to be bound on the lease. These indemnifiers provide additional security to the landlord in the event that the corporate tenant defaults in its obligations under the lease, as the landlord can pursue the personal indemnifiers as well as the corporate tenant for recovery. Of course, whenever possible, the tenant should try to resist providing such form of personal indemnity or guarantee. If unavoidable, the tenant should consider limiting the indemnification period to a period of time (e.g., the first two years of the term). Special Rights Examples of special rights include parking use and/or assignment, roof-top rights to install equipment, signage, and exclusive use restrictions to limit competition from other similar businesses. Where a tenant expects to have a special right included in their lease, they must ensure the special right is written into the lease with sufficient detail and clarity. Prospective commercial tenants should seek legal advice to avoid unreasonable costs and risk while they have the chance in the process of negotiating the offer to lease and the formal lease. If you or someone you know is a prospective tenant looking to negotiate a commercial lease, contact Stephen Sforza at stephen@durhamlawyer.ca or call 289-220-3239. “This article is intended only to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer.” This blog was co-authored by Law Student, Sanaz Sakhapour. Authors Stephen Sforza 289-220-3239 (905) 668-9737 stephen@durhamlawyer.ca