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T: 312-461-4314
F: 312-987-9854
E: shargadon@mpslaw.com
Many clients, including companies who have multiple locations and those that don’t, believe that they don’t need to have a “tenant lawyer” involved in a lease transaction because they believe 1) their corporate counsel or general real estate attorney can adequately advise them on lease matters, and 2) the landlord isn’t going to make significant concessions or modifications anyway. The first concern is not supported by the leases we review for clients who were not represented by an attorney experienced in lease negotiations for tenants; the second concern is not borne out by our experience representing tenants. We believe that we deliver value for our clients in every lease because our knowledge of leases and where tenant costs are located (and often hidden) gives our clients savings over the term of a lease which often far exceed the results obtained by other attorneys. Keep in mind, the leases we review are landlord forms. It should not shock you that those lease forms are calculated to maximize financial returns and minimize obligations for the landlord. Here is a small sample of lease items we scrutinize in every lease to save clients money:
1. Protect the Tenant Improvement Allowance.
As a common lease incentive, landlords provide tenants with an allowance to be used towards the cost to improve the premises for tenant’s use. To be blunt – it’s the tenant’s money. When this incentive is provided, the tenant fully expects to receive the benefit of the allowance; however, if the tenant is not careful when negotiating its lease, the tenant could lose all or some of its allowance.
First, the tenant needs to carefully consider allowance deadline provisions, which provide that if the tenant has not spent or requested the allowance by a certain date, any remaining allowance is void and no longer available to the tenant. When the tenant is constructing the improvements, then the tenant may agree to a deadline (and in some markets would have to agree to a deadline), but it better be 100% sure that it will complete the tenant improvements and be able to provide all of the allowance request requirements (such as lien waivers from the contractors and subcontractors) in advance of that deadline. We also recommend negotiating a right to extend the allowance deadline by notice to the landlord for causes outside the tenant’s control. Many unexpected things can happen throughout construction that delay completion, and this is especially true now with the COVID-19 pandemic and related government restrictions.
Second, the tenant needs to consider the limitations on the types of costs that can be paid for with, or reimbursed by, the allowance because if the tenant does not spend enough on permitted costs, the tenant could lose the balance of the allowance. If the tenant does not know if it will spend all the allowance on permitted construction costs, the tenant should negotiate the right to require landlord to apply any unused allowance to base rent due under the lease. The allowance is baked into the base rent that the tenant pays throughout the term of the lease and therefore, we do not think that the tenant should lose the allowance if the full amount of the allowance is not used for permitted improvement costs.
Third, the tenant needs to consider what happens if the landlord fails to pay the allowance when it is due. Typically, without additional language, this would be a landlord default, and the tenant would have to bring a lawsuit against the landlord to obtain a judgment in the amount of the unpaid allowance. However, this does not guaranty that the tenant will be able to collect the allowance from the landlord. What if the landlord is bankrupt? Therefore, we always fight hard to obtain a right to offset any unpaid allowance against rent due under the lease after notice to the landlord and a reasonable cure period for the landlord.
2. Negotiate Operating Expenses and Exclusions Hard.
I could write a book about just this topic, but suffice it to say that in general, landlord form leases permit an overly broad array of expenses incurred by a landlord to be passed through to the tenants. Increasingly over the past ten years, office leases are structured so that landlords can recoup some or all capital expenses. Be aware that capital expenses include capital improvements, capital repairs and capital replacements. As a result, an exclusion only for “capital improvements” does not go far enough; if a tenant agrees to that, the tenant could be paying to replace a building’s chiller or elevator system. Even if landlord amortizes these costs, the bill can be hefty. In industrial leases, a tenant may have to pay some capital costs, and the best result is to pay only for that period of the useful life of the expense item which falls within the lease term.
3. Fight for the Right to Use a Contingent Fee Lease Auditor.
If a tenant is paying operating expenses on top of a base rent, the tenant will (or should) have a right to examine landlord’s books and records to see if landlord’s calculations for those items being charged to the tenant are correct. The landlord’s form lease will usually require the tenant to use a major accounting firm and prohibit the use of an auditor whose fees are based on a contingency. Why is this? Landlords have very good reasons to reject contingent fee auditors. In my experience, contingent fee auditors are extraordinarily effective in ferreting out landlord overcharges. Overcharges often occur because landlords do not check individual leases when reconciling operating expenses. The “one size fits all” method is usually over-inclusive. Overcharges also occur because landlords, particularly if the tenant must engage an auditor that bills by the hour, take aggressive positions on what expenses are passed through. Tenants pay nothing to a contingent fee auditor if the audit fails to disclose any errors; because the audit either costs the tenant nothing or the tenant gets a refund of the overpayment (less the audit fee), tenants can and do use contingent fee auditors every year. Contrast that with the experience my clients have had with big accounting firms: fees are often cost prohibitive except with respect to very large leases and tenants must pay the accounting firm’s fees whether or not any error is found. That to me is a big disincentive for tenants to exercise their audit rights. Don’t think landlords do not know this.
4. Demand an SNDA But Don’t Pay for it.
In the last five years or so, we have seen a new development in form leases ¬– one where the tenant must reimburse the landlord for its costs in obtaining the subordination, non-disturbance and attornment agreement (“SNDA”) from the landlord’s lender. This document, when executed, secures that the tenant will not be evicted from the building if the lender forecloses due to a borrower/landlord default under its mortgage financing. In our view, this is wholly a landlord cost. A tenant should not have to pay costs related to a document the lender will generally require the landlord to obtain, even if it is a protection the tenant should not be without. These costs could exceed $10,000 if there are negotiations over the document requiring landlord to incur its own legal fees and on top of having to pay the lender’s counsel fees as well.
5. Avoid Paying Oversight Fees on Tenant Construction.
Landlord form leases often require a tenant who is constructing initial tenant improvements or subsequent alterations to the premises to pay a construction management fee to the landlord for oversight of the tenant’s construction. These fees are often 5-10% of the total cost of the construction. Given that most tenants have their own construction manager, be it a consultant or the tenant’s own employee, it is simply a landlord profit center to charge this fee. A much better alternative is to allow the landlord to bill only its out-of-pocket costs for any specialty consultant the landlord must hire (e.g., a structural or HVAC engineer) to review the tenant’s plans. In some landlord-favorable lease markets however, a tenant cannot avoid paying landlord an oversight fee so in those markets try to reduce the percentage payable and make the fee applicable only to hard construction costs of the project.
6. Avoid Overpaying on Landlord’s Review of Lease Assignments and Subleases.
Landlord form leases nowadays almost always say that the tenant will pay the landlord’s attorneys’ fees incurred with respect to consenting to the proposed transfer. In some markets such as New York City, San Francisco and Washington D.C., the landlord consent form runs 8-12 pages and will usually contain provisions to which the tenant as sublandlord/assignor and the subtenant/assignee can rightfully object. Just imagine the mindset of landlord’s counsel where all of his or her fees will be 100% reimbursed by the opposing party! Instead of writing a blank check to landlord’s counsel, it is important to cap what a landlord can charge for the tenant’s proposed transfer. Depending on the size and value of the lease, this number should be between $1,000 and $5,000.
7. Fight Landlord Remeasurement Rights.
Landlords often have provisions which say that the leased premises are approximately xx,xxx rentable square feet but that is subject to remeasurement by landlord. If a tenant agrees to this clause, it can end up paying a rent increase even though its usable space does not change. Over time, the Building Office and Management Association (“BOMA”) standards for measurement have gotten more and more inclusive as to what constitutes rentable square footage; in other words, tenants are paying on a larger “rentable area” despite the fact that the usable amount or space has not changed. For example, the 2017 BOMA standard for office buildings included patios and any covered space, even if unenclosed, as rentable space. If a tenant had either or both of those amenities, and landlord was allowed to remeasure, that tenant was vulnerable to an unanticipated rent increase. Landlords will also use these clauses, based on unsupported theories of how common areas have expanded, to increase tenants’ rent. The solution is to agree on the measurement of the premises in the lease and make that calculation unchangeable unless the usable square footage of the premises actually expands or contracts.
8. Prevent “Market” Increases for After Hours HVAC.
Office leases provide that tenants pay extra, most often on an hourly basis, for HVAC usage after regular business hours. If not negotiated, landlords will raise the rate to whatever the market is charging, even if tenant is five years into the term. To prevent this, we try to cap HVAC rates for significant users of that service. Even if a tenant does not anticipate significant usage, it is still a good practice to limit landlord’s increases to only increases in its actual cost of providing the service over the hourly cost stated in the lease.
9. Make Holdover Costs on a Per Diem Rather than Month-to-Month Basis.
It has always struck me as completely unfair for a landlord to get a full month of rent at a holdover rate (usually 125% or 150% of the rent) if the tenant holds over for one or more days. We negotiate hard for this because we encounter multiple holdover issues for our clients every year when the construction of new space is not finished for reasons both within and outside of the tenant’s control. The tenant should get at least seven days of per diem holdover rent before it changes to a month-to-month. Also, it is a good idea to make sure that operating expense/real estate tax payments remain billed at 100% rather than increased by the holdover percentage.
10. Clearly Define Where Building Systems (and Landlord’s Obligations) End.
In office leases in particular, the landlord generally must maintain the common building systems – HVAC, fire safety, electrical, plumbing – which are located both in building common areas and within the tenant’s premises. So if a landlord must deliver the premises in good working order (or similar standard), make sure that warranty applies to all mechanical parts of the above referenced systems. A common example is that landlords will often argue that sprinkler heads on the fire protection system or variable air volume (“VAV”) boxes for the HVAC system are part of the tenant improvements rather than a landlord responsibility. We think that distinction is totally arbitrary. And if the tenant has agreed to take the premises “as is”, it is a best practice to have those parts of the building systems located within the physical boundaries of the premises fully inspected before the lease is signed. Failure to do so can result in the tenant incurring the cost to replace items which are beyond their useful life.
This article has touched on only a few of the items we negotiate for our tenant clients. Most of the listed issues, if not negotiated to a reasonably fair result, could cost a tenant significant amounts of money both up front and annually over the term of the lease. If you are a corporate real estate manager, general counsel, or tenant broker, there are distinct advantages of using counsel like MPS Law that is experienced in tenant representation over less-specialized real estate counsel. We provide that representation at competitive rates and a superior cost to value proposition.