Dos and Don’ts in Commercial Leasing
By Jason D. Gabbard
July 21, 2010
We’ve had our hands full over the last couple of weeks negotiating commercial leases – cupcake stores, health and beauty outposts and office spaces for our growing clients. Unless I’m dealing with a client that regularly engages in lease negotiations – like Ricky’s NYC, one of our fast-growing clients – at least 30% of my job is education. With that said, I share with you in this article a short list of critical issues that surface in nearly every commercial lease negotiation along with my suggested “dos and don’ts”.
1. Indemnities. An indemnity can be thought of as contractual insurance. It requires one party to insure the other against certain losses arising in connection with a bilateral contractual arrangement. In the classic commercial lease example, tenant is asked to “indemnify” or insure the landlord against losses arising from tenant’s breach of the lease terms and certain other misconduct.
Do: Read carefully; assume that indemnities contain traps and pitfalls.
Do: Negotiate so that each party is liable for its own acts and omissions.
Do: Ask for landlord to give reciprocal protections to Tenant.
Don’t: Accept an indemnity clause that contains defense obligations – the word “defend” appears in the clause (e.g., indemnify, defend, and hold harmless…), requiring tenant to retain and compensate an attorney on landlord’s behalf, in addition to paying tenant’s own, separate attorney. Landlord may even have the right to choose his, high-powered, high-dollar counsel.
Don’t: Assume liability for others’ actions. You cannot control the actions of third parties, even if they are invitees.
2. Insurance clauses. Landlords love to dictate the types and amounts of coverage written into tenant’s insurance policy. Additionally, most savvy landlords will ask tenant to have landlord named as an “additional insured” in tenant’s insurance policy. This naming of landlord as an additional insured signifies that that landlord is entitled to all of the same benefits as tenant is under their policy, and any claims paid because of the landlord eat away at tenant’s aggregates and could have a lasting impact on the tenant’s insurance rates.
Do: Show these provisions to your insurance broker.
Do: Ask your broker about the possibility of issuing a separate policy in the name of landlord, where they would be a “Named Insured” and separate from tenant’s CGL.
3. Assignments/Subletting. In typical commercial leasing fashion, what’s good for the goose again is not good for the gander. Nearly every landlord will ask for the right to sell their building and assign a lease to the new owner, thus substituting landlords. Tenant cannot stand in the way of landlords’s business plan, so the reasoning goes. Nevertheless, in seemingly contradictory fashion, landlord typically attempts to prohibit tenant from doing the same.
Don’t: Assume your relationship with a potential new, substituted landlord will be the same as it is with the current landlord. So even if negotiations with your current counterparty are pleasant and accommodating, a new landlord may attempt to enforce each and every provision of the lease, even non-substantive ones.
Do: Flip landlord’s logic back on it. Landlord cannot stand in the way of your business plans. Do think about exit strategy. If an IPO is on the 5-year horizon, negotiate the ability to assign the lease in connection with an IPO. If a sale to a buyout shop is a possibility, do negotiate the ability to transfer the lease to related parties and in connection with a change in control (i.e., the sale of a substantial portion of your assets or stock).
Don’t: Accept provisions that might allow the substituted landlord to modify non financial provisions of the Lease, even if subject to “reasonable discretion.”
4. Damages. Recently my firm has become involved in a messy litigation with a wildcat, wannabe landlord; accordingly, this issue, unfortunately, is near to my head and heart. Damages speak to the remedy when something goes wrong. A commercial lease may ask for two types of damages – liquidated damages and consequential damages. Liquidated damages may be stated as a daily amount, payable for each day during a continuing event of default. Liquidated damages are certain, while the sky is the limit with respect to consequential damages – they could include lost opportunity, damage to goodwill and reputation, and pretty much any loss suffered as a consequence of tenant’s action.
Do: Limit time frames anytime you are forced to agree to liquidated damages.
Do: Always put a cap on any liquidated damages to which you agree.
Do: Negotiate a waiver of consequential damages – “Neither party shall be liable for consequential, incidental or similar damages arising hereunder or pursuant to the terms hereof, including, but not limited to, loss of business, lost profits, loss of use and similar damages.”
Don’t: Cave in on this issue. Bet the farm litigations often arise out of matters of consequential damages.
5. Alterations. Most commercial leases will require that tenant seek landlord’s approval for any alteration to the premises, whether structural or otherwise. Some aggressive leases even go as far as to require that any alterations be performed by landlord’s list of approved contractors.
Do: Seek to have your regular contractor preapproved.
Do: Insert a threshold on alterations that require landlord’s approval. In New York, we often ask for a $100,000 threshold, whereby any alterations with a total cost at or below this amount can be performed without landlord’s prior approval.
Do: Have your initial build-out plans submitted, attached as an exhibit to the lease and preapproved. You do not want to divert time and resources to having your initial build-out plans approved subsequent to lease signing.
Don’t: Forget to ask for landlord’s list of approved contractors and stated criteria for approval, if you are going to accept such a clause.
Don’t: Forget about restoration clauses. Does the lease require you to restore premises to their original condition at termination? If so, you could be facing an additional and substantial expense at the time of termination, a time at which you will likely need to divert capital to a new space and build-out.
Don’t assume this list is complete. Admittedly, there are other important commercial leasing terms that could have important (even disastrous) consequences to your business plan. The short list of issues above merely skims the surface. Most commercial leases extend for periods of five, seven, ten or more years. That’s a long time and your commercial leases may have a huge impact on your financial security and overall business plan. With time the subtle nuances of commercial leasing will become familiar. Until such time, read carefully and do not lose focus of the common goal – an occupied, performing space.
This article is not intended to constitute a comprehensive guide to commercial leasing and should not be construed as legal advice. Always consult qualified counsel.
Jason D. Gabbard is a partner at the NYC-based law firm of Gabbard & Kamal LLP.