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Leasing Commercial Property

June 21, 2019 4737

Your office lease can be one of the most expensive and important contracts you will ever sign. It contains both assets and liabilities that will govern your tenancy. A poorly negotiated lease, at a minimum, may result in greater expense and disruption to your practice. At worst, you could be held captive by your lease if you have not carefully considered each of the lease terms.

Many commercial tenants make the mistake of paying attention only to property location, rent and other costs listed in the lease. However, leases usually address many other important issues. For example, leases often allocate the responsibility and risk of loss that can occur to people or property. Risks are often allocated between the tenant and landlord in a manner favorable to the landlord. In addition, leases usually require the tenant to maintain various forms of insurance on behalf of both the tenant and the landlord.

Commercial leases are usually generic forms drafted by landlord trade associations. Although your lease may be presented as a “take it or leave it” proposition, do not assume that you cannot negotiate. Most landlords will negotiate at least some provisions, which can be easily modified by amendments to the form.

It is in your best interest to have an attorney experienced in drafting and negotiating commercial leases negotiate the legal terms and conditions of your lease. This is an ounce of prevention that is well worth the cost. Your attorney will help you focus on the more important terms in the lease. He or she can best guide you on the impact of the lease terms and what changes are necessary.

Determining Space

As a tenant, it is important to make sure you understand how much space you are renting; you do not want to be over-charged for rent. In referencing space size, the lease must clearly define the method used to determine the space dimensions. Was the space measured to the inside or outside walls? Were common corridors included in this calculation? Many landlords use the Building Owners and Managers Association (BOMA) measurement standard for calculating space size, but there are other methods. Whatever measurement standard is used, you and the building owner should agree upon it.

Tip: Measure the premises and calculate the exact square footage. Compare it to the measurements that the landlord is using to determine if your lease payment is accurate.

Rent Commencement Date

All too often, the Rent Commencement Date is written in a manner that may result in you starting to pay rent earlier than necessary.

In a dental office lease, the landlord often undertakes the construction of certain office improvements, such as painting walls or replacing carpet, prior to turning the space over to the tenant. As a new tenant, you expect to walk into your finished office, move in your furniture and begin paying rent on the day you open for business. Disagreements on the start of rent payments can arise when construction delays keep you from using the space until after the Rent Commencement Date. Therefore, a provision clarifying that rent will not be due until the landlord’s improvements have been completed and you have taken occupancy is necessary.

If you arrange the construction yourself, try to include a provision in the construction contract that requires the contractor to pay any rent you become obligated for prior to occupancy that is caused by the contractor’s delays.

Tip: Be sure that the rent begins on the date of occupancy. This provides for construction or any other delays that are beyond your control.

Common Areas

The lease should define and establish the rights of the tenant (and the tenant’s employees and visitors) to use the common areas of the building such as the lobby, driveway, parking lot, entrance, stairs, elevators, corridors and washrooms. Generic leases are often ambiguous on these points and therefore subject to interpretation.

Operating Expenses, Taxes and Common Area Maintenance Fees

In addition to paying rent, the lease may require you to pay a share of operating expenses and taxes for the building known as pass throughs and/or common area maintenance fees. Pass throughs may include a portion of the building’s operating expenses, property taxes and Consumer Price Index (CPI) increases. Common area maintenance fees are expenses associated with maintaining the common areas such as water/sewer, trash, restroom upkeep, landscaping, parking lots, fire sprinklers, roof or anything that all tenants share. The lease should define the tenant’s share of the common area expenses. These expenses are usually charged annually and may increase from year to year.

Tip: Request photocopies of operating expenses and property taxes to ensure that you are not being overcharged. Do not take the word of the landlord.

The lease should specify that the landlord is responsible for maintaining the common areas and for liability arising out of loss or injury occurring in the common area.

If you are leasing a single-occupancy facility, the landlord may propose a lease that requires you to pay all occupancy costs, including utilities, maintenance, insurance and taxes.

An experienced real estate lawyer can make some subtle changes to these provisions. You and your attorney may be successful in negotiating a cap on future pass-through expenses. Expect to receive a photocopy of the real estate tax bill for the property and an itemized statement of the expenses being passed through to the tenants. Request a copy of the landlord’s audited financial statements to ensure the charges are appropriate. Ask for an annual right to review and audit the landlord’s books and records relating to both operating expenses and taxes to verify that charges are accurate.

Regarding CPI, you should check the U.S. Department of Labor, Bureau of Statistics website to verify the current CPI.

The lease may contain language regarding the responsibility of all property owners and/or tenants to maintain their properties and remove access barriers. Review the lease to identify any tenant requirements to have the leased premises inspected, modified or repaired to meet all applicable construction-related accessibility standards. For example, leases in California signed on or after January 1, 2017 should state whether the premises being leased or rented has had an inspection performed by a Certified Access Specialist (CASp). If it has, and the CASp report indicates violations of accessibility standards, the landlord is required to provide you with a copy of the report at least 48 hours before you sign the lease. If you do not receive a copy of the report within that time period, you have a right to terminate the lease without a penalty up to 72 hours after signing. If the CASp report indicates the premises meets accessibility standards, the landlord is required to provide you with a copy of the report and certificate within seven days after signing.

Tip: Be aware of “pass-through” expenses, paying attention to the building’s operating expenses as presented in the audited financial statements and CPI.

Security Deposit

Take note of any security deposit the landlord requires tenants to pay. Be sure the lease includes a record of the amount paid for the security deposit. Typically, the security deposit amount is more than one month’s rent; however, there is no standard industry calculation to determine the exact amount.

Services Provided by the Landlord

It is common to assume the landlord will provide certain services to your office space. Carefully review the provisions of the lease that specify the services the landlord will provide. Ask for clarification if you are uncertain as to what the language means. While this list is not exhaustive, ideally a dental office lease should:

  • Afford you control of temperature ranges to ensure comfort during business hours.
  • State that you, your employees and patients will have access to the premises at all times, subject to reasonable security measures.
  • State that the landlord will ensure the property complies with applicable laws and the landlord will undertake maintenance and repair of the common areas, including the structure and roof of the building, building systems and utilities.
  • State that the sidewalks and parking areas will be well maintained, and that the landlord will undertake to keep the sidewalks and parking areas free of obstructions, defects and debris such as cracks, plants, construction debris, snow and ice as needed, etc.
  • State the security measures that will be in effect at the building during the lease term (such as the landlord’s obligation to lock exterior doors during nonbusiness hours, provide adequate lighting in the parking lot and whether a security guard will be on duty and during what hours).
  • State whether and to what degree the landlord will undertake janitorial and trash removal obligations within your space (or whether these obligations will be yours).
  • Stipulate whether the landlord will provide running water (and whether that will include hot water, or whether you will be obligated to purchase a hot water heater for your space).
  • State that the landlord will furnish your space with sufficient amounts of electricity for equipment you intend to install in your office.

Repair and maintenance of systems such as electrical, heating and air conditioning (HVAC) and plumbing is another area of responsibility to be reviewed, negotiated and written into the lease. Also, it is important to know which maintenance requirements are the tenant’s responsibility. Be sure to negotiate those costs out of the lease or factor them into the overall cost of renting the space.

Landlords are not bound to provide any services beyond those that are clearly stated in the lease. Carefully review the provisions of the lease that specify what services the landlord will provide. Ask for clarification if you are uncertain as to what the language means.

Tip: Review and question all services and repairs or maintenance that the landlord has agreed to provide and/or pay for.

Signage

Both internal and external signage can prove to be controversial. The lease should clearly spell out which party is responsible for providing, repairing and maintaining signage. The lease should also stipulate which party controls the design, style, size, wording, etc., of the signage. Landlords may go so far as requiring one sign vendor for all signage on the property. Before signing a lease, look at the signage on the property and that of other tenants to be sure it meets with your business goals, expectations and ideals.

Assignment and Subletting

Many generic leases do not allow a tenant to sublease space or assign the lease without the landlord’s prior consent. It is critical that the lease states the landlord cannot unreasonably withhold consent to a sublease or assignment of the lease.

It is also helpful to have a time limit for the landlord to respond to your request to sublease or assign the lease.

Transactions such as the merger or sale of your practice may be impacted by a landlord who will not consent to a sublease or assignment necessary for merger or sale. Consider including language in the lease that states [1] the landlord will not unreasonably withhold its consent of an assignment or sublease, or [2] the sale or legal reorganization of your practice will not constitute an assignment or sublease that would require your landlord’s consent.

Tip: Add language to the lease ensuring that the landlord will not unreasonably withhold or delay approval of a proposed sublease or subtenant arrangement.

Tip: Include language that confirms that the sale or legal reorganization of your practice will not constitute assignment or sub-lease and will not require the landlord’s consent.

Option to Renew

Before signing, make sure your lease provides you with an option to renew clause. Typically, the option will be for a renewal of five years, but this time period may be negotiable. This provision protects your office space from one lease period to the next. Some landlords may leave it out, which means that at the end of the lease term, you may lose your office space or may be required to renegotiate the lease.

When reviewing the option to renew, make sure it allows you to renew with a rent at the market rate. This will keep your landlord from arbitrarily increasing your rent upon lease renewal.

Tip: Do not allow automatic renewal of the lease. Instead, have an option to renew clause.

Insurance Requirements

As a rule, commercial leases require tenants to obtain several types of insurance, including property insurance, commercial general liability and worker’s compensation. The lease may also require that insurance limits in specified amounts be obtained from an A-rated insurance carrier. Many tenants enter lease agreements believing they already have the mandatory insurance requirements and do not contact their carrier/broker to verify that they have sufficient coverage. As a tenant, make sure you maintain all of the insurances required in the lease. Again, an experienced attorney can help to negotiate more favorable tenant terms.

Lease agreements require tenants to maintain business liability insurance or commercial general liability insurance throughout the term of the lease. Generally, business liability insurance or commercial general liability insurance covers your legal obligations for injury to persons or property arising out of the operations of your dental practice. Importantly, leases will often require that the landlord be named as a named insured, additional insured or loss payee on the tenant’s business liability insurance.

Tenants are also typically responsible for obtaining property insurance to insure the leased premises, tenant improvements and betterments. This would also include the tenant’s personal property, including inventory, furniture, equipment and business interruption for losses that occur as a result of fire, water, theft and other hazards.

You will most likely be expected to demonstrate proof of current insurance for the types of insurance required in the lease. Also, if you are subleasing or practicing with another dentist, your personal property insurance or your liability insurance may not cover those individuals. They must maintain their own policies with the same limits and provisions.

Typically, landlords insure against property damage to the building and the common areas, the liability arising from these areas as well as interruption in their rental income. For buildings located in flood or earthquake zones, a tenant will want to make sure the building is insured for damage from such perils. Be aware that insurance may result in greater pass-through expenses that should be factored into your decision to sign the lease. Not having these coverages may be a risk for all tenants should the building suffer damage from one of these perils.

Under most commercial leases, tenants are obligated to waive any right to recover from the landlord for lost income resulting from damage to the leased premises. This makes it important to obtain sufficient loss of income coverage from your own commercial property insurer.

Release and Indemnity Agreement or Hold Harmless Agreement

Office leases commonly contain a hold harmless provision stating that the tenant releases the landlord from all liability for personal injury or property damage claims arising out of the tenant’s operations. The release typically includes all visitors to your office such as employees, patients and their families, delivery persons, janitorial companies, repair persons, etc. The release can apply to injuries that occur both on the common area property and within the leased premises.

However, a properly drafted lease should state that the tenant does not release the landlord from liability in the event the loss occurs as a result of the negligence, gross negligence or willful misconduct of the landlord. If your lease does contain a hold harmless provision, it is important that the tenant be fully insured for potential perils that may cause personal injury or property damages to the tenant and its visitors.

Likewise, the typical commercial lease contains a provision stating that the tenant will defend and indemnify the landlord for claims that are brought by third parties for personal injury or property damage that arise out of the tenant’s business operations at the leased premises. Again, such a provision should contain an exception for liability caused by the landlord’s negligence, gross negligence or willful misconduct. The exception should also be made for injuries occurring in areas of the building under the landlord’s control.

Be aware of commercial lease provisions that make you responsible to defend and indemnify the landlord regardless of who is found responsible for causing the loss. Such provisions may require that you (as the tenant) provide coverage for the landlord related to any action that arises from your use of the premises, even if the reason for the loss resulted from the landlord’s negligence. If your lease does contain such a defend and indemnify, it is important that you are fully insured for potential occurrences that may cause personal injury or property damages to you and your visitors.

Tip: Negotiate overly broad obligations to indemnify, hold harmless or insure the landlord against losses and liabilities occurring outside your leased space or that result from the landlord’s negligence.

Waiver of Subrogation

Many leases contain a waiver of subrogation clause, but few tenants understand its importance. Subrogation allows an insurance company to step into the shoes of its insured and sue the party that is responsible for the injury or loss that precipitated the insurance claim to be made.

For example, assume a landlord’s negligence caused $20,000 in damage to the tenant’s property, and also assume the tenant’s property insurance carrier paid to repair the damage. Subrogation allows the tenant’s insurance company the right to sue the landlord to recover the $20,000. Because of an insurance company’s right to subrogate, landlords typically include a provision in the lease stating that the tenant waives its right to subrogation. The waiver operates to preclude the insurance company from suing the landlord to recover the money paid even if the landlord was negligent. When the lease contains a waiver of subrogation, it is critical that the waiver be mutual.

Before signing a lease containing a waiver of subrogation, contact your business personal property and business/ general liability carriers to be sure that the lease does not violate any terms of your insurance policies. If you sign the lease and later find that your policy does not allow for this provision, you may be in danger of losing coverage for losses you incur at your premises.

Tip: Ensure that a mutual waiver of subrogation exists in the lease and contact your insurance carrier to make sure that it allows for this provision.

Damage from Fire and Other Casualties

Business operations are often brought to a halt when a fire, flood, earthquake or other “casualty” causes damage to the building. Tenants often assume that their lease offers reasonable protections on these occasions, but this is not always the case.

Preferably, your lease would state that the landlord is obligated to give you notice after a casualty stating the length of time needed to complete repairs. The lease should also give you the right to terminate the lease if the repairs cannot be completed within a reasonable period of time (generally 90 to 120 days after the casualty). Your rent should also be abated or prorated from the date of the casualty until the premises are restored to a condition suitable for you to resume business operations.

Importantly, a provision in the lease that allows the landlord to terminate your lease after a casualty should require the landlord to terminate all of the other leases in the building that were affected by the casualty. Otherwise, the landlord may use this clause as a means of terminating your lease to bring in a higher paying tenant following restoration.

Tip: Confirm that if there is a large casualty to the building, the landlord will provide notice regarding the length of the necessary repairs, that rent will cease until repairs are completed to your satisfaction and that an option exists allowing you to terminate the lease.

Default

Many tenants assume they will never default on the lease and do not read the terms of the default provision. However, not all defaults are the result of bad faith on a tenant’s part. Unusual circumstances can happen. You could be on vacation and your office manager out with the flu when the rent is due; the rent is not paid on time. Honest mistake or not, this instance may put you in default of your lease.

The most critical provisions are those that define a default. Many dental office leases provide that a default occurs if you fail to pay your monthly rent or other amounts due under the lease on the day the rent is due. Some leases may even consider a rent check returned for nonsufficient funds (NSF) as a late payment, which may put you in default of the lease. A more appropriate default clause from the tenant’s perspective provides that a default will not occur until the landlord has given written notice.

Many leases also state that failure to perform certain obligations under the lease is also a default. This can include such items as zoning violations, failure to obtain required insurance, noncompliance with laws and/or violation of the landlord’s rules. Be sure that default provisions are reciprocal. Landlords are likely to make them more fair if they are held to the same standard. Require that you be given a 30-day written notice and opportunity to pay prior to default.

Duty to Remove Improvements

Many standard office leases contain a provision stipulating that at the end of the lease term the tenant not only vacate the premises, but also remove any and all tenant improvements and betterments (TIBs) installed within the premises during the lease term. This includes repair of any damage caused by the removal. It also includes improvements and alterations that may have been installed by the landlord for the tenant at the origin of the lease. This provision is fully enforceable. If you are unaware of this provision, you may find an unexpected expense waiting for you at the end of the lease.

The best solution is to have the provision modified to state that all TIBs remain with the premises and become the landlord’s property at the end of the term. Many landlords shy away from this revision because it can result in undesirable improvements remaining in place that can make the space difficult to lease.

An acceptable compromise would be for the tenant to remove those improvements designated for removal by the landlord at the time the landlord approved the tenant’s construction of the improvements. If you ask to install sinks in each operatory, the landlord decides at the time of approval whether you must remove those sinks at the end of the lease. Be sure these types of agreements are stated clearly in writing.

Condition of Existing Improvements

Very often, dentists lease office space that was previously occupied by another health care professional. In such cases, the landlord often delivers the space “as is” apart from repainting, recarpeting and perhaps undertaking some minor construction. You might assume that an overhead light fixture (installed by the prior tenant) that proves defective during the first month of occupancy will be replaced by the landlord. This is not always the case. Rather, most office leases provide that the tenant is responsible for anything that goes wrong within the tenant’s space, except for defects of a structural nature or that involve central building systems.

The solution to this problem is to make sure that your lease contains a warranty against “latent” and “patent” defects. Landlords try to limit such warranties to a period of less than the entire term of the lease, and generally the parties’ compromise anywhere from one month to two years. Nonetheless, even a one-month warranty gives an opportunity to discover any problems after taking occupancy, and makes the landlord responsible for repairing defects in the preexisting improvements on the premises.

Tip: Be sure the lease includes a warranty against “latent” and “patent” defects for the entire term of the lease.

Summary

Both parties should recognize that, as with any relationship, there will be disputes from time to time. TDIC’s experience indicates that when disputes arise, clearly written leases enable swift and amicable resolutions. Conversely, poorly constructed leases cause disputes that may escalate and become quite costly.

TDIC recommends that the lease include a provision regarding informal dispute resolution. To ensure the provisions in the lease are in your best interest, consult with an attorney experienced with commercial leases before and during the negotiation process. Remember, the provisions in the lease typically favor the landlord. Tenants should carefully analyze the lease the landlord presents, including any addenda which may impose additional restrictions or requirements, and negotiate changes to provisions that can result in significant losses and liabilities later on.

Tip: Have your attorney review the lease prior to signing any paperwork.

The purpose of this resource is to highlight some issues TDIC policyholders should consider when leasing office space. It is not a complete discussion of all the important issues a landlord’s lease will present, or all the lease terms you should try to negotiate before signing. We cannot guarantee this resource is complete, correct or up to date or that our opinions and recommendations here will be appropriate in your state. Before signing a lease, consult with an attorney experienced in drafting and negotiating commercial leases in the state where you practice.

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