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by Stephen Dillon
A lease is
an agreement granting use or occupation of real property during a
particular period in exchange for a specified rent. At common law,
the lease was traditionally regarded as a conveyance of interest in
land, subject to the doctrine of caveat emptor ("let the buyer
beware"). The landlord was only required to deliver possession to
the tenant; the tenant, in return, was required to pay rent to the
landlord. Davidow v. Inwood North Professional Group, 747 S.W. 2d
373, 375 (Tex. 1988). The modern commercial lease, however, is a
complicated instrument that spells out many aspects of the
relationship between landlord and tenant, including tenant's use of
the property, services that will be provided by the landlord,
allocation of costs associated with maintenance of the leasehold,
responsibility for utilities, improvements to the premises,
insurance, assignment and subletting, events of default, remedies of
the parties, expansion rights, and options to extend the lease term.
Commercial leases can be described in four categories: gross,
modified gross, triple net, and absolute net. A gross lease does not
require the tenant to reimburse the landlord for any of the expenses
that the landlord might incur in operation of the premises. Under a
gross lease, the tenant pays base rent and the landlord absorbs all
costs for common area maintenance ("CAM"), real property taxes,
landlord's insurance, and other charges associated with the
operation and maintenance of the property. A modified gross lease
typically requires the tenant to reimburse landlord for "pass
through" costs over a stated expense stop or base year. For example,
the tenant may be required to reimburse landlord for all CAM over
$4.00 per square foot, or alternatively, the tenant may be required
to reimburse landlord for all CAM in excess of base year 2005. In
most situations, the commercial tenant will be asked to sign a
"triple net" lease, which requires the tenant to reimburse landlord
for CAM, real estate taxes, and landlord's insurance. The "pass
through" costs included in a "triple net" lease can vary, and can
include additional items other than just CAM, taxes, and insurance.
Thus, a prospective tenant will be well served to review a proposed
lease with counsel to ensure that tenant understands the nature and
type of pass through costs it will be expected to absorb under the
lease. Also, in certain circumstances, a landlord may utilize a
"net" or "absolute net" lease, which requires the tenant to absorb
ALL costs of maintenance and operation of the property, including
capital expenditures and major repairs. Typically, an absolute net
lease is utilized where the tenant is the sole and 100% occupant of
the building - for example, a restaurant or an office building
occupied by one tenant.
Commercial leases can be further described by the type of use
associated with the property - office, retail, warehouse, pad, or
"ground". An office lease is generally used in buildings intended
for non-industrial business use. Retail leases are generally
utilized for shopping malls and strip centers. Warehouse leases are
generally seen for industrial or light industrial uses. Pad or
ground leases are often used for restaurant premises or for premises
where the tenant will be responsible for building and maintaining
the structure. Texas law does not require a commercial landlord to
utilize any specific form of lease, and the type of lease a
prospective tenant may be faced with signing will vary by the type
of building, intended use of the premises, and preference of the
landlord.
The lease's duration and base rent are of primary importance to the
commercial tenant. Usually, a commercial lease is for a term of 5 to
20 years with fixed escalations in base rent or escalations based on
an economic index, like the consumer price index. Also, the tenant
may be offered options to extend the lease term or expand into
adjacent or other areas of the property. Depending on the property
and the landlord, lease term and base rent may be negotiable. As a
general rule, the larger the space tenant intends to occupy, the
greater the flexibility the landlord will show in negotiating
provisions in the lease. However, if a property enjoys a high
occupancy rate, a landlord will be less likely to show leeway in
negotiating the economic terms of the lease. Yet, I am reminded of
two great adages of the commercial world: (1) everything is
negotiable; and (2) if you don't ask, you won't know.
Also, a tenant should take care to read and understand the
description of the premises contained in the lease. Most commercial
leases are based on "rentable square feet", a number which is
usually larger than "usable square feet". The tenant's rent and
responsibility for reimbursement of pass-throughs (CAM, taxes,
insurance, utilities, etc.) are normally based on the rentable
square feet of the premises. Discrepancies in square footage and
boundary lines should be resolved prior to execution of the lease,
or the tenant could face unforeseen costs or potential litigation.
Many landlords offer a tenant "build out allowance" as an inducement
to lease the premises. These sums, however, do not represent "free"
money and landlord's payment of the allowance is tied to specific
conditions in the lease. For example, if the tenant breaches the
lease and abandons the premises prior to the end of the lease term,
the tenant may have to repay the build out allowance, along with
landlord's other damages. The tenant should make sure it understands
when and under what circumstances the build out allowance will be
paid.
Additionally, the tenant should understand his "lease commencement
date" and "lease expiration date". The lease commencement date may
or may not be on the date tenant occupies the premises. Also, the
landlord may have promised the tenant a 60 month term but the lease
could provide a fixed expiration date for a term of less than 60
months. Again, careful scrutiny of the lease is required.
In addition to base rent, the tenant customarily will be asked to
pay "additional rent", which constitutes pass-throughs (CAM, taxes,
and insurance) and any other charges that landlord might deem to
include in your lease. CAM, pass-throughs, and other charges
reimbursable under the lease are the primary source of tension in
the modern commercial landlord/tenant relationship. The tenant wants
the certainty of knowing what his rent and charges are going to be
on a monthly and yearly basis. The landlord wants protection from
unexpected rises in taxes or the costs of providing services to the
property. The key: read your lease and KNOW every charge you will be
faced with once your tenancy begins.
In the retail context, in addition to base and additional rent, the
prospective tenant is often asked to pay landlord a percentage of
tenant's gross sales on a monthly or quarterly basis. The landlord
usually justifies these charges as a necessary component of
compensating landlord for providing a vibrant mall or strip center
for tenant to conduct business. In most commercially viable retail
property, payment of percentage rent is unavoidable. However, the
"breakpoint" and amount of percentage rent should be negotiated.
Another area of significance to the commercial tenant is the
services that will be provided by landlord and reimbursement of
landlord for those services. Similarly, tenant should understand
those services that landlord will not provide, because tenant will
be responsible for those services as an out of pocket expense.
Further, unless the lease is gross, the landlord should identify the
components that constitute the costs of operating the "common area"
for which it seeks reimbursement through tenant's monthly CAM
charges. The definition of CAM varies from lease to lease based on
landlord preference, the type of property, and the negotiations of
the parties. If a gross lease is not available, the tenant should
negotiate the items to be included in CAM, the items that will not
be included in CAM, and an annual cap or limit on expenses that
landlord may attempt to pass through to tenant.
The landlord will normally want reimbursement for tenant's share of
real property taxes and landlord's insurance costs. The lease should
provide a definition of "tenant's share" or "tenant's proportionate
share" based on the square footage tenant will occupy versus the
square footage of the building. The commercial tenant must have a
full understanding of all these provisions prior to signing the
lease.
Key provisions in the commercial lease define the events of tenant's
default and landlord's remedies for tenant's default. The tenant
should also address what constitutes landlord's default and tenant's
remedies. Tenant default provisions are usually defined by two
categories: (1) economic defaults; and, (2) non-economic defaults.
Economic default provisions deal with failure to pay rent, failure
to pay for charges assessed under the lease, failure to pay taxes
when due, etc. Non-economic default provisions typically refer to
other provisions in the lease - use of the property, hours of
operation, or failure to provide services required by tenant under
the lease. It is essential that the tenant have a full understanding
of (1) what constitutes an event of default; (2) tenant's right to
cure, if any; and (3) landlord's remedies for tenant's default.
Assignment and subletting provisions are also important to the
tenant. Texas law prohibits subletting without the consent of the
landlord. Tex. Prop. Code §91.005 (2005). If the tenant desires to
sell the business, merge with another business, or change the entity
under which it conducts business, lease provisions regarding
assignment and subletting will come into play. Many leases provide
that the tenant may assign or sublet the premises with the consent
of the landlord, which consent "shall not be unreasonably withheld".
Obviously, the more flexibility the tenant has in its assignment and
subletting provisions, the more flexibility the tenant will have in
the conduct and prospective sale of its business.
The modern commercial lease will normally address landlord and
tenant's responsibility for accidents and personal injury, casualty,
damage to the building, and eminent domain. These provisions vary by
jurisdiction, landlord, building, tenant, and use of the property.
The tenant should review these provisions thoroughly with counsel to
see if they meet the tenant's risk expectations with respect to the
property.
The tenant may also seek options to extend the term of the lease.
The option clause should state the number of options available to
the tenant, the term of each option, the rent for each option period
or the formula for determining rent for each option period, and the
method tenant will utilize to exercise the option. Also, the tenant
may want to include expansion rights associated with the premises,
which can include a "right of first refusal", "right of first
offer", or a general expansion right granted with respect to certain
space or areas in the building or property.
In sum, the commercial lease will address, in great detail, the
aspects of the relationship between landlord and tenant, and will
vary by use, location, landlord preference, tenant bargaining power,
and jurisdiction. In Texas, there are very few statutory regulations
governing the landlord/tenant relationship, and most characteristics
of that relationship will be defined by contract. There is no
"standard" form of commercial lease and the provisions that can be
included in the lease will be determined by the creativity of the
parties and their counsel. As with any other contract, the tenant
should KNOW WHAT IT IS SIGNING. The consequences of signing a "bad
lease" can include unforeseen expenses and business failure.
The Dillon Law Firm focuses on the representation of entrepreneurs
and businesses in the areas of contract, corporate, real estate, and
trademark law. The firm endeavors to provide quality legal services
at a reasonable cost and delivers many of its services on a flat or
fixed fee basis. The firm also offers small business consulting and
general counsel services to companies that do not have the resources
to justify full time in house counsel. In addition to its business
practice, the firm assists individuals with wills, estates, probate,
and guardianship matters.
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