Mastering the Art of Lease Negotiation: Crafting Win-Win Agreements

Clients often request that their counsel focus lease negotiations exclusively on those terms most likely to have the most significant impact on economics and the long-term relationship with the counterparty. This request comes up most frequently from tenants who are presented with a standard lease form for a relatively short-term lease at a particular landlord location, but it can also arise from landlords asked to accept a national or regional tenant’s standard form of lease with limited modifications.

While the needs and goals of each client are unique, this Insight outlines a few common considerations for this type of limited lease review. The focus is on areas where landlords and tenants often make compromises so that the core requirements of each side can be respected. Mutually beneficial outcomes on these issues are achievable, though the deal will be informed by the market environment and the relative value propositions/leverage of the parties. These issues are grouped in two sets. I first discuss issues usually resolved with assistance of a broker through a letter of intent before turning to issues usually resolved with assistance of counsel through a lease.

Use the Letter of Intent to Maximum Advantage

Regardless of whether counsel assists with a letter of intent, it is generally in both parties’ interest to confirm in the letter of intent the following items:

1. Parties. Creditworthiness of the tenant is a crucial term for the landlord. The letter of intent should identify the correct tenant entity and what other security, if any, is required for the lease (e.g., security deposit, guaranty, letter of credit). The tenant should also ensure that it is in fact naming the entity that needs possession of the leased premises.
2. Premises. The location and square footage of the premises should be specified, as well as whether there are any remeasurement rights that would impact rents. In addition, any future expansion or contraction rights should be noted in the letter of intent.
3. Term. Be specific about the estimated date when the premises will be delivered (the Commencement Date) as well as any “free rent” period following delivery (a later Rent Commencement Date). Often, a lease will not start immediately upon execution with an “as is” delivery; instead, time is required for the landlord to prepare the premises, for the tenant to obtain permits and build out the space and/or for an existing tenant to vacate. The letter of intent should specify when delivery of possession will occur and any post-delivery period where rent will be abated. Think through what remedies each party should have in the event landlord cannot timely delivery the premises or tenant is not able to timely take possession and complete its buildout. The letter of intent should also outline if there are any term extension rights and how rents will be determined for the extension period(s). In addition, any “special” early termination rights (i.e., those for reasons other than casualty and eminent domain) should be outlined.
4. Base Rent and Additional Rent. Confirm rates and timing of any increases. Confirm whether the lease is “net” of operating costs, insurance, taxes, and/or utilities (with tenant paying such amounts to landlord or directly to providers). The letter of intent should make clear which party is responsible for maintenance of the premises, the building and common areas. Confirm whether or not tenant’s liability for operating expenses will be limited to increases over an established base year. Confirm whether or not there will be a cap in any increases in operating expenses. Tenants can use letter of intent negotiations to obtain information about historical costs to assess the overall economics of the lease.
5. Improvements. The letter of intent should specify if there is any tenant improvement allowance and any contemplated landlord work. Typically, neither party wants to engage an architect until the lease is signed. However, the letter of intent can provide an opportunity to specify who will do design, who will do construction and who has what approval rights over design. If the letter of intent mentions landlord’s standards for construction, ask for a copy in case the standards contain union labor requirements or other particularly costly requirements.
6. Permitted Use. In addition to confirming the tenant’s intended use is permitted, consider flexibility to enable an “exit strategy” through assignment or subleasing in the future. If the permitted use is highly specific, it will be harder to find an assignee or subtenant who could take over the space without significant negotiations with the landlord to allow a different permitted use.
7. Common Areas. If any rights are needed in common areas (such as parking facilities and patios, they should be specified in the letter of intent with some indication as to how location and cost will be determined. It is usually helpful to clearly state whether these rights will be exclusive or in common with other tenants and whether the rights are subject to any interruptions or relocations.

Beyond the Letter of Intent

A well-negotiated letter of intent will usually streamline subsequent negotiations of the definitive lease because most of the material terms will have been negotiated in a thoughtful manner in advance. The issues that matter beyond those highlighted in the letter of intent will depend on the specific needs and priorities of the landlord and tenant. Below is a list of issues that often have larger implications and form components of an efficient lease review and negotiation.

1. Assignment/Subletting. Landlords want approval rights to ensure the creditworthiness of their tenants and the mix of tenants at their properties. Tenants, on the other hand, want to be able to complete unrelated corporate transactions without having to obtain landlord consent. Often the original tenant and any guarantors retain liability for the lease following an assignment, but this business term can be negotiated (for example, there could be a release if a “qualified tenant” and/or “qualified guarantor” is substituted). Tenants will want to make sure that any landlord recapture rights or any landlord rights to share in sublease profits do not apply to affiliate/corporate transactions. If sublease profits are captured, the tenant should have a right to deduct their transactional costs before splitting the profit.
2. Defaults/Remedies. Landlords usually agree to adhere to judicial procedures to retake possession of the premises, though they usually retain other self-help rights to cure tenant defaults. Tenants are sometimes able to secure written notice before a default occurs (up to 10 days for payment defaults and up to 30 days for performance defaults). Landlords will typically require liquidated damages if a lease is terminated due to tenant default. Full acceleration of rent is not allowed in all jurisdictions, but tenants often try to eliminate this remedy even in those jurisdictions where it is enforceable. Tenants can negotiate with respect to landlord’s duty to mitigate their liquidated damages and deduct the fair market value from the amount due.
3. Operating Expenses. Be sure that inappropriate charges (such as those that benefit only another tenant or are part of landlord’s acquisition/financing/development costs) are excluded from operating expenses. Confirm how these expenses will be billed and reconciled and see what rights tenant can have to audit/contest. Consider a “gross up” provision applicable to any base year for calculating tenant’s operating expense contribution. Confirm the lease is clear about responsibility for performance of maintenance obligations, in addition to which party pays the associated costs.
4. Services. Determine hours of operation and any overtime charges for HVAC. Is there any recourse for interruptions in services (and, if not, does the tenant have sufficient business interruption insurance)?
5. Relocation. Many landlord form leases contain a relocation clause, but many landlords have no present plans that would require relocation. Talking about this clause and the mechanics of any relocation (notice period, characteristics of replacement premises, cost reimbursement) can be important to a tenant who is making a significant investment in building out the space to suit their needs or who highly values aspects of the original location.
6. Landlord Lien Rights. Tenants anticipating an equipment financing may wish to negotiate in advance an adequate waiver of landlord lien rights.

Conclusion

This Insight outlined some provisions that are of particular concern to most landlords and tenants looking for efficiency in negotiation of a relatively standard lease. However, each lease negotiation ultimately depends on the leverage of each of the parties and the current leasing environment. Lease negotiations (other than renewals) are often first steps in longer-term relationships between the parties. Creating a win-win lease agreement — one that addresses each side’s critical concerns without compromising anyone’s core requirements — sets both sides up for success moving forward.

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