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Renewing Your Commercial Lease in 2012

Renewing Your Commercial Lease in 2012

SML Perspectives
(April 2, 2012)

Sign on the Dotted Line

Leases sometimes get short shrift in the operations of a company, especially a company without personnel dedicated to facilities and property management who are accustomed to dealing with these sometime lengthy and arcane documents. Failing to give these documents appropriate attention prior to execution can create real headaches down the road when unanticipated situations arise. Although a comprehensive review of leasing issues is beyond the scope of this article, this article will touch on some of the "big picture" issues that need to be addressed regardless of whether a tenant is renewing an existing lease or entering into a new lease.

The business terms of the lease document should be compared with the letter of intent or term sheet, if there is one, to confirm that the lease accurately reflects the deal that was struck. Is the rental amount correct? If rent is calculated on a per square foot basis, do the math to check the stated rental amounts in the lease. Are rental escalations properly calculated? If the landlord has agreed to grant renewal options, does the lease clearly define how the renewal options must be exercised? How far in advance of the lease expiration date must the tenant exercise its renewal option? Landlords generally want as much notice as possible, but a long notice period limits the tenant’s operational flexibility. Depending on the type of property, notice periods between 90 and 150 days are customary. For the benefit of both parties, a floor plan showing the boundaries of the leased premises should be attached to the lease.

Maintenance and repair provisions are often viewed as "boilerplate" but they merit careful review. Because a lease conveys exclusive possession of the premises and North Carolina law generally implies no obligation for a landlord to maintain commercial leased premises, what is not said in these provisions is often as important as what is said. Tenants should compare the portions of the premises to be maintained by the landlord and the portions to be maintained by the tenant in order to confirm that there are no gaps in the maintenance responsibilities allocated to the landlord and tenant. Typical maintenance and repair provisions vary depending on the type of space. While office leases in multi-tenant buildings generally require the landlord to maintain all areas outside the leased premises and the mechanical systems serving the leased premises, an industrial lease for an entire building may place all maintenance responsibility on the tenant. Tenants should try to avoid an obligation to bear the entire cost of making a capital repair the useful life of which will significantly exceed the remaining lease term. For example, if the tenant is responsible for the maintenance and repair of the HVAC, is it reasonable for the tenant to bear the entire cost of replacing the HVAC with only a year or two remaining on the lease term? We sometimes see compromises reached to provide for the allocation of cost between the landlord and tenant based on the relationship between the expected useful life of the capital item and the remaining term of the lease.

Assignment and subletting provisions also require careful attention. These provisions can limit a tenant’s flexibility to reduce operating costs if leased space becomes superfluous or if the tenant engages in some type of corporate sale or reorganization. In the absence of an express prohibition of assignment and subletting, a tenant may assign the lease or sublease the premises without the landlord’s consent. However, most landlords’ form leases will require the landlord’s consent to any assignment or subletting. At a minimum, a tenant should have its landlord agree that it will not unreasonably withhold, delay or condition its consent to an assignment or subletting. Setting objective criteria (e.g., minimum net worth, experience, and compliance with use requirements) for an automatic consent by the landlord can be helpful. In order to avoid losing a prospective assignment or sublease as a result of the landlord’s "filibuster," the lease should require the landlord’s response to a request for consent within a specified period of time, failing which the landlord will be deemed to have consented to the assignment or subletting. Especially for tenants with numerous locations, obtaining consents to assignments in connection with a sale of assets or other corporate reorganization can be, in the best case, a logistical burden.

Accordingly, a tenant should negotiate carve-outs in the assignment and subletting provisions for assignments to affiliates, assignments made in connection with the sale of substantially all of the tenant’s assets or stock transfers. If the assignee defaults under the lease, the original tenant may find itself liable for damages caused by the assignee’s default. In order to mitigate this risk, the tenant should attempt to include provisions releasing the original tenant from liability under the lease following an assignment of the lease, although landlords generally resist a complete release of the assignor. If the landlord will not agree to a complete release, then the lease should require the landlord to provide notice to the assignor of any default under the lease by the assignee and an opportunity to cure the default.

A purchaser of commercial real estate would never complete the purchase without having the title searched. However, tenants often do not consider that the interest in real estate conveyed to them by the landlord by way of the lease is only as good as the landlord’s title to the real estate. Accordingly, tenants should ask for a representation and warranty by the landlord that it owns good title to the leased premises subject only to the exceptions listed on an exhibit to the lease. If the landlord will not agree to make this representation and warranty (and perhaps even if the landlord will make this representation and warranty), then the tenant should consider having a title search performed. Any restrictions affecting the property should be reviewed to confirm that the tenant’s proposed use will not violate the restrictions. Are there recorded leases that give other tenants exclusive right to conduct particular uses? Do restrictive covenants require approval of alterations to the leased premises by a third party, such as an owners’ association? If the leased premises are subject to a mortgage or deed of trust in favor of the landlord’s lender, foreclosure of the mortgage or deed of trust may extinguish the tenant’s lease. In order to protect itself against this risk, the tenant may need to obtain an SNDA (subordination, non-disturbance and attornment agreement) from the landlord’s lender pursuant to which the landlord’s lender will agree not to terminate the tenant’s lease in connection with a foreclosure as long as the tenant is not in default under the lease.

In addition to protecting itself against holders of prior interests in the real estate such as mortgagees, a tenant should also be careful to protect its leasehold interest against future purchasers and other parties who acquire an interest in the real estate. In North Carolina, a purchaser of leased premises is not bound by an unrecorded lease which has a maximum term (including renewal options) of greater than three years. Most landlords object to recording the entire lease because they do not want other parties to see the economic terms of the lease, but North Carolina law authorizes the recording of a memorandum of lease which discloses only the parties to the lease, the location of the leased premises, and the term of the lease. Accordingly, the lease should authorize the tenant to record a memorandum of lease and should require the landlord to execute and deliver the memorandum of lease.

These are just a few of the basic issues that tenants should consider when reviewing leases. The lease is the "constitution" that will govern the tenant’s use and occupancy of the leased premises and the relationship between the landlord and tenant. Giving the lease appropriate attention on the front end can avoid disputes and unexpected obligations during the term of the lease.

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Brian W. Byrd
T (336) 378-5429
F (336) 433-7415
Associated Attorneys

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