Commercial Leases from a Tenant’s Perspective
For people who do not review and negotiate commercial leases on a regular basis, their main focus during a lease negotiation is typically the rental rates, the lease term and the rights of renewal. Everything else is assumed to be pretty standard, right? The assumption is that surely, by now, landlords and tenants over the centuries have worked out a fair and reasonable standard form commercial lease agreement. Think again.
Each landlord crafts their own form of lease. Even the large Canadian institutional property owners have different forms of lease.
In addition, the landlord has a significant knowledge and negotiation advantage over most tenants because: (1) the landlord prepared its standard form lease; and (2) the landlord negotiates the same standard form lease again and again with each new tenant in the office building, shopping centre, industrial park, etc. As a result, most landlords keep tweaking their standard form lease document and, over time, the lease becomes more and more biased in favour of the landlord.
Below is a list of important issues to consider before signing an offer to lease or formal lease agreement.
1. Offer to Lease and Formal Lease Agreement.
The offer to lease contains a summary of the key lease terms as negotiated by the landlord and the tenant. Once the parties sign the offer to lease and remove their respective subject conditions, the terms of the offer to lease are incorporated into the landlord’s formal lease agreement. The offer to lease is a much shorter document than the formal lease and the tenant often has a good understanding of the deal terms set out in the offer to lease. In contrast, the tenant has much less familiarity with the landlord’s standard form lease, which can be 40-60 pages long, plus several schedules.
It is highly recommended that the tenant include a term in the offer to lease that if there is any conflict, inconsistency or ambiguity between the terms of the offer to lease and the landlord’s standard form lease, that the landlord’s standard form lease will be revised to incorporate the terms agreed to in the offer to lease. If possible, the tenant will want both the offer to lease and the formal lease to be the operating documents, with the offer to lease being the paramount document.
Most landlords will insist that the formal lease agreement, once signed, replaces and supersedes the offer to lease. In that case, it is important that the tenant read the entire formal lease carefully to make sure there is no provision buried deep in the lease that is contrary to a key term the tenant negotiated and won in the offer to lease (such as special parking or signage rights, the right to assign the lease to an affiliate without landlord consent or rights to audit the calculation of additional rent, etc.).
It is also recommended that the tenant not agree in the offer to lease to accept the landlord’s standard form lease, subject to incorporation of the terms set out in the signed offer to lease. It is very likely there will be landlord favourable terms or even non-market terms in the landlord’s standard form lease that were not addressed in the signed offer to lease and which the tenant will wish to negotiate when settling the formal lease agreement.
2. Landlord Redevelopment Right.
Often a landlord will include in its standard form lease a landlord right to redevelop the property and, if the landlord elects to exercise this right, the landlord may terminate the tenant’s lease before the end of the lease term on a certain period of advance notice to the tenant, which can be as short as two or three months’ notice.
Depending on the tenant’s negotiating leverage with the landlord, the tenant may be able to obtain certain assurances or concessions from the landlord with respect to the redevelopment right, such as: (1) the landlord covenants not to exercise the redevelopment right for a certain period of time; (2) an extension of the notice period the landlord must provide to the tenant; (3) a reduction in the rental rate if the landlord exercises the redevelopment right or some other form of compensation (such as a contribution to the tenant’s relocation costs to new premises and printing of new letterhead, business cards, etc.); (4) reduced obligations on the tenant to restore the premises if the lease is terminated for redevelopment purposes; and/or (5) a tenant right to terminate the lease early if, during the notice redevelopment period, the tenant finds alternative new premises (ie. avoid an overlap of paying rent for two different premises).
3. Landlord Relocation Right.
Landlords often include in their standard form lease the right to relocate a tenant to other premises in the building or shopping centre. Landlords will typically insist on the relocation right for small tenants. In the retail context being relocated from a high traffic area or from premises beside an anchor tenant can have a significant negative impact on in-store business sales. In the office context, being on a top floor overlooking the ocean has a much different feel than being on the third floor and looking over the back alley.
While a small tenant likely cannot negotiate the relocation clause out of the lease, they can attempt to minimize its potential impact by: (1) requiring the new space be of equal or greater in size than the old premises and that the level of tenant improvements be to the same standard or higher; (2) require the new premises to be on the xth floor or higher or on certain side (the view side) of the office tower; (3) restrict the areas of the shopping centre where the new premises may be located (to areas the tenant views as comparable or better to their current location); (4) allow the tenant the right to terminate the lease if they find the new premises unacceptable; (5) require a reduction in rent if the premises are relocated; (6) if the new premises are larger than the original premises, keep the basic rent at the same amount as for the original smaller premises; and/or (7) require the landlord to pay for all reasonable relocation costs, to change the letterhead, business cards, website and marketing materials, provide an allowance for tenant improvements to the new premises and for general marketing purposes to advise clients/customers of the new location.
4. Personal Tenant Rights and/or Required Conditions.
Tenants often obtain lease renewal or extension rights and sometimes other important rights in the lease, such as an option to lease additional space or a right of first refusal to lease other space in the building or shopping centre. Landlords often make these rights personal to the original tenant and/or that the exercise of the rights is subject to compliance with the “Required Conditions”. By making these rights under the lease personal to the tenant, the rights do not transfer to any assignee of the lease (even if the landlord consents to the assignment). The rights may even be lost if the tenant completes an internal reorganization (again with the landlord’s consent) and transfers the lease to a related but different company. In regards to the Required Conditions, a landlord may specify that if the tenant breaches the lease, even a non-material breach (for example, a noise violation, a parking violation or failure to follow the landlord’s recycling policy), then the tenant is offside the Required Conditions and cannot exercise any of the special rights. Except for very small tenants, most tenants should be able to negotiate better terms from the landlord with respect to these important lease rights.
5. Tenant Request for Landlord Consent.
Some very landlord-slanted leases include a provision that if the tenant seeks the landlord’s consent to an assignment or sublease of the lease, then the landlord has the right to terminate the lease and take the premises back from the tenant. This would obviously be a major risk whenever a tenant wished to sell their business or downsize and sublease part of the premises. Tenants should attempt to have such rights deleted from the lease or, if not deleted, the tenant should have a right to withdraw its request for landlord consent so that the landlord cannot terminate the lease.
6. Landlord’s Consent to an Assignment or Sublease.
The right of a tenant to assign or sublease its lease will be very important to a tenant looking to sell their business or if the tenant is experiencing financial difficulty and wants to assign the lease to a third party or sublease a portion of the leased premises to reduce its rent obligations. Most leases contain restrictions on the tenant’s right to assign or sublease its premises. The restrictions can range from being at the landlord’s sole discretion, the lease may require the landlord to act reasonably when considering a request, or the lease may require the landlord to act reasonably but list several situations where it would not be unreasonable for the landlord to withhold its consent. It is not unreasonable for a tenant to request that the landlord cannot unreasonably withhold, delay or condition a tenant request for consent to an assignment or sublease. If a landlord refuses to act reasonably with respect to a tenant request for consent to an assignment or sublease, that is a red flag for the tenant as to what the landlord-tenant relationship will be like with that particular landlord.
7. Delayed Possession.
If the leased premises are not available by a certain outside date, a tenant should consider if it needs the right to be able to walk away from the lease or to require the landlord to provide the tenant with temporary lease space. Another possibility is that the landlord should cover the tenant’s overholding costs at its current premises if the landlord fails to deliver occupancy of the new premises on time. If the leased premises are within a building that is under construction or if the premises are occupied by a current tenant, there is a greater risk that the landlord may be delayed in delivering possession to the tenant beyond the commencement date set out in the lease.
8. Restoration of the Premises.
In the excitement of entering into a lease, tenants often overlook their obligations at the end of the lease term. The costs to remove the tenant improvements from the premises (including those installed by previous tenants) and return the premises to the base building shell condition and to remove all cabling and wiring from the premises can be very expensive. For certain tenants with special fixtures, such as a vault for a financial institution or an internal staircase between floors in an office, the costs to remove these special tenant improvement features can be a nasty financial surprise. If the tenant receives the premises from the landlord in turn-key condition with certain existing tenant improvements, the tenant should seek to amend its obligation to return the premises to the landlord at the end of the lease in the same condition as they were received, reasonable wear and tear excepted, and not to the base building shell condition.
9. Non-Disturbance Agreement from the Landlord.
If the landlord has mortgaged its interest in the property that includes the leased premises, the tenant should consider obtaining a non-disturbance agreement from the landlord’s lender. Under a non-disturbance agreement, the landlord’s lender will agree that if the landlord defaults under its mortgage and the lender forecloses on the property then so long as the tenant continues to pay its rent to the lender and comply with the terms of its lease, the lender will not terminate the tenant’s lease and will allow the tenant to occupy and enjoy the premises.
10. Registration of the Lease in the Land Title Office
For leases with a term of three years or more, the tenant has the option, but is not legally obligated, to register its lease at the Land Title Office. One of the primary benefits of registering a lease is that any future purchaser of the property would be bound by the terms of the lease whereas if the lease is not registered, a bona fide purchaser for value may claim it has no knowledge of the lease and is not bound by the terms of the lease. Many tenants chose not to register their lease because of the costs to prepare the required survey plans and because they view the risks of not being registered as relatively low. However, if a tenant decides to register its lease on title, it should keep in mind that for leases with a term of more than thirty years (which include all renewal or extension rights under the lease) property transfer tax will be payable to the Province.