Signing a lease is a part of starting or expanding any small business, but it’s by no means routine. If you don't really understand what you are signing, your business could find itself in jeopardy. For example, you could greatly underestimate the cost of your space, or you might inadvertently violate a clause of the lease that could cost you dearly, or you could be surprised to find your expansion (or contraction) options severely limited.
Small costs can add up quickly for a small business owner. Understanding the language of your lease with the help of a lawyer can prevent getting buried by unexpected costs in the long-term.
Lawyers skilled in lease negotiations understand how duties, costs and risks of ownership should be shared between a landlord and a tenant. A good lawyer with experience in leasing is on the lookout for several legal landmines that can result in significant financial burden for a small business owner, particularly among these top five legal pitfalls.
CAM Fees. Common Area Maintenance (CAM) fees frequently require a lot of negotiation because tenants can end up paying for costs that aren’t core to the operating of the office building or shopping center or that extend beyond the life of their lease if they don’t read the language carefully. CAM fees are shared amongst tenants and associated with maintenance, repair and, to some extent, replacement costs and expenses.
Many tenants don’t fully understand everything that they’re paying for – from the decorative flowers in the lobby, to the late fee incurred because the landlord forgot to pay the utilities bill on time, tenants could be incurring costs not directly related to their tenancy. A lawyer can help decipher exactly what the landlord and tenant are individually responsible for and can make sure that the lease reflects the real business deal.
I’ve seen leases that allowed a landlord to put a new roof on the building and charge the entire cost of the roof under CAM in a single year, even though a roof is considered a structural element, which can have a lifespan of 20 to 25 years. Roof replacement is usually at the landlord’s sole cost and expense. At the very least, CAM charges associated with capital items should be spread out over a number of years, with charges stopping at the expiration of the lease.
Occupancy Provisions. Without legal guidance, small business owners can also get stuck paying more than their fair share of fees if their lease doesn’t include occupancy provisions as part of the basis for calculating CAM. It’s one thing if a building is 98 percent occupied and the CAM fees are being shared amongst all the other tenants. But what if the building is only 50 percent occupied and the tenants are still expected to cover all maintenance costs? A business owner should make sure that their lease includes strong language stating that fees are not dependent on the landlord’s ability to lease and have tenants occupy the rest of the building.
In one case, a tenant’s building was only 45 percent leased, but all tenants were paying 100 percent of operational costs. For every $1 of expense on the lease, a tenant paid about 65 percent more than the share the tenant would have been paying if the lease had been carefully negotiation.
Liabilities. Misunderstanding tenant liabilities is yet another way a tenant’s lease can result in unexpected costs. Risk allocation usually arises in issues of indemnification. Environmental liabilities are somewhat obvious – who’s responsible for covering damages and corrective work caused by environmental incidents?
But less obvious and harder to spot in a lease are use and operations indemnifications. A landlord can end up levying large costs on his or her tenants for damages caused by a third party who entered the property, even if the tenant is completely unrelated to the third party’s actions.
Legal guidance can help tenants make sure that a landlord doesn’t have broad indemnification rights, potentially saddling tenants with costs far beyond their control.
Usage rights. It’s also important for tenants to understand what their lease allows them to do with the property, particularly in relation to their line of business. For example, if a tenant is intending to use the property as a medical office, having a general use provision is not going to be enough. Or a retail business needs to make sure that the lease allows for property to be used as needed and as product lines and services evolve. Most importantly, the lease needs to allow tenants to do what the market is driving their business to do.
Improvement allowances. Leases can get even more complicated with construction obligations and, again, it’s important to negotiate which party is responsible for what part of the construction process. This negotiation includes how much a landlord is willing to give in allowances.
Construction can take years, and recessions and budget cuts can occur between a project’s start and end date. Tenants should be aware of exactly what they’re responsible for and what they’re owed in the event that things go differently than expected. For example, in one lease, the landlord was to pay a tenant improvement allowance after the tenant had finished the tenant’s work. Between the signing of the lease and the completion of the tenant’s work, the landlord suffered financial problems. The lender foreclosed on the property and, since there wasn’t any assurance to provide financial support for the landlord’s promise to pay the allowance, the tenant found itself in the unhappy predicament of not having its allowance easily forthcoming and having to work through issues with the foreclosing lender, at substantial unbudgeted expense.
Leases are complicated legal documents, which often require a sharp legal eye to fully understand. No lease is “boilerplate.” Each lease is different and allocates the risks and benefits differently. How a lease is written can make thousands of dollars worth of difference to the tenant.
N. Courtney Hollins is an attorney with the Nashville office of Dickinson Wright, PLLC. She focuses her practice in commercial real estate law and banking law. She can be reached at CHollins@dickinsonwright.com.