Negotiating Commercial Leases: The Essential Terms
By: Richard E. Korb[1]
A commercial lease enables a tenant to rent space in a building for the purpose of a business such as an office or a shop. This differs from a residential lease that is for renting a room, an apartment, or home as your home. Beyond this, these two types of leases differ in several ways. Firstly, in a commercial lease, the consumer is less protected. In California, there is no rent or eviction control, no upper cap on the security deposit, and the tenant can be made responsible for maintenance of the property. Secondly, there is no standard form such as in a residential lease and it can instead be customized for the landlord’s needs. The lack of standardization necessitates close examination of all commercial leases, but also enables a lot more negotiation and flexibility. Lastly, a commercial lease is a lot harder for a tenant to break.
To successfully negotiate a commercial lease, understanding the legal clauses is essential.
Parties
This clause may also be called “Lessor and Lessee” clause or “Landlord and Tenant” Clause. If you are the tenant, you will want to review how the landlord and tenant are named to avoid personal responsibility. If you are an LLC or a corporation, you want the tenant termed as such, not in your personal name. Otherwise, you will be personally responsible. If you are the owner or landlord, you will want the tenant to sign a personal guarantee so that he or she is personally responsible for all rents and other obligations.
Premises Clause
This clause will describe and identify the space or property that you are leasing. It can be as simple as a street address if you are leasing an entire building or quite detailed if you are leasing certain space. It is important to review the premises clause to define precisely what you do and do not have access to. If you are only renting a limited space within an office building, you may want to specify whether you have access to the kitchen, conference rooms, storage space, secretarial stations, etc.
Term or Length of Lease Clause
The term clause refers to the length of the lease. This clause will specify not only when your business moves into the property, but also when you must make any deposits, begin to pay rent and start paying insurance. Careful scrutiny of this clause is necessary to evade excessive start-up costs to your business. For instance, you probably want to avoid paying rent or insurance prior to moving in. To avoid this, term clause may stimulate separate start dates for moving in, paying insurance, and rent payments. This clause may also include options to renew the lease.
Rent Clause
The rent clause specifies the amount to be paid monthly. The landlord may also include a clause here for an annual increase in rent. Rent payments may be categorized as a “gross lease” or a “net lease”. A gross lease means that rent includes utilities, repairs, insurance and taxes. A net lease requires the tenant to pay for these things separately. (There are additional variations such as a Triple Net Lease etc.)An allowance for improvement and alterations may also be negotiated as a part of the rent.
Improvement and Alterations Clause
Often the needs of a business will dictate the customization of the lease .An improvements and alterations clause will define what work can be done to improve or alter the existing space, who can do the work, who will pay for it, and when it can be done.
Maintenance, Utilities, Code Compliance
The maintenance clause will stipulate the duties and responsibilities concerning care of the rented space for which the tenant is responsible. All provisions regarding the utilities are usually covered in the utilities clause. There may also be a clause requiring the tenant to keep the rented property ‘up to code.’ Prior to signing a commercial lease, it is necessary to be clear on exactly what compliance with code means in your circumstance and what items will be brought up to code and by whom.
Use Clause
These clauses will limit how you may use the space. Generally, the fewer use restrictions, the better for the tenant. However, a landlord may want to restrict the tenant’s business activity through a use clause due to concern over liability, personal discretion, or because the landlord has signed an exclusive use clause with another tenant. An exclusive clause ensures that you are the only tenant allowed to do a particular type of business. This clause is ideal for preventing competing businesses from moving in next door. An ice cream vendor might sign an exclusive clause with a landlord. The next tenant that moves into the building will have to sign a use clause requiring the tenant to not sell ice cream.
Subleases
It is typically favorable for the tenant to ask for a sublease clause allowing him or her to assign the space to another tenant. In the event that your business is unsuccessful or you need to move out, someone else can pay the rent for you without breaking the contract. Landlords typically resist such clauses fearing lack of control over who sublets the premise.
Other clauses that may be important in your circumstance are parking and use of signs, insurance, security deposit, and security arrangements. For instance, if your business is a retail store, it may be vital to your success to include an allowance for posting business signs and advertisements. In a security deposit clause, you may want to opt for a “Letter of Credit” from your bank, in which your bank reserves the agreed amount of your funds instead of paying the deposit up front.
The flexibility of a commercial lease is dependent on a variety of factors.. Generally, a tenant’s bargaining power is restricted by the demand for the space. If demand for commercial spaces is low in the area, then a tenant can have significant negotiation power, but if demand is high, then his or her leverage will be diminished. Knowing where your leverage can be used best can be tricky, but can greatly affect the success of your venture. If your business is a retail store or a coffee shop, location will be very important. You can’t predict the success of your enterprise, so you may want help deciding between a long-term lease, short-term lease with renewal options, and a short-term lease. If you want to be the only coffee shop in the building, you may consider using most of your bargaining power for an exclusive clause. Enlisting legal help to negotiate a commercial lease can be the first step to a profitable business.
For more information about your options, contact Berkeley-Oakland –Walnut Creek, business and real estate attorney, Richard Korb, at 510-524-0903 for a free consultation to evaluate your situation.
[1] RICHARD E. KORB is a seasoned attorney with 30 years of business, real estate, bankruptcy litigation and contract/transactional experience. Over his legal career, Richard has successfully litigated and resolved over 300 court cases in the fields of contract law, real estate, employment, unfair competition, and general civil law and he has drafted and negotiated over 200 contracts and licenses for large and small companies alike. Richard leverages his experience as a former partner in a 100-person law firm and chief counsel for a public software company to assist individuals and companies, from start-ups to multi-nationals, with a broad spectrum of legal matters. In addition to his legal practice, Richard is a court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts.
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