A Standard Commercial Lease Agreement Explained
What is a standard commercial lease agreement?
As the name implies, a standard commercial lease agreement is simply an agreement by which a landlord (the party that owns or intends to sell the property) permits a leasing party to rent or lease the property for a specific time at a specified price (as with anything, the terms can be negotiated) to be used specifically for business purposes. This is in contrast to a residential lease agreement, which is typically meant to secure the use of the property as a place of residence . In contrast to a residential lease agreement, a tenant can expect to negotiate and pay different terms such as more substantial rent, additional fees or security (in addition to deposit) and other regulation as it relates to business operation on the property. As with any contract, read the terms carefully and seek professional advice if you are not clear on a provision or a term before you agree.
Terms Used in a Commercial Lease
Standard commercial lease agreements contain several essential terms and clauses that all parties should be careful to understand. Most of these terms are fairly descriptive, but their application can vary based on both the type of lease agreement and the specific applicable state/county laws where the lease is executed.
Rent
The first term most landlords will include in any commercial lease will be the amount of rent due and the date that the rent will be assessed, due and payable. The rent amount may be either a fixed or adjustable figure (meaning it will rise or fall according to an objective standard, such as inflation or a predetermined sliding scale).
Lease Term
The "lease term" refers to the duration of the lease, which can be expressed in terms of years (or months, if the lease is short-term). Some commercial leases are "net leases," which means that the tenant pays not only the rent, but also the insurance, taxes and maintenance for the property. This is also sometimes referred to as a "triple net lease". "Gross leases" require the landlord to pay for some, if not all, of these expenses. Both types of leases can persist for a term of up to 99 years, depending on applicable state law. If the lease does not specify a term and neither party properly terminates the lease, the agreement will be terminated by law after one year.
Renewal Options
Sometimes, parties will list the "renewal options" in the original lease agreement, or the parties may sign an addendum containing these terms. The renewal options may be for as little as one year (or less), or for as much as the parties wish to include. The commercial lease may provide one or more of the following options:
• The tenant will have the right to renew the lease at the same terms and conditions, for a set period of time
• The lease may contain a clause allowing the tenant to renew, but the rent amount may be increased
• The lease may contain a provision allowing the tenant an option to purchase, or one to terminate, the lease
A lot depends on the price that the landlord is willing to pay for the right to have a "captive audience" for performing commercial activities on a parcel of real property. In any case, it is essential that the lease agreement clearly state what right the tenant has at the end of the lease term. Like many other options or rights that arise during the life of a lease agreement, the tenant will be able to exercise their renewal rights under the lease.
What Parties are Involved in a Commercial Lease
The primary parties to a lease agreement are the landlord and the tenant. The landlord is the landlord entity (which can be some private person or entity) or its assignee who has the right to possess the premises after the termination of the lease. The landlord is obligated under the lease to deliver the premises to the tenant.
The tenant is an individual or business entity that pays rent to a landlord for the right to occupy or use the landlord’s property. The tenant has the right to occupy the property for a specific period of time and to utilize the space in accordance with the use provisions of the lease, which includes a description of the intended purpose of the agreement. In exchange for these rights, the tenant must pay the rent and other expenses and assess any other terms and conditions contained in the lease. At the expiration of the term, the landlord may dispossess or evict the tenant if the tenant tells or refuses to pay the monthly rent.
In order for the landlord to protect his/her investment, he/she will ask for guarantees from the tenant that are intended to protect the landlord in the event of default. There may also be apparel guarantees from a third party. The tenant may be willing to assign the lease to the landlord for the remainder of the lease term with the remaining balance included in the purchase price.
A landlord may need to evict a tenant for several reasons, including: If a landlord evicts a tenant without just cause, then the landlord may be liable for any damages caused by the eviction.
Types of Commercial Lease Agreements
Full-Service Lease:
A full-service lease agreement is one where the landlord is responsible for all operating costs associated with the property. A full-service lease is a good option for tenants who do not want to pay for common area expenses. The rent is usually higher because the landlord is paying for all costs. In addition, full-service leases are usually gross leases or modified gross leases.
Net Leases:
A net lease is a lease agreement that is used when the tenant pays for costs associated with the property. There are three types of net lease agreements: Under a net lease, the landlord would pay for things like the land that the property is built on, but the tenant would pay for things like property taxes and insurance. The amount that the tenant pays for insurance, the net lease being used, and how the lease is constructed is up to the parties.
Percentage Lease:
A percentage lease is commonly used by shopping centers. In this type of lease agreement, merchants in the mall pay a base lease payment along with a percentage of their sales for the period. The agreements must be carefully drafted to provide for the percentage and the period. In some instances, the lease requires a floor and ceiling.
How to Negotiate a Commercial Lease
The negotiation process can often be tricky when it comes to commercial leases. For businesses, it is essential to ensure that the terms and conditions impose positive obligations on the landlord or other contracting party to the benefit of the business. Similarly, it is also necessary to ensure that terms benefiting the business such as exclusivity, rights of first refusal or providing rights to modify space are incorporated into the lease agreement. Businesses should take care to review any terms which may be unacceptable to them before signing an agreement and, if possible, request revisions to the terms in the proffered draft lease.
The terms of a standard commercial lease can often be deemed unacceptable for various reasons but the most common include exclusivity clauses and rights of first refusal. Generally, an exclusivity clause prohibits the landlord from offering the same type of space or competing products to other businesses within the same commercial property.
In determining the most favorable terms for the business, it is essential to consider the location and find a space that has no other businesses similar to those operated by the company . A right of first refusal gives a potential tenant the first option to rent a space before it is offered to others.
Rights to modify space are also crucial so that the business can make reasonable alterations as needed. When negotiating a commercial lease, it is essential to work with a lawyer who can help the business search for the most favorable terms and discuss which terms can be modified and which can be left intact. Similarly, it is also necessary to determine how long the lease term will be for the business. Some standard commercial leases are for a six month to one year term before they are subject to renewal while other leases are much longer (five to ten years or more). The longer the term of the lease, the more important it becomes to ensure there are reasonable rights to renew or pre-emptive options to buy.
For business owners who are seeking a commercial lease for the first time, it is essential to carefully plan for all aspects of the commercial lease. As with any significant business endeavor, developing an effective negotiation strategy will often be beneficial.
Common Traps in a Commercial Lease
Businesses, year in and year out, all make the same commercial leasing mistakes. I see these mistakes every day but they are surprisingly easy to correct.
The first is that businesses choose a commercial broker with a big marketing budget, one who will promise anything to get a deal and one that does not insist on the business actually being represented by its own lawyer to negotiate the commercial lease. Very few brokers are experts at commercial leases. Many are not even licensed to practice law. So to get an attorney experienced with commercial leases, the business needs a lawyer who specializes in commercial real estate. This is critical because there are many pitfalls in the standard form commercial real estate lease. The tenant making a deal without an experienced lawyer to help negotiate the lease is asking for trouble. Many businesses, especially those that are larger, believe they can get by with using the X standard form for offices in one city or neighborhood. While this can work for a business that moves annually from neighborhood to neighborhood, it will not work for a growing business that buys or leases a large manufacturing or distribution facility. It also will not work if the business almost never moves its office location. Cities have different zoning restrictions, different building codes, different approvals, different incentives, different tax structures—often of no real value to attracting new business but significant enough to make a terrible impact on the business’s bottom line such as when you cannot write off lease payments for federal tax purposes. Businesses should have their lawyer intimately involved in almost all parts of a commercial deal to assure the right deal is made. Too many businesses fail to have their lawyer review all important documents before the deal becomes binding. An inexperienced lawyer will not adequately protect the business, but an experienced lawyer will. Finally, businesses should not deal with a commercial landlord who does not understand the balance of influence between the landlord and the tenant. Rental property is an investment and the landlord wants to make money. The problem for the landlord, however, is that its interests are not the same as the business’s interests. The landlord negotiates the lease, which is a form lease that favors the landlord. The problem is that the lease must be amended, often and significantly, to modify the form and deal with the specific circumstances the business faces and the landlord might consider significant, such as how the landlord’s approval rights will be triggered for renovations or how disputes will be handled when they occur. It is important to recognize that the business is the one bringing the local economy the jobs, the productivity and the sales taxes-the landlord just collects the rent that generates a taxable asset for the landlord. In the construction of the business relationship with the landlord, the needs of the business come first, not the needs of the landlord. The landlord is the landlord’s lawyer, not yours.
Legal Effects of a Commercial Lease
A commercial lease is a contractual agreement and is therefore governed by the general contract law. In the event of a breach of the lease terms, the aggrieved party may seek a remedy through a civil court. Alternatively, damages may be claimed through an arbitration proceeding in accordance with the provisions of the arbitration clause in the lease. A sub-tenant or compelled tenant who sub-lets the premises in violation of the lease could be subject to actions in tort for wrongful interference with the landlord’s rights. If the landlord’s case is proved, the sub-tenant or forced tenant would be liable for damages. Damages for breach of a lease would ordinarily be limited to the actual loss suffered by the innocent party and any loss unreasonably suffered or incurred is not recoverable in ordinary contract law. The exception applies to a loss which was within the contemplation of the parties at the time of a breach of the contract. If the terms of a lease agreement are ambiguous because of uncertainty or vagueness, it may open the way to a dispute over the proper interpretation of the agreement. The courts are the ultimate arbiters of disputes involving unclear or uncertain provisions in a contract. They follow the parol evidence rule which applies to the interpretation of a contract: that extrinsic or parol evidence cannot be admitted (except in certain circumstances) to fill in the essential agreements. The parties are entitled to include any provision that the law does not prohibit in a commercial lease agreement. However, the parties may not contract out of a requirement imposed by statute. A statutory provision that is not capable of being waived or contracted out of includes section 13(1) of the MPRDA. Parties can be held liable to an expropriation claim, in the form of a delayed delivery claim for vacant possession, if they fail to comply with the statutory provision. An expropriation claim for delayed delivery is a special claim referred to as a real right that is guaranteed by the Constitution. South African jurisprudence has evolved to the extent that the courts lean in favour of protecting the lessor and interpreting any alleged ambiguity in favour of the lessor – as tenant is able to plead an estoppel based on the forms of abuse of its statutory rights. There is always room for negotiation concerning the contents of a standard commercial lease agreement. However, the specific needs of the proposed use and nature of the property must be taken fully into account in any changes that are tailor-made to suit the individual requirements of both the landlord and the tenant. The interests of both the landlord and the tenant should be protected.
Ending a Commercial Lease
Depending on the duration of the term of a commercial lease, it may last over a significant period of time. Although predictable, the lengthy duration also creates uncertainty. People change their minds, rear-end accidents happen, landlords go bankrupt, and businesses shut down. Sometimes something happens in the world that forces you to change your plans. Even corporate structures change, and entities might have a need to use the leased space for a different location or to avoid business disruption, except for the normal course of business.
Fortunately, parties are usually able to resolve their differences amicably, especially within the context of a standard commercial lease that allows for early termination upon inscribing upon a few blank lines in the lease agreement. "The parties agree that the Tenant shall have the right to terminate this Lease at any time after the ______ day of ______of the year _____ by giving the Landlord 90 days prior written notice of its intention to terminate the Lease."
Sure, that’s usually an acceptable way to terminate a commercial lease and avoid any penalties, but it’s not the only way to do so . What if the parties can’t agree to an early termination and the business is just up and gone, leaving no forwarding address and no sign of life? Or what if a business has a six months left of its lease term, and the landlord is willing to accept a sum of money in exchange for the tenant’s immediate departure?
Unless you’re ready to put your foot down about how to go about terminating the lease, there might be room to work out a deal with the landlord or tenant. Just because the parties did not provide for an early termination agreement, it does not mean that it was prohibited. And just because there was a dispute about the termination of the lease does not mean that it did not occur, voided the agreement, or makes it unenforceable by a court of law. For example, if a breach of contract action is premised on the failure of a party to pay the rent, then the landlord usually has the duty to mitigate the damages, which, depending on the facts of the case, could mean resuming the tenant’s use and possession of the premises.
The manner in which a commercial lease terminates usually falls on the question of whether the parties intended to end their obligations, rather than upon whether the parties followed the termination requirements. For some, the opportunity and ability to terminate a lease agreement under such circumstances is a desirable feature, whereas for others, it could be seen as an unwanted power play.