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Monday, September 30, 1996

Commercial Leases May Trap Law Office Tenants

Lawyers seeking new space should hire commercial leasing attorneys to help avoid pitfalls.




INCREASED TRANSITION in the legal community during the past 10 years has caused more attorneys and law firms of all sizes to negotiate or re-negotiate the commercial leases on their office spaces. While the majority of these leases in the 1980s covered traditional law offices for independent law firms, more lessors and entrepreneurial attorneys now are marketing law office "suites" in response to law firm downsizing, spinoffs, the re-emergence of sole practitioners and the resulting need for turn-key space.

One of the hottest trends is the leasing of law office suites, which typically provide offices, secretarial stations and conference rooms. Small firms and sole practitioners are attracted to these suites because of the reduced initial capital outlay, such as limited costs regarding construction, installing phone, modem and fax lines and office equipment, the provision of receptionist services and access, on a "variable cost" basis, to support staff.

Regardless of whether a firm seeks a traditional office or a suite with all the amenities, it would be foolhardy to assume all lawyers are equipped to undertake this task without the expertise of a commercial leasing attorney. Commercial leases are complex legal documents, and real estate brokers often create a sense of urgency and may rush a prospective tenant to sign a lease before adequate due diligence can be performed and the lease is properly reviewed and negotiated by an attorney experienced in this area.

While a commercial lease is one of the most essential contracts underlying a law firm, it can also become a firm's--or its principals'--greatest liability. More particularly, because a commercial lease defines the parameters of the firm's home, problems with the lease can affect a firm's profitability, growth potential or the ability to appear stable to clients.

Accordingly, attorneys and firms contemplating acquiring new space or re-negotiating an existing commercial lease, should carefully consider the following factors.

Permissible Uses

The "use" provision is one of the first provisions in commercial leases. Landlords typically attempt to narrowly define the permissible uses of the premises by allowing only the current business of a tenant.

This provision should be negotiated broadly in order to cover law office uses and any related or ancillary uses which may later become desirable. Thus, instead of limiting the use to "law office uses," a tenant's attorney should consider negotiating instead for: "use for general office purposes, including, but not limited to law office uses" (with no limitations as to the type of "office use").

This expanded-use provision affords a firm the opportunity to provide a major client with use of a portion of its space and to sublet or assign the lease to a broader spectrum of potential subtenants or assignees--presumably, subject to landlord consent. Further, the tenant should obtain a representation from the landlord that the agreed permissible use will not violate any laws, regulations, contracts or leases. Given the cadence of transition and the uncertain economic climate of the 1990s, this flexibility in permissible uses is crucial.

The lease term, one of the most essential provisions in the lease, at the very least, should be long enough to allow tenants to recoup their capital and intangible outlays for moving, alterations, furnishings, administrative matters, such as notices to clients and vendors, and lost billable hours. The option to extend the length of the term should have no openings--as open terms are an invitation to a dispute with the landlord.

The lessee should confirm that such options are true tenant options and are conditioned only upon the tenant being in substantial compliance with the lease at the time of exercise. Also, the following provisions should be considered: options or rights of first refusal regarding contiguous space for expansion purposes and a right of first refusal to purchase the premises.

Base Rent, Indexed Increases

Many tenants foolishly tend to focus on the initial base rent for the premises, often losing sight of the method by which this charge, typically the largest financial component of the lease, shall be increased over time.

Because many firms place a premium on predictability of expenses for budgeting purposes, fixed-scheduled rent increases are frequently preferred. But if an index, such as the Consumer Price Index, or CPI, is the means of determining increases (commonly used in long-term leases or in options), the following provisions should be negotiated: a favorable base year, which may not necessarily be the most recent year, and limits on increases--e.g., to exceed neither a given percentage in any one year nor an average of annual increases over a given percentage during the lease term.

Tenants should beware of "catch-up" CPI provisions designed to allow the landlord to catch up for years when the scheduled increases were less than the CPI increases. Tenants should identify, with precision, the actual CPI formula to be employed.

Often, a low base rent will attract a tenant's initial interest, though additional items, such as real estate tax increases; common area maintenance, or CAM, charges; sprinkler charges; electric usage; and porters' wage, may not be apparent at first. These additional items can significantly increase the total rent.

Thus, the prospective tenant should have the landlord: enumerate all such items, as well as quantify initial amounts and previous schedules of increases; confirm that the tenant's percentage share regarding such items will not be excessive; budget for the bottom-line rent expense, i.e., the total base plus additional rent; and provide the method of calculation of any such increases. The tenant should negotiate for limits--annual and/or over-the-lease term--regarding such expenses.

Most leases now contain both apparent and not-so-apparent restrictions, procedures and fees, for assignment or subletting. The ability to assign or sublet is essential, and any provision which allows the landlord to withhold, delay or require additional compensation for this right could adversely affect a tenant.

Avoid The 'Landlord-Partner'

To avoid the surprise "landlord-partner" scenario--when the landlord has so much leverage over the tenant that the landlord becomes, in effect, the tenant's partner--tenants should initially negotiate for clearly defined approval standards, limits on approval fees; short "landlord approval/review periods," i.e., 15 business days; and releases of the tenant from post-assignment liability.

Prospective lessees also should be wary of provisions that require tenants to deliver to the landlord a percentage of the consideration received for assignment. If such a fee is exacted by the landlord, the lessees should consider a liquidated amount, because ascertaining the precise consideration can be problematic.

The lessee should also determine which nonfinancial obligations are the tenant's and which are the landlord's. Tenants should avoid accepting responsibility for physical-plant type items such as heating-ventilation-air-conditioning systems, or HVAC, power supply and structural maintenance.

Lessees should beware of additional rent "pass-throughs," in which tenants are required to pay a share of expenses normally absorbed by the landlord, such as capital improvements to the premises.

Due Diligence

As with any other legal matter, early and extensive research into the essential and underlying considerations is vital.

A prospective tenant should conduct a title search of the premises to determine: that the chain of title confirms that the landlord is, in fact, the owner and not a mere net or ground lessee; the existence of any violations of record, such as municipal, building department or board of health, which could affect the tenancy; that the building is properly zoned for the tenant's use; that the certificate of occupancy is current and there are no outstanding violations; and that the landlord has a mortgage on the premises.

Tenants who lease traditional law offices should consider obtaining a leasehold title policy. This policy insures the tenants' right to possession of the subject premises for the term described in the lease, subject to any limitations contained in the lease, such as subordination provisions, and compensates tenants for certain financial losses. These losses would typically include reasonable costs of relocation and, in New York for example, 10 years of aggregate rents, or all monetary obligations, payable by tenant pursuant to the lease.

Most commercial leases and many law office suite lease/occupancy agreements provide that the tenant's leasehold estate is subordinate to the landlord's mortgage(s), net leases or ground leases. In the event the landlord defaults with respect to any of these underlying agreements, a tenant's leasehold estate will be adversely affected and, in some instances, terminated.

For firms that have invested a significant amount of time and capital in the space, or when the appearance of stability is essential, consider negotiating for a nondisturbance provision, subject to approval by any mortgagees, net or ground lessors, which ideally would provide that in the event of a breach by the landlord of any agreement to which a lease is subordinate, the firm's leasehold estate and the lease's terms and provisions, such as base rent, additional rent items, escalations, term and options, will remain unchanged.

'Good-Guy' Guaranty

Landlords often require the firm's principals to assume personal liability for the lease. In this event, tenants should consider: having a corporate tenant execute as tenant and the principals execute as guarantor (in separate agreements); and

Familiarity with key clauses in commercial leases can help prospective tenants obtain favorable terms.

executing a separate "good guy" guaranty in which the principals would incur personal liability only in the event that the corporate tenant has breached the lease, not cured the breach within the applicable grace period and the guarantors have not vacated the premises by the end of such grace-cure period.

Tenants should negotiate to specifically limit the exposure of the principals to base rent and certain ascertainable monetary obligations, such as real property tax increases, CAM charges, sprinkler charge, electric usage or porters' wage, for the period starting from the date of the tenant's uncured breach (not from the beginning of the lease to date); and only then, if the tenant and guarantors have not vacated by the end of the grace-cure period.

There are other relevant considerations. If a broker is involved, tenants need to consider who is responsible for the broker's fee, including renewals. Further, if the lease provides for written notice from the landlord of any alleged breach, the provision also should provide the tenant with sufficient time to either cure or to take affirmative measures to cure.

If the landlord is giving the tenant a rent concession, the tenant should determine whether the concession includes the additional rent charges and whether the concession is contingent upon the tenant's compliance with the lease over its entire term.

The tenant should also ascertain the specific services provided by the landlord, and the limitations of such services, such as overtime charges for weekend use of the elevator or HVAC. Also adequate parking for employees is a consideration, including whether parking is provided free of charge.

If the landlord will be performing work on the premises prior to commencement of the lease, a detailed description of the work should be attached to the lease, together with damage provisions for landlord's failure to timely complete.

Further, if the rent and/or additional rent items are based upon square footage, this measurement should be reasonably accurate.

If the tenant is making alterations to the space, the tenant should consider submitting the proposed plans to the landlord for pre-review and approval concurrent with the lease execution. This will reduce delays and avert additional expense for landlord's professionals to review the proposed plans.

A provision should be included in the lease that covers all instances in which the landlord's consent or approval is required, establishing "reasonableness" as a standard and further requiring the landlord to promptly respond to any such requests.

Prospective tenants should be wary of provisions which limit a tenant's remedy exclusively to the landlord's consent or approval. When a landlord unreasonably withholds consent, this provision has the practical significance of undermining the effectiveness of requiring the landlord to be reasonable.

Finally, the tenant should be sure to obtain sufficient listings in the building's directory.

By conducting thorough due diligence and engaging counsel experienced in commercial leasing, independent attorneys and firms alike can avoid numerous pitfalls and obtain an advantageous lease during these uncertain times of transition.


Copyright 2001 The Gulotta Law Group, PLLC

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