UNDERSTANDING YOUR COMMERCIAL LEASE - THE DENTAL OFFICE
Kenneth Glasner, Q.C., C.Arb, C.Med., JJP
The lease document binds the landlord (the lessor) and the tenant (the lessee) to a long term relationship, each dependant on the other to some degree for economic gain and in certain circumstances for economic survival. The covenantor, (the guarantor, the indemnifier), if any, has a substantial stake in this relationship.
The lease is similar to a collective agreement in that both documents set out the rules of conduct, obligations, duties, benefits, and burdens of each party. When analyzing a lease (or offer to lease, sometimes called an agreement to lease) there is a plethora of possible scenarios which could occur over the life of the lease agreement, including its renewal.
Together with these obligations, one must also consider the financial investment each party incurs in this venture, together with the expectation of economic success.
All too often we, as lawyers, are faced with a client who requires us to review a "standard" 46 page lease and possibly a 12 page offer to lease they are about to sign the next day. The document is usually received by way of fax or is photocopied such that its quality is unreadable.
In addition, we receive the standard request to "give it a quick review of any major problems, but don't spend too much time as I want to keep the bill down to $500.00 or $600.00". The lease is usually delivered at about 3:45 p.m. the day before signing, with the additional requirement that the leasing agent needs it to be signed before 10:00 a.m. the next day.
I have long since refused to take those instructions from a client in order to keep my errors and omissions insurance down to its proper level. I don't propose to entertain accusations from the same client, 6 months or a year down the road, "why didn't you tell me about this clause - I counted on you".
In the business community today, very seldom can a lawyer "review a standard 46 page lease" adequately within the span of a couple of hours, let alone fully advise their client. The most knowledgeable lawyer in commercial leasing requires substantial time to review the lease, as well as meet with the client in order to ascertain whether or not the terms of the lease are not only fully understandable to the client, but also meet the requirements now and for years to come.
All too often, the tenant informs you that "he or she has a good rate at only $18.00 per square foot". As you scan the lease for the quadruple net costs; net taxes; net insurance; net maintenance; and new net everything else, your attention is generally drawn to those "new terms" such as:
- The payment of depreciation on fixed assets;
- The 15% administration fee based upon the basic and additional rent;
- The 16% gross up between rentable and usable (remember, the building is measured by BOMA standards);
- The lack of waiver of right of subrogation in favour of your client;
- The one-sided indemnity clause;
- The assignment of your client's authority to the landlord regarding the estoppel certificate if he fails to sign the agreement within 3 clear working days;
- The new "shotgun clause" allowing the landlord to terminate the lease if the tenant wishes to assign or sublet the lease for the remainder of the term; and
- Other such covenants of a "trivial nature".
The converse occurs when your client, the landlord, leases his premises and instructs you that all he wants you to do is to "prepare a short lease, like those printed on the stationary store forms, but please protect him". At this point, I usually hand the client the most applicable 40 page (double spaced, including indexed) hard copy "standard lease" that I may have on my computer, requesting the client to review the document and delete those matters that do not concern him.
By this time, red flags should be appearing everywhere. It is imperative that you explain to your client the process involved in reviewing, preparing, and negotiating a lease. Contemporaneous with this education procedure, it is necessary to set out, preferably in writing, the instructions you have from your client.
All too often, as a lawyer we fail to define who is the client and the purpose of being retained by that client. Is the client:
- an existing company, or
- a company yet to be formed, or
- an individual, or
- a partnership, or
- some other entity, or
- a combination of the above, or
In addition, are we being retained to:
- review an offer to lease, or
- review a lease document, or
- to advise, either orally or in writing, on the existing document, or/and
- take an active part in the negotiations.
Once the lawyer has established the ground rules with the client, the lawyer should set about discussing with the client the nature of the business, the short and long term objectives of the client, and any other relevant information so that the lawyer may review the lease document within the proper set of circumstances.
"A VERBAL CONTRACT ISN'T WORTH THE PAPER ITS WRITTEN ON
Leases, like other agreements, should be reduced to writing. The document should contain all of the terms relied upon by each party. In addition, leases, like all good agreements, require execution. It simply benefits no one to rely upon an unsigned agreement.
It is not sufficient to rely upon an agreement to agree. For an agreement to agree is no agreement at all. Neither should you rely upon a "gentleman's agreement".
A gentleman's agreement is an agreement which is not an agreement entered into between two persons, neither of who is a gentleman, with each expecting the other to be strictly bound, while he himself has no intention of being bound at all.
There is no such thing as standard commercial lease agreement. Standardization only occurs where, for example, a shopping centre ensures that the bulk of the clauses contained in its lease are consistent among all of its commercial retail units (not its anchor tenants).
I shall attempt, in the rest of this paper, to explain some of the fundamental areas of a lease. I do not propose to go into any detail. Such details should be reviewed with your lawyer at the appropriate occasion.
A PRACTICAL GUIDE TO REVIEWING A COMMERCIAL LEASE
Who is a landlord? Do they really own the property or are they a lessee under a ground lease, a partnership or limited partnership, or a shell company? If you are relying upon the landlord's covenant, then the landlord should be an entity of substance - what is the quality of the covenants?
Do a land title search to ensure that the landlord does, in fact, have the right to lease.
Who is the tenant? Is it a partnership? If so, then the landlord should ensure that all of the partners sign personally. Is the tenant a company? If so, then ensure that the document is signed by the company. Is there a guarantor? If so, then ensure the guarantor signs the lease and that the terms of the lease are sufficient to bind the guarantor. Again, what is the quality of the covenants?
Do you have an indemnification or a guarantee? What is the nature of the indemnification? Is it for the whole term of the lease or a portion of the lease? Is it for an unlimited amount of money or is the indemnification capped? What happens when the tenant goes into bankruptcy? Does the indemnifier have to sign a lease for the remaining term?
Date of the Agreement
What is the date of the agreement? When does the lease take effect?
Is it a Lease or a License?
There are a number of interests in land that are analogous to a lease and share many features of a lease, but do not create a lease. A lease creates an interest in land. It is an interest less than fee simple. A license is a grant of a right to something which otherwise would not be lawful. For example, the right of a vendor to sell hot dogs at a football game - such license is not exclusive. Hotels, boarding houses and parking lots are some of the examples of interests that are licenses and not leases.
At the outset, the parties should have a clear understanding of the description of the demised premises and the appurtenances thereto, (ie. parking). If the lease is for an entire building, then it is easier to ascertain the demised premises. If the lease deals with a portion of the building, then the lease should contain the plan of the demised premises which should be attached to the lease. If it is surveyed, so much the better. If the tenant has the right to use common area, then the common area should also be set out clearly in the lease so that there is no misunderstanding.
The dimensions of the demised premises may have an impact upon the economics of the lease. The parties must determine who has the burden to pay for taxes, utilities, repairs and maintenance, insurance and general operating expenses. In a shopping centre anchor tenants may not pay the same amount of operating expenses as a commercial retail unit (CRU).
In addition, the parties should know, for certain, the exact size of the demised premises and whether it is measured by BOMA standards. No tenant likes to think that they have 1,200 square feet and find out later that, in fact, the premises have been remeasured and they are now paying for 1,400 square feet or more.
Provisions of the lease should relate to the condition of the demised premises and the obligation to maintain and repair the same. Are the premises being rented on a "as is" basis? What is the cost for renovation, including tenant improvements? Will the tenant be able to get the required licenses from the municipality in order to effect the fixturing which is necessary.
The term of the lease should be clearly set out. Generally, the term is a period during which the tenant has exclusive right to possession of the premises and the corresponding obligation to pay rent. It is of a primary concern to all parties that the provisions governing the commencement and termination of the term are clear and unambiguous.
The term of the lease or the remaining portion thereof is a critical factor to the tenant where the tenant wishes to sell their business to a third party.
In many leases, the commencement date of the term of the lease coincides with the date of the lease agreement, and consequently, there is no room for ambiguity. However, in many commercial leases, the commencement date of the term depends upon the occurrence of another event, usually related to the completion of improvements which the landlord has agreed to build. In addition, the commencement date may be tied to a period in which there is free "basic rent".
Usually rent is divided into two sections (possibly three - percentage rent). The first section is basic rent. It usually refers to the amount of rent per square foot on an annual basis, payable monthly over the term of the lease.
For example, if you are paying on 1,000 square feet (rentable - not usable), at a basic rent of $10.00 per square foot, your basic rent payable on a monthly basis would be $833.33 (1,000 X $10.00 = $10,000.00 divided by 12 = $833.33).
In addition to basic rent, you will, as a tenant, pay additional rent. This can vary greatly from lease to lease. Generally, it is referred to a triple net, which means you pay everything else that the landlord would pay, save and except his income tax and mortgage payments (and sometimes that). This amount may include:
- All taxes, including corporation capital tax;
- All insurance the Landlord decides to put on the property;
- All operating costs, charges and expenses;
- An administration fee. For example, 15%;
- A sinking fund so that they can, on an annual basis, collect enough money to replace the HVAC, elevators, furnace, roof and other structural matters.
Payment of Rent
The payment of rent is generally on a monthly basis, payable in advance on the first day of each month (as opposed to a mortgage payment which is a payment after the use of the money for a period of one month).
Sometimes the landlord will require a series of post-dated cheques from the tenant.
It is not unusual for the lease to contain a waiver by the tenant against any off-set, abatement, or deductions. This means that the tenant waives and renounces any and all existing and future claims or off-sets or compensation against the rent and will pay the rent (basic and additional) regardless of any claim the tenant may have against the landlord.
Occupancy and Permitted Use
Leases generally contain a term indicating the use of the premises. If the use is narrowly defined, ie. dental offices only, then the tenant cannot use the premises for any other purpose. The landlord's consent can in certain circumstances be unreasonably withheld. This becomes a problem if the tenant wishes to sublease or assign the premises to a third party who wishes to use the premises for something other than a dental office).
It is also important to define the use of the premises, as it will reflect on what the appropriate rent should be, should the tenant exercise an option to renew.
- Pay Rent
- Waste and Nuisance
The landlord wishes to ensure that the building is not subject to waste or injury to the building and accordingly, the tenant will have to covenant not to cause waste or any form of nuisance.
- Insurance Risks
The landlord does not wish to incur additional insurance costs and therefore the tenant will be bound to act in a manner such that he will not increase the costs of insurance.
- Compliance with Laws
The landlord wishes to ensure that the tenant does not breach any of the municipal, provincial or federal laws, including fire, safety laws, bylaws and regulations. These laws may also include environmental laws under the Waste Management Act of British Columbia, as well as the general environmental laws, (amalgam waste?).
The landlord wishes to ensure that there is no installation of equipment or alterations to the premises which would breach any law or cause interference with the enjoyment of the building by other tenants.
- Rules and Regulations
The landlord will generally set out a set of rules and regulations which they may change from time to time.
Where the tenants stays in the leased premises after the expiration of the lease without any further written agreement, without objection by the landlord, the rent usually equates to 150% of the monthly annual base rent.
The landlord will ensure that the signs meet with the building requirements.
- Inspection and Access
This section allows the landlord, at any time and from time to time, to enter the premises with its authorized agents, employees and contractors, for various purposes including but not limited to window cleaning, maintenance, janitorial service, repairs or alterations or improvements to the demised premises.
- Showing Leased Premises
This permits the landlord or its agents or employees to show the leased premises to prospective tenants during normal business hours, during the last few months of the term of the lease.
- Quiet Enjoyment
This is generally the major covenant given by a landlord to a tenant, allowing the tenant to enjoy the premises without disturbance, or interruption of possession from the landlord. It doesn't mean, "no noise".
- Interior Climate Control and Lighting
If you are not on the main floor, then you wish to ensure that the elevators are operational at all times, or, if the elevator breaks down, that the landlord will promptly have the elevator repaired or replaced so as to facilitate access for your patients.
- Entrances, Lobbies and Other Common Areas
As a tenant you wish to ensure that your customers and patients have access to your demised premises during normal business hours.
- Janitorial Service
- Repair, Damage and
- Landlord's Repairs
Ensure that the Landlord has the duty to keep the premises in a good and reasonable state of repair, consistent with the general standards of a building of a similar nature, age and character and that the landlord will repair defects promptly.
The lease should be very specific, from a tenant's point of view, to indicate that the tenant is not liable for any structural repairs or replacement. You may also wish to define what is meant by structural repairs, including replacement of roof.
- Tenant's Repairs
The landlord wishes to ensure that the tenant keeps the demised premises in a like, good and reasonable state of repair.
- Landlord's Repairs
- Abatement and Termination
Where there is substantial damage to the premises, such that the tenant can no longer enjoy full use of the demised premises or a substantial portion of the demised premises, you, as a tenant, wish to ensure that the rent will abate for a period of time with the requirement that the landlord make up its mind as quickly as possible whether or not they will repair or terminate the lease pursuant to the termination provisions contained in the lease.
The tenant will not only have to pay its taxes for its business, but also the real property taxes (and probably the landlord's taxes pursuant to the Corporation Capital Tax Act).
As a tenant you should ensure that you obtain prompt notice of any increase in the tax assessment, with the right, at your cost, to oppose any such increase.
Assignment and Subletting
Assignment and subletting are different. A sublet is a situation where the tenant allows a third party (a subtenant) exclusive use of the premises for a portion of the remaining term of the lease. An assignment contemplates the assignment of the whole of the remaining term of the lease.
Generally speaking, any such assignment will require the written consent of the landlord. The landlord may have the right to unreasonably withhold such consent or may have to act reasonably, depending upon the wording of the lease. This term is very important when you want to sell your practice.
In most situations where the tenant assigns or sublets, they will still be liable to the landlord should the assignee fail to live up to the covenants of the lease. This remains a contingent liability to the tenant and should be addressed in the lease, including whether or not the tenant is liable to the landlord on an assignment during a renewal term.
In some cases, where the tenant wishes to assign, the landlord has the right to terminate the lease. Generally, the landlord wishes this right where the value of the premises has increased during the terms of the lease.
In most instances, the landlord will want to have the financial and other background of the prospective new tenant or subtenant and will charge the tenant for such review prior to giving its consent.
Change in Control of Tenant
If the tenant is a corporation, then the tenant could avoid the assignment or subletting clause by simply transferring the shares in the company to the new third party. In order to avoid this avenue of escape, the landlord usually has a clause in the lease which says that if there is a change in control of the tenant company, then that is deemed to be an assignment.
Liens and Encumbrances on Fixtures and Improvements
The landlord prefers to not have its property encumbered by builder's liens or Personal Property Security Act charges. The landlord likes to have a clear title, subject only to any mortgage it has granted to a financial institution.
As a tenant, if you wish to give security to your financial institution, then it must dovetail to the terms of the lease.
Removal of Fixtures and Improvements
All leasehold improvements upon the premises generally become the landlord's property at the end of the lease, without compensation. It is important to distinguish between improvements, fixtures and chattels. In certain instances, the landlord may require the tenant to remove certain improvements, fixtures and chattels at the tenant's expense (ie. a bank vault).
Relocation of Premises
It is not unusual to see a clause in the lease allowing the landlord to move the tenant to a different floor in the building, particularly without compensation.
Insurance and Liability
1. Landlord's Insurance
The landlord will insure the building as a prudent owner. The cost of the insurance will be borne by the tenant or if the tenant leases a portion of the building, then the tenant will pay its proportionate share of the insurance.
The type of insurance will, in all probability, include:
- property insurance, including fire and extended perils, all risk, boiler and pressure vessel, plate glass and earthquake insurance;
- insurance against environmental risk;
- business interruption insurance;
- rent abatement insurance;
- income insurance.
In addition, the landlord's lease generally contains a clause allowing the landlord's insurance company the right of subrogation. What does this mean? It means that in spite of the fact that the tenant may have caused "a fire" (or some other sort of hazard) where insurance proceeds have to be paid by the insurers to the insured (the landlord), the landlord's insurers can still sue the tenant. It is not uncommon for the tenant to ensure that the lease contains a waiver of that right of subrogation.
2. Tenant's Insurance
The tenant should take out all of the appropriate insurance as a prudent tenant, including commercial general liability of an amount not less than "x" million per occurrence, loss of income insurance and any other insurance that a tenant's reputable insurance agent deems prudent.
Insurance should also be kept to a level which does not trigger co-insurance. Co-insurance occurs where some insureds may decide to insure for an amount that is less than the full value of the property.
In order to deter insureds from under insuring, insurers stipulate that minimum percentage of the overall value must be insured, usually in the amount of 80% or 90%. The value is not determined when the policy is issued, but at the time of the loss.
3. Severability of Interest and Cross Liability Clause
As a general rule, if there are two insureds (for example a landlord and a tenant) named in a policy, one insured cannot recover under the policy for any damage to its property caused by the other insured and a default by one named insured will generally void the policy as against both insureds. In order to avoid these problems, the insureds should require that a severability of interest and cross liability clause be added to the policy. This clause enables the insured to receive the benefits contained in the policy, notwithstanding the fact that the damage was caused by the other insureds policy. Further, a default by one named insured under the policy which would otherwise void the policy in its entirety, applies only to the party making the default and does not affect the coverage of the other named insured.
Subordination, Attornment, Registration and Certificates
The rights of the landlord under the lease may be mortgaged or assigned to a purchaser or purchasers as the case may be. The landlord generally requires the tenant to attorn to and become a tenant of such purchasers or mortgagees under the term of the lease and therefore is required to sign certain documents.
2. Subordination and Attornment
The subordination clause requires the tenant to subordinate their interest to that of the mortgagee. If this is required, then the tenant should obtain a non-disturbance agreement signed by the landlord and the mortgagee basically stating that if the landlord is in default under its covenants in the mortgage, and the mortgagee intends to take action against the landlord, then it will give notice to the tenant and provided that the tenant has complied with all of its requirements under the lease, not to disturb or affect the tenancy - basically leaving the tenant alone.
It is generally prudent, particularly where the lease is 3 years or more, to register the lease in the Land Title Office. However, most landlords do not want these lease to be registered for obvious reasons. Sometimes a compromise can be worked out.
From time to time, the landlord may require the tenant to give an estoppel certificate to a subsequent purchaser of the building or to the mortgagee, indicating that there are no defaults by the landlord. If in fact you sign an estoppel certificate saying that the landlord is not in default under the lease, knowing that the landlord is in default under the lease, then you may be precluded from prosecuting your right under the lease for that default.
Tenant's Defaults - Remedies of Landlord
You should review carefully the remedies provided to the landlord on the non-payment of rent, payment of interest, and time to remedy a default.
The Whole Lease
As I said earlier in this paper, a verbal agreement is not worth the paper it is written on. Consequently, any side deals, arrangements or representations made between the parties should be reduced to writing. Generally, the lease says that there are no covenants, representations or warranties, express or implied, save and except that which is set out in the lease.
Depending upon the age of the building, it is not unusual to have a demolition clause in the lease. Accordingly, if the demolition clause kicks in under a specific time (ie. 1 year), then it would be prudent not to put a lot of money into tenant fixtures and tenant improvements. In effect, notwithstanding the term of the lease, the landlord has the right, upon giving you appropriate notice, to terminate the lease on the basis that the building will be demolished. A demolition clause will affect the value of your practice.
The expropriation clause should be so designed as to allow both the landlord and the tenant to effectively press their claims forward so that both will benefit from any expropriation.
Option to Renew
This is one of the most neglected clauses contained in a lease. If you wish to exercise an option to renew, please understand that it must be done within the time limits specified in the lease, preferably acknowledged by the landlord, and if the rent cannot be agreed to, then you are still bound by leasing the premises during the option period with the issue of the amount of rent to be determined generally by arbitration.
You cannot, as some client believe, simply walk away from the lease once you have exercised your option to renew, simply because you did not agree on the appropriate rent.
For a further discussion on options to renew and arbitration, please visit my website at http://glasnerqc.tripod.com where there is a lengthy paper on options to renew.
For many tenants, parking is an important issue. For example, if you are in a strip shopping mall where parking is limited, you may wish to have certain stalls marked exclusive for your use. You may also wish to consider the need for parking stalls of the other tenants in the strip shopping mall or building. For example, you may not want to be next door to a real estate office where over 20 agents come and go from the premises on a daily basis.
If the lease contains a Right of First Refusal or an Option to Purchase then make sure the document is registered in the Land Title Office. Also ensure that these personal covenants (which do not run with the land) carry over during a renewal period.
This paper hopefully will serve as a practical guide to reviewing a commercial lease. It is not a substitute or an alternative to seeking professional advice (on a timely basis) from your lawyer, accountant, appraiser, or another professional.
Kenneth J. Glasner, Q.C.
Throughout this paper, I have, where otherwise appropriate, used pronouns in the masculine gender only. I did this solely to avoid the cumbersome and awkward technique of referring to both genders concurrently, such as "he/she", "he or she", "his/her" or "his and her". It was therefore merely an attempt on my part to improve readability. No sexist connotations should be inferred or implied from this purely stylistic decision. As a result, wherever the masculine gender is used in this book, readers are encouraged to read in a reference to the feminine gender, or to both.
The course material deals with complex matters and may not apply to particular facts and circumstances. As well, the course material and the references contained therein reflect laws and practices which are subject to change. For these reasons, the course material should not be relied upon as a substitute for specialized professional advice in connection with any particular matter.
Although the course material has been carefully prepared, neither the Vancouver and District Dental Society, nor Kenneth J. Glasner, Q.C., nor any of the persons involved in the preparation of the material, accepts any legal responsibility for its contents or for any consequences arising from its use.
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Kenneth J. Glasner, Q.C.
Tel: (604) 683-4181 / Fax: (604) 683-0226
Suite 1414, Nelson Square, Box 12156, 808 Nelson Street
Vancouver, British Columbia, V6Z 2H2 Canada