Essential Strategies for Negotiating Commercial Lease Agreements

Commercial leases can be lengthy and complex. They require careful consideration of specialized provisions that cover many obligations and potential liabilities. Landlords will typically provide their standard form, but these can vary significantly across properties and industries. Although tenants can suggest changes to the proposed form of lease, the level of negotiation depends on the tenant’s leverage. Unless a tenant is a well-established business or seeking a large space, it may be challenging to negotiate significant changes to the landlord’s form. In these cases, it is that much more important to negotiate strategically and focus on critical issues.

While numerous issues and considerations may arise during a typical lease negotiation, here are five important provisions to consider:

1. Lease Transfers

To reduce risk and ensure an appropriate tenant mix, landlords often spend significant time assessing financial stability and suitability of a potential tenant. As a result, most commercial leases prohibit the tenant from transferring the lease without the landlord’s consent (a “transfer” is often defined to include any assignment of the lease, subleasing of the space or change of control of the tenant).

From the tenant’s perspective, a lot can change over the course of a lease term (which can be lengthy) and they will want flexibility to enable an exit strategy if their space needs change. Below are three considerations for tenants when negotiating lease transfer provisions:

• Reasonableness Standard: The lease should state that the landlord must act reasonably in considering any request to transfer the lease.
  

• Permitted Transfers: Tenants may negotiate the right to transfer the lease without the landlord’s consent in connection with the sale of the tenant’s business, or transfers to affiliates, related parties or entities resulting from corporate mergers or reorganizations.
  

• Termination Rights: Some commercial leases will allow the landlord to terminate upon the tenant’s request to transfer the lease. These “recapture rights” allow the landlord to take back the space and lease it to a new tenant at current market rates. At first glance, this may seem helpful to the tenant. After all, the tenant may be asking for consent because it no longer wants or requires the space. However, there are situations where such a provision could severely impact the tenant. For example, the tenant would not want the landlord to terminate upon a request to assign the lease to an affiliate, or a potential purchaser of its business. In this scenario, the termination of the lease could jeopardize the purchase or reorganization of the business.
  

It is important to note that tenants typically remain liable under the lease following a transfer. So, if the new tenant defaults, the landlord can pursue either the current or former tenant (or both). In some cases, a lease may extinguish the tenant’s liability upon a transfer provided certain conditions are met, such as a satisfactory net worth of the new tenant. Such rights would depend on the tenant’s negotiating leverage.

2. Restoration Obligations

In commercial leases, restoration obligations outline the tenant’s responsibility to restore the premises at the end of the term by repairing damage and removing leasehold improvements.

Understanding these obligations is essential for tenants to avoid unexpected costs. If the landlord requires the tenant to remove improvements, the tenant should clarify that it will not be responsible for removing improvements installed by the landlord or previous tenants. In some cases, the lease may require the tenant to restore the premises to a “base building” condition, which generally means the core structural and mechanical components of the building that existed before the installation of any tenant improvements. This can be a very costly project and should be avoided if possible.

Landlords want broad rights to require the tenant to restore the premises to any desired condition. Tenants want to simply clean the space and leave it in “broom swept condition”. Although restoration provisions can vary significantly depending on the industry, the nature of the space and the negotiating leverage of the parties, a common compromise is to require the tenant to return the premises to the same condition as when it took possession.

3. Relocation

Relocation clauses allow landlords to move tenants from their original premises to new premises located in the same building or development. This provides landlords with control and flexibility to optimize tenant placement, maximize rental income and accommodate tenant expansions.

Tenants often resist relocation clauses altogether since moving in the middle of a lease term can have significant operational impacts and business disruptions. Moreover, the new premises may lack key features such as visibility and access that are key to sales and profits.

If the landlord insists on a relocation clause, there are protections that a tenant can negotiate. For example, the new premises should be substantially similar or better than the original space, and the landlord should provide sufficient notice and reimbursements for relocation costs. Landlords may also agree to limit rent increases where the new premises is larger. Another protection for the tenant would be to restrict relocation to specific areas of the building or times of the year, or to certain circumstances, such as demolition or renovation.

4. Permitted Use

The permitted use clause should clearly outline acceptable tenant activities that can (or cannot) operate at the premises. While landlords often prefer a narrower permitted use to ensure control, tenants should ensure broad enough language to capture their current and any planned or potential use for the space. They should also inquire as to the zoning for the property to ensure that their intended use is not prohibited by municipal bylaws.

If any other tenants have negotiated an exclusive use clause (which allows that tenant to be sole provider of a certain type of business or service at the property), the landlord will need to ensure that the permitted use does not conflict with any other such uses. The tenant should also review any exclusive use clauses – which are typically appended to the lease – to ensure their intended use will not conflict with any current or future uses of other tenants.

5. Third Party Indemnities

Landlords may require some additional security, especially where the tenant is a corporation or partnership without a strong financial background. This security can take various forms (e.g., cash, letters of credit or guarantees), but a common approach is to require an individual (often a shareholder) or another entity (often a parent company) to indemnify the landlord for losses arising from the tenant’s actions.

Tenants may be able to negotiate limitations to an indemnity. First, it could be limited to specific defaults rather than all tenant obligations under the lease. For example, the indemnitor may be responsible if the tenant misses a rent payment, but not if the tenant fails to restore the premises as set out in the lease. Another option would be to limit the indemnity to a time period (e.g., the first three years of a five-year term) or to a maximum amount (e.g., $25,000).

Conclusion

Successful commercial lease negotiations hinge on a thorough understanding and careful drafting of key provisions. By paying close attention to these key provisions, parties can mitigate potential disputes and establish a solid foundation to ensure long term success. Given the complexity of commercial lease agreements and the significant financial obligations, parties should carefully approach negotiations and seek legal advice to reduce risk and avoid unexpected costs.