Identifying & Avoiding Commercial Lease Pitfalls

There are four hidden issues in a commercial lease that every tenant should be mindful of when lease—and even term sheet—negotiations commence.

When entering into lease negotiations, the tenant’s representative is of course focused on the key business issues, like rent, term and security deposit. However, there are many other less apparent leasing issues that could financially impact the tenant that the tenant’s representative ignores at its peril. This article, the first of a two-part series, discusses four more hidden issues in a commercial lease that every tenant should be mindful of when lease—and even term sheet—negotiations commence.

Rentable Square Feet

It is essential to understand what rentable square footage is, in contrast to useable square footage. Useable square footage is the common understanding of the square footage of a particular space—measuring the dimensions from the inside of the walls. Rentable square footage, however, increases that useable square footage number, in what can be mysterious ways. The landlord will calculate the useable square footage (and, as discussed below, that calculation method can be a negotiated point), and then multiply it by a building-wide “load factor” or “gross-up” to determine the rentable square footage of the premises. This gross-up allocates common areas (like public areas, utility closets, elevator shafts, etc.) to each useable square foot, sometimes increasing the square footage of a particular premises significantly.

This hits the tenant’s wallet directly: Base rent is calculated on a dollar basis times rentable square footage. Tenant’s “percentage share” of the building (typically used to determine the tenant’s share of operating expense and tax charges) is calculated using rentable square footage.

This issue becomes even more critical in new construction. The tenant must negotiate for a right to remeasure the premises after construction is completed. Plus, the parties need to agree on a method of such measurement. This is typically using the then-current Building Owners and Managers Association International (BOMA) floor measurement standard for the particular type of building. But just remeasuing will not be enough protection for the tenant in a new building, and that tenant should also negotiate in a cap on base rent and its percentage share. That is, if the tenant is entering into the lease expecting a 15,000 square foot space, and the remeasurement after construction determines a rentable square footage of 15,500 square feet, the tenant’s rent can be determined as if the space was 15,000 square feet, but if the space measures out smaller, the tenant should pay that lower amount.

Deemed in Possession

The commencement date of the lease term is typically after the landlord has “substantially completed” its work to deliver the premises to the tenant. This date will either commence the tenant’s rent payment obligation, or commence a free rent period; so, getting this particular date right is of utmost importance.

Tenants must be mindful that leases often have language that will deem the tenant in possession prior to the landlord completing its work and delivering the premises to the tenant, which would prematurely start the rent clock. This could be as innocuous as having the tenant’s architect inspect the progress of the landlord’s work. The tenant must protect itself by negotiating for rent-free early access rights.

First, the lease should be clear that entry by the tenant, in itself, is not a deemed a trigger of the tenant’s possession, rather, the commencement date trigger would be if the tenant commenced its business operations prior to the landlord substantially completing its work. Second, if desired, the tenant should negotiate a specific right to enter the premises prior to the substantial completion of the landlord’s work. This would be desirable if the tenant was also performing work (including, for example, installing wiring and cabling) which due to smart construction practices should occur simultaneously with or prior to some of the landlord’s work. Or, if the tenant is not performing work, the tenant can negotiate the right to install furniture prior to substantial completion of the landlord’s work, so that moving time is not wasted once the rent clock starts.

Failure of Landlord to deliver on time

In the event the lease calls for a definitive timeframe in which the landlord shall deliver the premises, the tenant should always negotiate a remedy to be available in the event the landlord fails to deliver the premises on time (such as if there is a holdover tenant or if the landlord fails to complete its work by a certain outside date). Remedies may include: (i) a per diem charge for each day of delay, (ii) a rent abatement until the landlord delivers the premises, (iii) the right for the tenant to use self-help means to complete the landlord’s work, or, in extreme circumstances, (iv) the tenant’s right to terminate the lease.

In the event the landlord fails to pay the tenant the per diem charge as mentioned above, the lease should provide the tenant with offset rights against rent or any other payment due under the lease (without limiting any other right or remedy of the tenant to collect such payment). The lease should provide that the landlord (and the landlord’s contractor, if applicable) keep the tenant (and the tenant’s contractor, if applicable) apprised of construction progress and timing or any potential issues relating to holdover of an existing tenant in the premises.

In the event the tenant elects to terminate the lease for failure to deliver on time, the landlord should reimburse the tenant for the following in connection with the lease: (i) all legal and consulting fees and expenses paid or incurred by and (ii) all architectural and engineering fees and expenses paid or incurred by the tenant. Any termination should not be deemed to relieve the landlord from any claims for damages that the tenant may have suffered as a result of the landlord’s failure to deliver the premises to the tenant within the time prescribed in the lease.

Permitted Use

The tenant should always draft its permitted use clause broadly in case the tenant’s business changes or tenant needs to assign or sublet. The less restrictive the use clause, the better it is for the tenant. A broadly written permitted use will expand the potential pool of subtenants or assignees that would be able to operate in the premises. A broadly written use clause will also allow for the evolution and expansion of a business.

The tenant should request that the landlord attach a copy of the building’s certificate of occupancy as an exhibit to the lease and have the landlord represent that the tenant’s permitted use will not violate the certificate of occupancy. The tenant should also obtain pre-approval for incidental uses, such as automated teller machines, ancillary retail, food preparation facilities and other amenities, and uses for meetings, events and conferences. The tenant should try to get the landlord to agree to state that the tenant may use the premises for any legally permitted purpose ancillary to office use.

In the event the permitted use clause identifies prohibited uses, the tenant should work with the landlord to ensure that the clause allows for flexibility. The tenant should think through whether the prohibited uses would affect any current or future planned use by the tenant, but also the impact the clause will have on the ability to sublet or assign the premises.

Daniel Suckerman is senior counsel in Lowenstein Sandler’s Real Estate practice. He represents a broad range of clients in commercial real estate transactions, including acquisitions, leasing, financing, negotiation of joint venture agreements and matters relating to asset management.

Kimberly Lomot is counsel in Lowenstein Sandler’s Real Estate practice, where her work spans the full spectrum of commercial real estate, banking and commercial transactions.