Commercial Leasing: Starting with an Offer to Lease? What to expect and pitfalls to avoid

October 17, 2017

Many commercial leasing situations start with an “Offer to Lease” or an “Agreement to Lease”. These terms are virtually interchangeable. I will call them both Offer to Lease for the rest of this article. Typically, these documents set out the bare essential terms of a leasing arrangement such as the description of the premises, the permitted use of the premises, the time period of the lease, the rental rate, the deposit, if there is to be construction of leasehold improvements, the nature of the construction and who is responsible to pay for the construction.

An Offer to Lease is usually two to four pages long. It is short because the parties do not want to invest any significant amount of time negotiating or drafting a formal lease document before knowing whether these basic elements of the leasing relationship are agreeable. Formal leases often contain upwards of 30 to 60 pages. The Offer to Lease will often contain a clause that says something like the landlord will prepare the lease at the landlord’s expense or the lease will be the landlord’s standard form of lease. These clauses can become problematic. They may result in the tenant later becoming bound to sign a formal lease document which it may not have ever seen or approved and with no legal right to negotiate the terms contai

ned in it.

The landlord’s form of lease will generally contain clauses that are often not referred to or even addressed in the Offer to Lease. These clauses can have a significant impact on the tenant, if not initially, then during the term of the lease, at the end of the lease, or both. Samples of the kinds of things these clauses deal with are:

1) Minimum insurance coverage requirements:

Commercial leases often require the tenant to have $5 million or more of liability coverage. The premium cost for this amount of insurance can be expensive and unexpected especially if the prospective tenant’s operations do not justify such a large amount of insurance coverage. To avoid surprises, the insurance coverage requirement should be negotiated as part of the Offer to Lease and the tenant should obtain a quote for the premium cost from its insurance agent prior to signing any Offe

r to Lease.

2) Calculations of Additional Rent:

Many commercial leases allow for retroactive annual adjustment to the additional rent component of the rental rate. This allows the landlord to pass on to the tenant increases to the landlord's costs for taxes, maintenance and insurance. Often there is an additional percentage override amount to add an additional profit component for the landlord. These clauses often have complicated measurement calculations to apportion the allocation of the costs among all of the tenants of the building or complex. It is handy to know these details in advance. Ask for information abou

t previous annual additional rent amounts and adjustments.

3) Restrictions on the Business:

Many commercial properties with multiple tenants have restrictions on tenants operating businesses on the property in competition with other tenants. Many commercial leases do not allow the tenant to change the nature of the business it operates on the property because of these restrictions.

4) Restrictions on Signage:

Many commercial leases limit the size and prominence of the signage that a tenant can put up at the premises. Some also require the landlord’s consent to the tenant’s signage. If signage is important to a prospective tenant, then the location, dimensions, material, illumination, placement, colors, logo and wording of the prospective tenant’s signage should be clearly made a condition of the Offer to Lease at the outse

t.

5) Over-holding Rent Obligations:

If the parties do not renew the lease and the tenant remains on the premises after the expiry of the term, many standard form commercial leases require the tenant to pay double or triple the monthly rent that was applicable during the last months of the term.

6) Lease Renewal and Extension:

Many standard form commercial leases provide the tenant with an option to renew the lease or extend the term but only if notice is given in a particular manner within strict deadlines. Often these clauses also provide that the rental rate for the renewal term will be the market rental at the time of the renewal, which if not agreed upon at that time,

will be subject to mandatory arbitration.

7) Ownership of Fixtures, Leasehold Improvements and Equipment:

Some commercial leases state that anything affixed to the premises become the property of the landlord at the expiry of the lease, including, the leasehold improvements and the tenant’s fixtures and equipment. Others specifically require the tenant to remove its leasehold improvements, fixtures and equipment from the premises at the expiry of the lease. The cost of replacement or removal at the expiry, as the case may be, is something the prospective tenant should consider and be aware of at the Offer to Lease stage.

8) Make Good Provisions:

These clauses require the tenant to repair any damage to the premises by the installation or removal of the tenant’s fixtures, furniture, leasehold improvements or equipment.

9) Restrictions on Assignment and Subleasing:

Landlords assess the financial viability of their tenants. Many commercial leases reserve to the landlord the right to refuse to agree to an assignment or sublease unless the landlord is fully satisfied with the financial viability of the proposed assignee or sub-lessee.

10) Restrictions on Change of Ownership of Tenant:

In many commercial leases it is a violation of the lease for the tenant to sell its business carried on at the premises unless the landlord consents to the sale. In order to consider whether to consent to the sale, the Landlord reserves the right to require financial disclosure of the buyer’s financial viability. This could also apply to a change of control of the tenant if the tenant is a corporation.

11) Conflicts Clauses:

Some commercial leases state that the clauses of the lease supersede or take precedence over the Offer to Lease. Others state that they incorporate the clauses of the Offer to Lease. This can be confusing to prospective tenants. The terms of the Offer to Lease should become part of the formal lease. Both the Offer to Lease and the lease should clearly state that if there is any inconsistency or conflict between the two documen

ts, the clauses of the Offer to Lease supersede and take precedence over any inconsistent or conflicting clauses in the lease.

These are only some of the clauses that are in landlord’s leases. There are many more to look out for.

In many instances the landlord and tenant delay in signing a lease even though an Offer to Lease has been signed and accepted. The tenant then moves in to the premises and starts paying the rent on the strength of the signed and accepted Offer to Lease. The parties may never actually get around to signing a lease. In certain circumstances when this occurs, the signed Offer to Lease can be deemed in law to be the “lease” binding on the tenant for the entire term. If the landlord’s standard form of lease is referred to in the Offer to Lease, the landlord may be able to claim that the clauses in its standard form of lease are binding on the tenant even if those clauses are not specifically set out in the Offer to Lease. The tenant will not be able to claim that since a lease was never signed, it can leave and walk away without liability.

At the Offer to Lease stage virtually everything is negotiable. To avoid these pitfalls it is a best practice to ask for a copy of the landlord’s standard form of commercial lease before preparing or signing any Offer to Lease. If the prospective tenant is using a commercial real estate agent, the tenant should ask the agent to get a copy of the landlord’s form of commercial lease before the prospective tenant signs any Offer to Lease. If the real estate agent balks, insist! This way the prospective tenant will get an idea of the types of clauses the landlord will require. The tenant can determine which clauses to exclude, change or address as part of the Offer to Lease and require those changes to be conditions in the Offer to Lease. Alternatively, a tenant’s form of lease, or the landlord’s form of lease as revised by the tenant, can be attached to the Offer to Lease to make it crystal clear what all of the terms of the relationship will be if and when the Offer to Lease is accepted by the landlord.

If the Landlord refuses to provide its form of lease prior to receiving a signed Offer to Lease from a prospective tenant, be suspicious! If the space is so important to the prospective tenant that it wants to risk signing an Offer to Lease without seeing the landlord’s proposed or standard form of lease, then the prospective tenant should make sure any Offer to Lease states in clear language that it is conditional on the prospective tenant being satisfied in the tenant’s discretion with the terms of the landlord’s form of lease. Also give the landlord a deadline to present its form of lease to the prospective tenant.

Prospective tenants should not only engage a real estate agent well versed in commercial leasing but they should also retain a lawyer knowledgeable about commercial leasing who is ready, able and willing to review the proposed Offer to Lease and proposed form of lease before any Offer to Lease is signed. The effort taken at this early stage will be well worth it especially if it avoids surprises, liability and litigation later on.

This article is not intended to be relied upon as legal advice. Those considering signing an Offer to Lease, Agreement to Lease or Lease should consult with a lawyer and a real estate professional in advance to discuss their real estate and legal needs, rights and obligations applicable to their particular circumstances.

© 2017 Martin Z. Rosenbaum, Tel: 416-364-1919