Decided on a Business Lease? 20 Lease Provisions
Familiarize Yourself With These Standard Commercial Lease Provisions
If you are leasing your business facility, you should be familiar with the following terms and provisions which are commonly found in commercial leases:
1. Gross lease. This is the most traditional type of lease: the tenant pays rent; the landlord pays taxes, insurance, and maintenance expenses relating to the property. Increasingly, gross leases contain escalation clauses, which provide that the amount of rent is to be adjusted (usually each year) to offset increased expenses.
2. Net lease. A net lease transfers some or all of the expenses that the landlord is traditionally responsible for to the tenant. With a single net lease, the tenant pays rent plus taxes relating to the tenant’s portion of the property. Under a double net lease, the tenant also pays its proportional part of insurance premiums. Finally, with a triple net lease (which is often favored by larger businesses), the tenant pays all charges payable under a double net lease, plus maintenance expenses.
3. Fixed lease. A fixed lease provides for a fixed amount of rent over a fixed rental period (term). These types of leases usually seem the least threatening for the small business owner tenant, since you don’t obligate yourself today for rent increases in the future. But, there is a downside to a fixed lease: if you want to renew the lease when it expires, the landlord may choose to raise rent sharply, particularly if your business appears to be doing well, and would suffer from relocating elsewhere. If your initial lease term was short, you might end up wishing that you had opted for a longer term lease with fixed or determinable rent increases.
4. Step lease. A step lease provides for set rent increases to take effect at stated times. This will provide you with the peace of mind of knowing what your rental amounts will be for a longer time period, while giving the landlord some protection against rising costs. If you are considering renting a facility under a step lease, carefully consider whether each of the scheduled rent increases is reasonable. Are the increases out of line with historic consumer price indexes or local rental increases?
5. Percentage lease. With a percentage lease, your landlord shares in your good (or bad) fortune. The lease provides for a fixed amount of rent, plus an additional amount that is set as a percentage of your gross receipts or sales.
6. Lease term. Identifies how long the lease will be in effect. If you suspect that you will want to stay at this same business location beyond the initial term, try negotiating the inclusion in the agreement of a renewal option that entitles you to renew the lease for a specified period and a specified rent.
7. Rental rate. Tells how much the rent is and when it must be paid. Most leases also include late payment provisions that impose additional charges if you fail to pay the rent when it’s due or within a specified grace period. If your business experiences seasonal or irregular sales activity, try negotiating a flexible rental rate that corresponds to the changes in your cash flow.
8. Escalation clause. This clause provides for increases in rent over a specified time period. The escalations can be fixed, or determined with reference to an outside factor, such as increases in the landlord’s operating costs, increases in a cost index (such as the consumer price index), or increases in the tenant’s gross receipts or sales.
9. Maintenance. Specifies who is required to maintain which portions of the building and land. If you are responsible for doing so, the lease should say whether you can contract with anyone of your choosing to provide these services, or whether the service providers have to be approved by the landlord.
10. Competition. In the case of a lease of retail space, such as a store in a shopping mall, there may be restrictions placed on the landlord’s right to lease nearby space to businesses similar to your business. (If there are not, you should consider pushing for such a provision.)
11. Subletting. Spells out whether, and under what conditions, you are entitled to sublease the premises to another. Remember, if you sublet the property, you normally will still be liable for paying the rent if the subletting tenant does not pay.
12. Improvements and modifications. Identifies whether you have the right to make improvements or modifications to the facility so that it better suits your needs.
13. Taxes. Specifies who is responsible for the real property taxes.
14. Insurance and liability. Fixes who is responsible for casualty and liability insurance and how much coverage must be carried. Also may contain language that says under what circumstances, if any, the parties to the contract (the landlord and you) will excuse each other for liability for injury to persons, or to the property.
Tip: Although you may be willing to reimburse the landlord for losses caused by your actions, watch out for language that would legally excuse the landlord from damages that the landlord caused to the leased premises or to persons or property on the premises.
15. Renewal option. Specifies whether the tenant has the option to renew the lease when it expires and, if so, specifies the amount of rent to be paid (or how the rental amount is to be determined) for the renewal lease term. A renewal option can give your business protection against your landlord’s wanting to hit you with an unreasonably large rent increase when your first lease term expires.
16. Purchase option. Tells whether you’ll have the right or obligation to purchase the facility at the end of the lease term. This provision should specify an option price or range and how and when the option may be exercised.
17. Destruction or condemnation. States whether the landlord is required to rebuild if the property is destroyed. Specifies whether rent will be abated, and whether you can terminate your lease obligations if the facility is totally or partially destroyed. This provision will specify what rights you and your landlord enjoy if the facility is taken by eminent domain (that is, acquired by a local government body for a public purpose).
Tip: Most leases include a provision for termination of the lease following destruction of the facility, based on either the time it will take to repair or the costs involved. You should insist that there be an absolute cutoff time beyond which you may treat the lease as terminated. This will protect you against a landlord who drags his feet making repairs while you continue to lose business.
18. Landlord’s solvency. A useful provision from your point of view, which spells out your rights as a tenant if your landlord’s mortgage company forecloses on the leased premises.
Tip: If you have any doubt about the landlord’s solvency, before you enter the lease, consider requiring the landlord to obtain a non-disturbance agreement from any mortgage holder. The agreement would obligate the mortgage holder to adhere to the terms of the lease in the event of foreclosure.
19. Zoning and land use restrictions. Specifies what zoning or other restrictions apply to the building.
Warning: If your intended use would violate a zoning rule or private land use agreement, insist on a provision that lets you back out of the deal unless you are able to obtain a zoning variance or judicial relief from a private land use agreement within a specified time. Because of the importance of this transaction to your business and the legal technicalities that are often present with commercial lease transactions, we suggest that you obtain competent legal advice about the content of such a contingency provision.
20. Tenant “going dark” rights. A fear of many small tenants in a shopping center is that a major tenant will go out of business or not renew its lease, known as “going dark”. In the present economic climate, in which major department stores are filing for bankruptcy and closing stores, this is a real problem. One approach to this problem would be for you to negotiate a clause that gives you the right to close your store or get a large rent reduction if a major tenant or several other tenants go dark. Defining “major tenant” is usually a simple matter; defining “other tenants” may be done in terms of a percentage of the total square feet occupied by all other tenants.
This series ongoing series handbook prepared by Marjorie Weber was prepared will also be part of the Miami Bayside Foundation to qualify small business owners for the Miami Bayside Foundation loan program.
Handbook series Small Business Start Up Part 1: Small Business Start Ups Making It Legal; Part 2: Small Business Start Up Capitall Access Primer and Key Steps ; Part 3 Definitive Steps to Create the Optimal Small Business Growth Team; Part 4: Once You Have the Dream Team, It’s About Employee Retention, Part 5: Delegating Responsibilities Policies and Procedures – Letting Go Part 6: Breaking Down the Set Up of Small Business Financial Records Part 7: Three Best Bet Picks for Small Business Accounting Software Part 8: To Lease or To Buy? Issues Relating To Both In Today’s Market part 1
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