Additional Clauses in the Lease
Disclaimer regarding the Lease: Even though legal information appears in this chapter it is not intended to be legal advice as per that stated by an attorney. When dealing with a lease the tenant and the landlord are advised to seek legal advise from an attorney.
The discussion in the previous chapter focused on the legal components in a lease and the major elements of lease law. Beyond those important elements, residential, commercial, and industrial leases contain additional clauses that form the total agreement between the landlord and the tenant. These clauses are the subject of this chapter.
31.02 DESTRUCTION OF THE STRUCTURE
In Georgia when a tenant has an estate for years in the land, he or she has a responsibility to pay the rent and to honor other lease provisions even if the building is destroyed; but if the tenant leases only part of a building, the destruction of the building terminates the lease. In order to identify exactly the rights and responsibilities of the parties, the lease must have a clause dealing with destruction of the structure, especially regarding the payment of rent.
31.03 DAMAGE TO THE STRUCTURE
The lease should also make provisions for the possibility of damage to the structure to clarify the legal obligations of the parties to the lease agreement. In Georgia, landlords owning residential rental property have a statutory obligation to repair leased property. They face liability for failure to repair under a usufruct agreement with a tenant. On the other hand, in an estate for years, the tenant is responsible for all repairs and other expenses to preserve and protect the property. To avoid any confusion, the lease should clearly state the tenant’s and the landlord’s responsibilities in the event of damage regarding the following items:
(a) rent payment adjustments;
(b) the tenant’s right to terminate the lease in case of substantial damage;
(c) the time for the landlord to make repairs;
(d) the tenant’s right to terminate if repairs are not made in a timely manner; and
(e) the degree or nature of the repairs.
If a tenant is able to occupy the premises while repairs are underway, the lease could provide for reduced rent payments during that period. A clause requiring completion of repairs within a specified time might excuse the tenant from the lease if the landlord does not make the repairs promptly. The landlord could also stipulate that the repairs to the property will only be to the same level of quality as before the damage.
The clause covering damage must anticipate several possible situations. While the lease can easily provide for the consequences of fire damage to an apartment or for water damage from firefighting efforts in another apartment, the destruction of an elevator system in a high-rise apartment building presents a more complex situation. While not suffering direct damage to their apartments, tenants in the upper level apartments no longer have the same degree of accessibility as before the fire. The damage clause may need to address reasonable expectations of the tenants for the timely completion of the repairs and any rights the tenants have to adjust the rent or to terminate the lease.
In negotiating the damage clause, the parties will have very different objectives. The tenant will want immediate repairs to the elevator and, perhaps, a stipulation for a rent reduction to compensate for reduced accessibility. The landlord, however, will resist reducing rents because this financial loss is generally not insurable; or if it is, the landlord’s insurance premiums would increase. The landlord would also like a reasonable amount of time to perform the repairs to avoid paying the contractor for overtime or premium wages for the workers.
31.04 CONDEMNATION PROCEEDINGS AGAINST THE PROPERTY
Condemnation proceedings, or the taking of the property under eminent domain, terminate a lease because both the landlord and the tenant lose their rights. The landlord loses the ownership rights, and the tenant loses the rights of use and possession. Consequently, condemnation frees the landlord of responsibility to provide possession and simultaneously frees the tenant from liability to pay rent to the landlord. However, including a condemnation clause in the lease can clarify the issue of possession and the disposition of the condemnation award.
In short-term residential leases, the clause can merely state that the landlord’s responsibility to provide space under the lease agreement terminates upon a taking of the property under eminent domain since the residential tenant typically does not have a claim on the landlord’s award from the condemnation.
In longer-term commercial leases, the landlord and the tenant will most likely want more detailed provisions dealing with the consequences of condemnation. To avoid future disputes and legal problems, the landlord will want the tenant’s rights of use, possession, and exclusion to terminate on the day of condemnation. He or she may also seek to eliminate the tenant’s rights to any portion of the condemnation award. On the other hand, the tenant will want compensation for any financial loss caused by the loss of space at favorable or below market rent or the additional costs he or she must bear due to an unfavorable change in location. If the tenant does not waive a claim to any part of the condemnation award in the lease, the tenant may have a legal claim to some portion of the proceeds from the condemnation. Since the lease (an estate for years) passes the rights of use, possession, and exclusion from the landlord to the tenant and since condemnation takes these rights from the tenant, the tenant can claim compensation for the financial loss of these rights.
If the tenant is unwilling to waive his or her claim on a condemnation award, the clause can address the issue of the amount of the tenant’s claim. The tenant potentially can claim compensation for the unexpired portion of the lease as well as compensation for his or her fixtures and the improvements he or she added to the structure. The landlord and tenant may agree that upon condemnation the landlord will compensate the tenant on some prorated, mutually agreed upon, basis for the tenant’s unexpired lease term and the tenant’s expenditures for fixtures and improvements. If the presence of these fixtures and improvements increased the appraised value of the structure, the tenant is justified in asking for this compensation.
In addition to these issues, the condemnation clause could address the issue of advance rent payments, if applicable, and could require the landlord to prorate or refund the advance rent payments to the tenant as of the date of condemnation.
31.05 ABANDONMENT OF THE PROPERTY BY THE TENANT
In Georgia a tenant abandons a property when, before the expiration of the lease, he or she forgoes the use of the property, stops paying the rent, and demonstrates the intent to relinquish all rights under the lease. If the tenant vacates but continues to pay the rent, that action does not constitute abandonment. Abandonment of the premises by the tenant entitles the landlord to terminate the lease and obtain a new tenant or to leave the property vacant and continue to accrue rent. A clause in the lease can incorporate this point of law by stating that the tenant is liable for the rent until the expiration of the lease, even in the case of abandonment, with the exception that if the landlord obtains a new tenant, the original tenant’s responsibility ends. However, if the new tenant pays rent that is less than the original contract rent, the original tenant is still liable for the difference.
31.06 SALE OF THE PROPERTY
If the landlord sells or gives away the property, the new owner accepts that property subject to the rights of the tenant under the existing lease. The new landlord remains responsible for fulfilling all the original landlord’s obligations in the lease unless the lease specifically includes a clause relieving the new landlord of the obligation. Georgia law requires new owners to abide by existing leases; however, the tenant might want to insist on the inclusion of a clause incorporating this legal requirement in the lease.
Many landlords will seek to negotiate a clause that cancels the lease in the event the property sells. This clause obviously works to the benefit of the landlord. Without such a clause, the buyer would have to purchase the property subject to, or subordinate to, the existing lease. The new owner would not have the power to raise rents immediately or to seek new tenants as long as the existing tenants’ leases are in effect. This clause is not a major problem to tenants in short-term residential leases, but it could be detrimental to tenants in longer-term commercial leases. If the tenant signs the lease containing such a clause, he or she faces some uncertainty and risk and hopes that the existing owner will not sell the property or that any new owner will consider him or her to be a valuable tenant.
31.07 FIXTURES CLAUSE
The tenant’s fixtures are personal property that the tenant installs in the property and that he or she intends to detach and remove when the lease expires. The fixtures clause should clearly identify the tenant’s fixtures and distinguish them from the landlord’s fixtures to prevent confusion at the expiration of the lease. The issue of fixtures can arise in both residential leases when tenants install additional fixtures for their enjoyment and convenience and in commercial leases when tenants install trade fixtures for use in their trade or business.
31.08 IMPROVEMENTS BY THE TENANT
The probability of the tenant making improvements to the property is much higher under commercial than under residential leasing. Retail and office tenants may want custom floor and wall coverings as well as ceiling finishes, or they may need special configurations of non-structural interior partitions.
The lease can contain a clause that eliminates any confusion about the ownership of such improvements by providing that, once installed, such improvements become the real property of the landlord. The lease agreement must also identify the party or parties responsible for paying for the improvements. The landlord may agree to pay for the improvements as part of the lease negotiation, or the landlord may only give permission to the tenant to put in the improvements. The latter arrangement can create financial problems for the landlord. If the tenant contracts for the improvements but does not pay, the contractor can seek a mechanic’s lien against the property, but only against the tenant’s interest. If the tenant is responsible for constructing the improvements, the landlord might add the expenses to the tenant’s rent. In this way, the landlord can pay for the improvements with the tenant’s funds and avoid the possibility of a mechanic’s lien.
31.09 LANDLORD’S RIGHT TO RELOCATE THE TENANT
When attempting to lease space in a commercial property, the landlord realizes that all the space will not lease simultaneously. The leasing process takes time and problems can arise as the landlord attempts to achieve 100 percent occupancy. For example, in an office building, one of the first tenants to sign a lease could be a small business that requires a small area within the property. The landlord and this tenant reach an agreement about a portion of the property’s ground floor, and both parties sign the lease. Then, another desirable prospect approaches the landlord and requires an entire floor in the four-story building. This tenant wishes to have the ground floor, part of which is already leased to the small tenant. The prospective tenant will not accept space on two floors and is adamant about these requirements. Consequently, the larger prospective tenant probably will not rent under the current circumstances.
A landlord can anticipate such a possibility and prevent it by including a clause known as “landlord’s right to relocate the tenant” into the first tenant’s lease. This clause would allow the landlord to move the first tenant into alternate comparable space. That alternative space would have to be comparable space in terms of the tenant’s needs and no smaller than the original space. If these conditions are not met, the landlord and the tenant would have to renegotiate the lease, possibly for a rent reduction. Moreover, if the landlord exercises the right to relocate, the relocation cannot worsen the tenant’s position in any way. Any expenses associated with the relocation should be the landlord’s responsibility. If the tenant had installed trade fixtures, they would have to be dismantled and moved or replaced at the landlord’s expense in the new space. This right of a landlord to relocate a tenant under the terms of a lease has been challenged in court and held to be legal. The courts have ruled that the landlord’s right to relocate the tenant does not destroy the tenant’s right of possession and use of the property.
Financial issues issues could be important in this relocation issue especially for retail tenants. On the cost side the rent on the original space and the relocation space could be different as mentioned above. However, a loss in sales and thereby profits could be affected by the relocation. Sales in the original space could be $300 per square foot per year while sales in the relocation space in the shopping center could drop to $275 per square foot. The spaces would be the same size and the same quality but in different parts of the shopping center. The landlord and the tenant need to agree on the existence of this effect.
31.10 BREAKDOWN CLAUSE
In many commercial operations, the landlord supplies the tenant with services and facilities other than the leased space. The landlord may promise to provide cleaning services, elevator/escalator service, and air conditioning and, therefore, needs protection against liability if these services are temporarily interrupted. In the case of mechanical equipment such as the elevator, the escalator, and the air conditioner, the lease could include a clause that frees the landlord from liability if these services are interrupted for repair, inspection, or other reasons beyond the landlord’s control. For cleaning services, the clause may read that the landlord is not liable for interruption of services due to labor disputes such as strikes or walkouts.
The breakdown clause could also provide that the tenant’s responsibility to pay rent will continue during service interruptions. Since the interruption of these services may last for more than a few days and may render the property unusable, the tenant might want a contingency clause allowing for rent abatement until the services are provided or premises are again usable.
Shopping center leases typically contain a clause that defines the hours during which the stores are to stay open. In general, the business hours of the anchor tenants–the major department stores in regional malls –will establish the standard hours for all tenants. This stipulation benefits the landlord because it keeps the shopping center in operation for the maximum number of reasonable hours. During this time all stores are open, and the customer does not see a patchwork of open and closed stores as he or she walks through the mall. Under these circumstances the total sales of the shopping center should increase and the landlord’s revenues from percentage leases should also be greater. However, extended hours of operation could harm small tenants financially. The cost of staying open during marginal hours, such as the hours late in the evening or on Sunday afternoon, may exceed the additional sales revenue. Consequently, the smaller tenants may resist the “stay open” or hours-of-business clause.
In a neighborhood shopping center, the anchor stores (supermarket and/or discount store) typically stay open for more hours than the in-line tenants. A supermarket anchor could be open all night or operate from 6:00 a.m. through midnight. The in-line tenants might close at 6:00 p. m. because the late night shoppers only shop at the anchor tenant.
In an office building some tenants may need access to their space at non-typical times such as 8 PM to 6 AM. The “hours-of-business” clause should define the means of access and the use of lighting and HVAC which has been dialed back for the entire building during these non-typical hours.
Another clause in the lease identifies the party responsible for the payment of utilities. Typically, the tenant pays for utilities when he or she is the sole occupant of the structure. When there are multiple tenants in the building, the landlord usually pays the utility bills for the common areas and the tenants pay for the utilities for their leased space either directly to the utility company or on a proportionate basis to the landlord. Moreover, the landlord usually recoups the cost for utilities in the common area by including an assessment for a portion of the common area in each lease agreement.
31.13 THE COMMON AREA MAINTENANCE (CAM) CLAUSE
The common area maintenance clause allocates a portion of the landlord’s common area operating expenses to each tenant. These operating expenses include utilities, custodial service, repairs, insurance, advertising, promotion expenses, and property taxes. A typical allocation method uses the ratio of each tenant’s square footage to the total leasable square footage. In retail space the ratio is the tenant’s space divided by the gross leasable area (GLA) of the shopping center. In office space it is the tenant’s space divided by the total rentable area of the building.
31.14 THE OPERATING EXPENSE STOP
The operating expense stop clause defines the extent to which the landlord will pay for operating expenses when he or she is responsible for them. Under this clause when those operating expenses exceed a predetermined maximum, the extra expense becomes the responsibility of the tenants. The typical language in this clause states that the landlord will pay the current level of operating expenses and the tenant(s) will pay all amounts over the current level or some predetermined maximum level.
31.15 TENANT SIGNAGE
The commercial lease should also contain a clause describing the nature and placement of the tenant’s identifying name sign and other advertising. The landlord may not want a hodgepodge of different-sized signs in dramatically gaudy and contrasting colors and in inappropriate places. Nor does the landlord want the store windows and mall walkways covered with advertising and placards. Therefore, the lease will likely specify the nature of and use of signs and other advertising displays by the tenant.
31.16 LANDOWNER’S MONUMENT SIGN
A shopping center typically has a monument sign that is visible from the major streets serving the center. The tenant and the landlord may need to clarify the tenant’s relationship to the monument sign. The tenant may be able to place a sign onto the monument showing the name of the store; but provisions in this clause govern the tenant’s right to a sign as well as its size, shape, and color. The monument sign may also have a message board for individual tenants to advertise a special sale or a grand opening. This clause may address tenants’ rights to use this advertising space. For example, a smaller tenant may negotiate a one week period twice a year to use this advertising space. A more dominant tenant may negotiate the use of the advertising space for the shopping period the week before Christmas. Major tenants may get the right to use the monument sign at all times while minor tenants my only get the right to use the sign on a rotating basis.
The zoning ordinance may specify the nature of the monument sign by defining its location, height, width, etc.
31.17 LANDLORD’S RIGHT TO FINANCE THE PROPERTY
When a tenant signs a lease, his or her rights in the property are subordinate to any security deed, mortgage, or other liens currently recorded against the property. However, a new security deed with the property as collateral would be subordinate to the lease. To avoid a situation which lenders dislike, the landlord could negotiate a clause in the lease making the tenant’s leasehold rights subordinate to a new security deed. Such a clause stipulates that the tenant allow the landlord to increase the amount of the existing loan, to refinance the current loan, or to take out another loan against the property and that all such liens are superior to the lease. Landlords usually insist upon this type of subordination clause in the lease to allow for financing of the property.
The effect of the subordination clause on the tenant can be profound if the landlord defaults on a loan. If a property owner in Georgia obtains a new security deed and subsequently defaults, foreclosure by the new lender automatically terminates the rights of the tenant. The tenant becomes a tenant at sufferance and subject to dispossessory proceedings. However, tenants can seek several methods of limiting risk under the subordination clause in case the landlord defaults on a new security deed recorded subsequent to the date of the lease.
First, the tenant can attempt to insert a clause limiting the landlord’s future loan to a specific sum. The amount of the new loan plus the sum of all other loans could be less than some percentage (such as 70%) of the property’s current market value. This type of clause seeks to lower the possibility of default by limiting future loan amounts to a level such that the property revenues should cover loan payments and operating expenses.
Second, the tenant can seek to limit future refinancing so that the debt service, when added to the property’s operating expenses, does not exceed the rent collected on a monthly or yearly basis. In this way, the tenant attempts to reduce the likelihood of the landlord’s default because the property does not generate enough net operating income to cover the debt service. The tenant, however, should realize that this approach does not eliminate the risk of the landlord’s default and the tenant’s associated risk of losing his or her leasehold. If the landlord is paying most of the operating expenses and those expenses increase in the future, the net operating income that the landlord derives from the property could fall below the level of debt service.
Third, the tenant may be able to obtain a nondisturbance agreement from the new lender. If the lease contains a clause subordinating the rights of an existing tenant to a new lender, neither the landlord nor the tenant can force a new lender to leave the existing tenant undisturbed in the property. Such a situation can occur only if the new lender is willing to waive the right to dispossess the tenant after a default. The tenant may find it easier to obtain a nondisturbance agreement from a new lender by asking the lender during the loan negotiations to agree in writing not to terminate the tenant’s lease in the event of a foreclosure. The lease would still be subordinate to the future mortgage, as the landlord and future lender desire, but the tenant would have a guarantee that his or her possession of the property will continue if the landlord defaults. Typically, the lender will only give a nondisturbance agreement to a very desirable tenant.
Fourth, a tenant can minimize the risk of losing the leasehold from foreclosure by inserting a clause giving the tenant the right to pay the mortgage if the landlord defaults. This clause could also give the tenant a way of shifting that burden back to the landlord, for example, by subtracting the loan payments from the tenant’s rent. If the loan payment exceeds the rent due, the tenant could seek future rent concessions equal to the total value of the payments in excess of the rent. In other words, in the event of the landlord’s default, the term of the lease can be lengthened to a period of time that exceeds the length of the loan term and includes a free rent period.
This clause to minimize the risk of losing the leasehold is simpler to implement if a single tenant controls the entire property. If there are several tenants, they must all have this clause in their leases and must agree on their proportionate share of the mortgage payment to be covered. If the other leases on a multi-unit structure do not contain this clause, the latest tenant can insist on a companion clause that allows him or her to receive rental payments from the other tenants in the event that the landlord defaults. Furthermore, this clause should stipulate that the tenant have the right to use the rent as a receiver to pay the loan payments that are in default.
31.18 NONDISTURBANCE CLAUSE
Given the landlord’s right to obtain a new loan on the property subsequent to the lease and the repercussions on the tenant if the landlord defaults on the new security deed provisions, the tenant may be able to negotiate a nondisturbance clause in the original lease. This clause would state that the lease shall be subject to and subordinate to any future security deed, but that the new lender must agree not to dispossess the tenant in the event of a foreclosure. Such a clause clearly states that the lease is subordinate to the future mortgage as the landlord and the future lender desire. At the same time, it gives the tenant some degree of assurance that possession of the property will continue in the event of the landlord’s default and the lender’s foreclosure.
Before agreeing to lend money on a property with such a nondisturbance clause, the new lender will examine the entire lease for terms that may have a disadvantageous effect after default and foreclosure. For example, the lease may require advance payment of rent in the early years of the lease. This provision would leave the lender with a tenant who had already paid the rent to the landlord and consequently may owe no rent for the period of the lease still in effect. In other words, the lender would receive a tenant in possession of the property and no rent revenues. This arrangement would make it difficult for the lender to find a buyer for the property or to operate it as part of the lender’s real property portfolio.
31.19 TENANT’S RIGHT TO OBTAIN A LOAN ON THE LEASEHOLD
The tenant has the right to use the leasehold as collateral for a loan unless a specific prohibition exists in the lease. A tenant may find it desirable to maintain this right. If the property is in a good location, the use and possession of the property is a valuable asset. For example, if a tenant holds a long-term lease on a building at the corner of the busiest commercial intersection in town and if the business is successful because of the ideal location, the space is valuable not only to the current tenant but also to a new tenant who could establish a retail operation there. Therefore, a lender might issue a loan for which the collateral is only the right to use and possess that property for a limited amount of time.
The landlord may want to eliminate the tenant’s right to use the leasehold as collateral for a loan since a default on the loan by the tenant could create problems for the landlord. If the tenant defaults on the loan but not on the rent or if the tenant defaults on both the loan and the rent, the lender can move to obtain the space and sell the right of use and possession to a different tenant. The landlord, on the other hand, would probably want to retain control over tenant selection.
31.20 OPTION TO PURCHASE
The purchase option clause in a lease gives the tenant the right to buy the leased property. In Georgia a lease with an option to purchase must meet all the requirements for sales contracts for land. One of those requirements is that a purchase option establishs a fixed or clearly ascertainable price for the property. The landlord and the tenant need to agree on a definite future sales price at the time they sign the lease, and they can simultaneously identify the manner in which the tenant will make the payment to purchase the property. Alternatively, the landlord and tenant may agree to stipulate the sales price as being equal to the market value of the property on the day of sale at some time in the future. In this case, the landlord and the tenant must also agree on the method of determining the future market value of the property.
One method of determining the market value of the property is to have a real property appraisal made at the time that the tenant exercises the option. This method raises issues regarding the process for selecting the appraiser and the question of whether either party has the right to withdraw if the estimated market value is too high for the tenant or too low for the landlord. The two parties could decide to agree on a single appraiser and accept that appraiser’s estimate of market value or to agree that each would hire a separate appraiser and reconcile the two market values as the sales price, or they could adopt any other method that is mutually acceptable.
The landlord and the tenant may both wish to establish an escape provision for the option-to-purchase agreement. If the landlord and the tenant establish the purchase price at the time they sign the lease, and if the lease is long-term, the sales price may not adequately reflect future price appreciation. Consequently, the sales price in the purchase option could be substantially less than the future market value of the property. In this event the landlord would like the right to refuse the tenant’s exercise of the purchase option. Conversely, if the option agreement sets the purchase price as the fair market value of the property at the time for exercising the option, the tenant may find the price to be prohibitively high compared with his or her resources and ability to obtain financing. In this event the tenant would like the right to withdraw. An alternative could be a contingency clause making the purchase option contingent upon the tenant’s ability to obtain mortgage financing at the market rate of interest at the time of the sale. In addition to the sales price for the purchase option, the delivery of the warranty deed is also a matter of concern since in Georgia, payment of the purchase price and delivery of the deed must be simultaneous acts.
When the tenant exercises the purchase option, it creates a binding sales contract for the property. The parties to the lease become the parties to the sales contract. Therefore, the purchase option must contain all of the necessary elements of a sales contract: the sales price or how it is to be determined, the terms of payment, delivery of possession, contingency clauses, closing arrangements, the nature of the deed that passes ownership, and any other clauses required to specify the agreement of the parties in the sales contract. A simple way of drafting the purchase option is to prepare a sales contract containing the purchase agreement, attach the sales contract to the lease, and refer to it in the purchase-option clause in the lease.
The purchase option can remain in force for the entire time covered by the lease or for a clearly stated period that is shorter than the lease. In the latter case, the option clause can state that the purchase offer remains in effect for “the first three years of the lease” or “until midnight of December 31, 2XXX.”
The purchase option also specifies the manner in which the tenant exercises the option. The parties can avoid any confusion or unnecessary legal complications by agreeing that the tenant will exercise the option in writing. Many purchase-option clauses require that the tenant give advance notice of intent to exercise the option and clearly describe the nature of the notice.
A lease with purchase option requires both the tenant and the landlord to give serious consideration to their respective legal rights in the property including the landlord’s right to encumber the property with future loans, leases, and easements and the tenant’s right of assignment of the lease and/or the purchase option. The tenant’s purchase option may make it impossible for the landlord to obtain a loan on the property unless the purchase option is subordinate to any future security deed. At the same time, the tenant will resist allowing future security deeds to supersede the purchase option. In addition, the tenant may not wish the landlord to use the property as collateral for a loan when a purchase-option clause is in the lease unless the purchase option anticipates the manner of handling the obligation to repay the loan after the tenant exercises the purchase option.
The right of the tenant to exercise the purchase option is transferable if the lease itself is transferable. Conversely, if the lease contains a prohibition against the tenant’s right to assign and sublet, that prohibition also applies to the purchase option.
The landlord may choose not to give the tenant an outright option to purchase the leased property. Instead the landlord may choose to give the tenant a limited right to buy the property. Among the many terms used to describe this arrangement are “first option,” “first privilege to buy,”or “a first right of refusal.” In general, these clauses do not create a purchase option; they merely give the tenant the right to buy the property if the landlord receives an acceptable offer from a third party by matching or bettering that offer.
31.21 RIGHT OF REDEMPTION WAIVER
A tenant who is in default on the obligation to pay rent has the right to pay the unpaid rent plus expenses before the completion of dispossessory proceedings and thereby stop the eviction and retain possession of the property. This right is the tenant’s right of redemption. Since a landlord may not consider a tenant against whom the landlord has been forced to initiate dispossessory proceedings to be a desirable tenant, he or she may want to eliminate this tenant’s right to retain the property. Therefore, the landlord could insist on a clause that waives the tenant’s right of redemption. If a waiver of the right of redemption does not appear in a long-term lease, the landlord faces the danger that the tenant will retain possession and default during the lease term, or the tenant will be delinquent on any number of future rent payments and continue to use his or her right of redemption.
31.22 CO-TENANCY CLAUSES
A co-tenancy clause gives the tenant the right to terminate a lease agreement if the shopping center fails to achieve a predetermined minimum situation regarding some aspect of an occupancy level. In the most typical case, the co-tenancy clause is written in relationship to the property owner’s ability to secure an anchor tenant for the shopping center. But the co-tenancy clause can also be addressed to the achievement of a minimum occupancy in the non-anchor tenant space.
The co-tenancy clause can be directed at the landlord’s reaching a predetermined occupancy level at the opening of the shopping center, or the co-tenancy clause can give the tenant the right to terminate the lease if and when the occupancy level falls below a predetermined minimum at any time during the lease term. Thus the tenant would have the right to terminate the lease if the anchor tenant closed down ( “goes dark”) or if a significant number of non-anchor tenants did not renew their leases, and the landlord did not find replacement tenants. The co-tenancy clause can be general or specific. The clause may state that the owner must secure a super market or it might state that the owner must secure a specific brandname store.
31.23 USE RESTRICTIONS
A use restrictions clause either eliminates or limits the owner’s ability to rent space to a business that competes with a tenant. In practice, the anchor tenants, having the most clout with the owner, will exercise the most influence in use restrictions. However, the in-line tenants will also seek restrictions. For example, a shoe store might negotiate a use restriction clause that would eliminate the owner’s ability to lease space to a second shoe store. Since the tenant will want the use restriction to be as narrow as possible, the shoe store tenant would like the clause to say that no other tenant will be allowed to sell shoes in the shopping center. This wording would eliminate directly competing shoe stores, but it could also eliminate a department store’s ability to have shoe sales on the premises.
The property owner would probably want to avoid agreeing to any use restrictions since these clauses can affect future marketing and leasing activity. However, the owner might just try to limit the exclusiveness as much as possible. For example, in a regional shopping center the owner may agree to a restriction that limits the total number of stores selling men’s dress shoes to three, thereby retaining the owner’s right to lease space to a sports shoe business. Property owners might also consider that changes in the retailing business could create future problems for his leasing activity where none exists today. For example, a use restriction against selling women’s clothing in favor of a specific retail establishment that sells a full line of women’s clothing could eliminate the landlord’s ability to lease space in the future to a specialty boutique that sells a limited line of women’s clothing.
31.24 RADIUS RESTRICTIONS
The radius restriction clause in a lease prevents the tenant from opening a retail establishment within a predetermined distance from the location of the space that he or she is leasing. The wording of a radius restriction clause states that while the lease is in effect that neither the tenant nor any person or entity either directly or indirectly associated with the tenant will operate, manage, or otherwise have any interests in a business within a radius of “x” miles from the shopping center. A developer might want this clause to protect the sales volume of the retail establishments located on his or her property.
This lease clause can identify a set of financial penalties for violation of the restriction. For example, if a percentage lease is in effect, the lease may require that the tenant add a certain percentage of the sales of the other store when determining percentage rent for the business covered by the lease. If, on the other hand, a gross or net rent agreement is in place, the lease could state that the level of the rent payment will increase by a predetermined percentage such as 150% of the rent level agreed to in the lease.
Certain exemptions or exclusions can also appear in the radius restriction clause. The tenant may want any existing stores located within the predetermined radius excluded from the restriction but may agree to a radius restriction on new stores. The tenant may also wish to limit the radius restriction by excluding any existing competitors that he or she may acquire or merge with in the future.
31.25 REVERSE RADIUS RESTRICTIONS
A reverse radius restriction clause eliminates or limits the landlord’s ability to lease space in his or her other properties within “x” miles to competing establishments. Like the conventional radius restriction clause, the reverse radius restriction can also contain exclusions. The landlord will want to exclude existing businesses in these other properties and will also want to protect his or her ability to acquire other properties in the future.
31.26 TENANT’S RIGHT TO LEASE ADDITIONAL SPACE
The tenant may wish to insert a clause into the lease that gives him or her the right of first offer or the right of first refusal to lease additional space within the shopping center. This clause gives the tenant the option to negotiate for space when it becomes available at some point in the future. The additional space could be contiguous or adjacent space to the tenant’s existing space, or it could be a larger block of space at another location within the shopping center or office building.
A right of first offer gives the tenant less control and imposes a smaller impact on the landlord. Under a right of first offer the tenant in good standing has the right to make an offer for the additional space to the landlord. If the offer is reasonable, the landlord can elect to accept it. The right of first refusal to a tenant in good standing comes into play when the landlord and a third party have reached agreement on terms and conditions for a lease for the additional space. At this point, the tenant has the right to lease the additional space under the terms and conditions negotiated between the landlord and the third party.
31.27 TENANT’S OPTION TO EXTEND THE LEASE TERM
It is good business practice for the tenant to secure the right to extend the original lease beyond its first term with an option clause specifying that right. This clause identifies the number of renewal options and the length of each of the renewal periods. The clause also identifies the procedure by which the tenant uses or imposes the option at the expiration of the initial and subsequent lease periods. It is also good practice to specify both rent levels and any changes in the rent that will apply during each extension to the original term of the lease. For example, the clause could identify any escalations in the rent, any changes in percentage rent, or any change in an index used to calculate periodic rent during the lease extension.
31.28 THE USE CLAUSE
The use clause identifies the activities that the landlord permits in the space leased to the tenant. In an apartment building or complex the use clause typically limits the use to “residential.” In retail activity, the clause can limit use directly by stating that “the premises shall be used solely for the purpose of conducting a specifically named retail activity such as a shoe store or apparel store or other such use. The clause can also be written as a list of activities that are not permitted in the retail space. For example, the clause could state that the space cannot be used as a bar, tavern, cocktail lounge, warehouse, automotive maintenance or repair shop, training or educational facility, or entertainment or recreational facility such as a bowling alley, skating rink, gym, health spa, billiard hall, massage parlor, or other such activities the landlord chooses to specify.
31.29 MERCHANDISE-INVENTORY CLAUSE
Commercial leases can also speak to the inventory of merchandise that the tenant keeps on the premises and offers for sale. This clause usually contains general terms, such as wording requiring the tenant to stock merchandise on the premises that is consistent with operations at other locations. Such a statement is suitable for a branch store; but for a single store operation, the clause might require that the stock of merchandise be consistent with the merchandise and inventory of competing stores.
This clause protects the landlord from a tenant who is attempting to reduce sales in order to force the landlord to invoke the cancellation clause in a percentage lease. Under that clause if sales are too low, the landlord can cancel the lease and the tenant can move without penalty.
31.30 CANCELLATION OR KICK-OUT CLAUSE
Tenants who sign a percentage lease can fail to achieve the gross sales volumes anticipated when they negotiated the lease. This clause anticipates that possibility and specifies the rights of both the landlord and tenant to terminate the lease in the event the tenant does not achieve the gross sales targets and is paying only the fixed, gross minimum rent for the space. The clause identifies whether the landlord, the tenant or both the landlord and tenant have the right to terminate the lease. The landlord might want the right to terminate the lease and to seek a replacement tenant whose gross sales volume will warrant a percentage rent above the fixed minimum rent level. The tenant might want the right to terminate the lease if the gross sales volume were to be so low as to make the business unprofitable.
31.31 THE ESTOPPEL CLAUSE
The estoppel clause obligates a tenant to sign a certificate or statement testifying to the existence of certain facts, conditions, and/or obligations associated with the lease agreement. The landlord may need such a certification or statement when he or she is seeking to sell the property, to refinance the existing loan, or to obtain a new loan. For example, a prospective buyer of the shopping center may want a certification from each tenant with regard to their rent payments and the remaining term of their lease. The estoppel clause identifies the tenant’s obligation to provide a statement about these pertinent facts.
31.32 THE GROUND LEASE
The ground lease is an agreement between a landlord and a tenant for the lease of vacant land. An important provision of the ground lease is the tenant’s promise to erect a building on the vacant land. This promise necessitates a thorough discussion between the two parties about the length or term of the lease and the disposition of the improvement when the lease expires. Generally the ground lease is a long-term lease. Few such leases are written for less than twenty years and in some agreements, fifty years is the minimum term. When the tenant fulfills the promise to build the structure, the structure legally becomes the property of the landlord. Consequently, the lease must deal with any financial settlement that would occur when the lease terminates. The tenant may insist on compensation for the value of the structure at the expiration of the lease. The landlord and the tenant may agree that an appraiser will estimate the market value of the structure at the end of the lease to establish the value of the structure. On the other hand, in a long-term ground lease, the value of the structure may be insignificant. For example, a fifty-year-old industrial plant may be so functionally obsolete and physically deteriorated that its value at the end of the ground lease is zero. Whatever the situation at the end of the lease, the landlord and the tenant will want to reach some agreement at the beginning of the lease concerning the value of the improvement at the end of the lease and whether the landlord will compensate the tenant for the improvement.
In the majority of cases, the ground lease is a triple-net agreement. The tenant typically incurs the obligation to pay a flat rate to the landlord plus all property taxes and assessments against the property, construction costs of the building, insurance on the improvements, and all expenses for maintenance and repair. The flat rate can be enhanced by specifying an agreed upon escalation or indexing of the rent payment. In addition, the tenant assumes all responsibility for personal injury to third parties. Consequently, the landlord is free of all expenses associated with the property. The tenant receives the use of the land without having to finance its purchase along with the long-term use of a building that specifically meets his or her needs. The landlord receives an income stream for the term of the lease as well as his or her interest in both the structure and the land at the end of the lease. Most clauses or provisions in a ground lease are very similar to those clauses that appear in a commercial lease. However, there are different points of concern between the landlord and the tenant in the ground lease.
First, in a commercial lease if the tenant defaults, the landlord’s typical remedy is a suit for breach of contract. In the ground lease, the tenant has a valuable building on the landlord’s property, and this building serves as the landlord’s security against the default of rent payments. Second, the ground lease tenant typically borrows money to construct the building, and the lender wants collateral for the loan. Since the building usually becomes the real property of the landlord, the only collateral the tenant can offer is the ground lease with its inherent rights of use and possession of the property. Thus, a ground lease must give the tenant the full right to use the leasehold as collateral for a loan. Moreover, the lender will want protection against the landlord if the tenant defaults on the loan and the lender must take over the lease. In this event, the lender will want the right to assign the lease to a new tenant without the landlord’s interference. In other words, the tenant in a ground lease will probably insist that the lease contain provisions allowing for unimpaired rights to use the leasehold as collateral and to assign or sublet the property. Third, the landlord and the tenant must understand their respective rights and responsibilities when the landlord sells the property. The ground lease should give the tenant assurance that the new owner will fully recognize and honor the unexpired term of the lease and all other provisions in the original lease. In other words, the buyer takes possession of the property subject to the existence of the ground lease, and the tenant protects his or her rights of possession and use. Finally, if the tenant uses the leasehold as collateral for a loan, the lender will want the ground lease to require formal notification to the lender of any default on the lease by the tenant along with the right to step in and clear away any default to prevent a forfeiture of the leasehold that serves as the collateral.
The ground lease is beneficial to both parties. The landlord receives a periodic rent payment, is free of major expenses associated with owning vacant land, and should receive an increase in the value of the land. The tenant receives the use and possession of the land and the building, avoids having to make capital outlays for purchase of the land, and may receive compensation for the value of the structure at the expiration of the lease. The tenant can also receive income tax benefits derived from deductibility of depreciation allowances, interest payments on the leasehold mortgage, and ground rent as a business expense.