Practical provisions of commercial leases in the face of changing times

Rental conditions

November 18, 2022 – Over the past two years, standard attorney lease language has been tested by natural disasters, the pandemic, and drastic changes in the way people work. To adapt to changing times, lawyers should consider incorporating a variety of practical provisions into their corporate leases regarding term, base and additional rent, liability insurance, premises rights and force majeure.

Tenants are asking for longer, not shorter, terms to protect against market uncertainties, including inflation. But tenants are also trying to hedge their bets, remembering how Covid-19 affected their businesses.

There are a few legal tools for tenants to solve this problem. The first is to include one or more termination options in favor of the tenant, at fixed times. The second concerns the exclusion provisions. These allow the tenant to terminate the lease if a government-declared disaster or health emergency results in external conditions or a government order that reasonably renders the tenant unable to conduct business for a specified period of time.

Basic rent

Lawyers should consider incorporating pandemic and accident provisions, as well as addressing the effects of inflation, into the base rent terms of a lease.

Tenants remember the delicate negotiations that took place during the pandemic, where landlords often authorized a combination of rent reduction, rent reduction and rent deferral. Now, tenants are trying to negotiate covenants that incorporate one or more of these elements upon the occurrence of specific events in the future, such as a declared health emergency that results in a government order that reasonably renders the tenant unable to conduct business. . trade in the rented premises.

Most often, it is a rent deferral business for an extended lease term. The landlord will, for example, authorize a 30% reduction in the base rent in exchange for the tenant’s commitment to repay the deferred amount over a longer lease term than that initially provided for in the lease, thus allowing the landlord to recover his lost money returned.

What about the effects of a catastrophic casualty like a major hurricane? This falls under business interruption insurance. Landlords and tenants should ensure that the party who is required to carry property/casualty insurance is also required to carry business interruption insurance. If that party is the tenant, the lease must clearly state that the tenant’s rental obligations continue despite any loss.

Inflation is another current social/economic trend causing landlords and tenants to take a closer look at rent increases based on the Consumer Price Index. Leases often cap CPI increases in base rent. Landlords facing inflation rates of 7 or 8% now regret those 2% or even 5% caps, and future leases are less likely to contain such limits on rent increases.

Renters, on the other hand, see the importance of having limits on CPI increases. Strong tenants will seek low caps on CPI increases.

Damage insurance

More severe natural disasters have taught us not to take P&C provisions for granted. There are many questions to consider in order to answer the myriad of issues that can arise.

What determines if a claim is so severe that termination of the lease is permitted? Is it based on the duration of the restoration, the cost of the restoration or the percentage of the total square footage of the leased premises and/or furnishings that is damaged? Other factors to consider include a lack of access to the premises and whether the premises have otherwise become unsuitable for the intended uses.

Who has the right of termination, owner, tenant or both? If termination is not permitted, what are the possible pitfalls in getting the premises restored? Is the owner only required to make repairs to the extent of available insurance proceeds? It’s a problem if the owner’s lender takes the product instead, or if the owner’s insurer is late in paying or underpaying. The tenant could be protected by a right of termination linked to these issues.

What if the owner experiences extended delays in completing the restoration? To solve this problem, the tenant could try to negotiate a termination right after a specified period of time. In this case, the tenant should be prepared to give the landlord specific notice that the tenant intends to terminate, with additional time to remedy, to allow the landlord to expedite the work.

Which party is obligated to take out damage insurance? It must be the same party that is obligated to restore the premises.

Who is required to insure what? Often, the landlord is required to insure the envelope of the building, and the tenant is required to insure its “capital gains”. As part of this arrangement, it is essential to define what constitutes “improvements” and the building envelope.

These damage insurance provisions must also be coordinated with the provisions relating to rights and remedies after the occurrence of a claim.

Also keep in mind that business interruption insurance is only available to the party that has P&C insurance. If the landlord is the party required to purchase damage insurance, but the tenant is required to pay rent despite the occurrence of a claim, the tenant could be left with no insurance product with which to pay rent.

Finally, we have learned from COVID-19 that a pandemic does not constitute “damage” for the purposes of triggering damage and business interruption insurance. Therefore, tenants should pay particular attention to whether they are required to continue paying rent in this case.

Additional rent

Recent events have surprised landlords and tenants on the generally prosaic subject of the tenant paying their proportionate share of the landlord’s operating expenses.

Tenants are often surprised to learn that the landlord’s deductible under the landlord’s damage insurance is part of the operating expenses for which the tenant must pay their proportionate share. A catastrophic hurricane, combined with a 3-5% hurricane deductible, can result in a multi-million dollar deductible.

In addition, rising vacancy rates have drawn attention to the “95% mark-up” provision found in most leases. This provision generally provides that, where the operating costs of the building will be passed on to the tenants on a proportional basis but the building is not yet fully occupied, the landlord may “mark up” or overestimate his operating costs. operating variables as if the building were 95% occupied to reflect the expenses the owner will incur once occupancy increases.

In an office lease with a reference year, this clause is essential for a new tenant. Vacancies can cause a landlord’s current expenses to be underestimated, and when occupancy rates rise, increased operating expenses in the low base year can be a problem for the tenant.

In a commercial or industrial lease, on the other hand, the landlord usually passes on all operating costs, so a tenant of a building that is only 50% occupied could end up paying almost double the costs that would be allocated. to its space based on a pure percentage. The tenant therefore wants to try to negotiate a cap on variable charges.

Premises and neighboring rights

The popularity of remote work is pushing tenants to seek flexibility in the size of their spaces. This has led to provisions allowing a reduction in the size of premises at specified time intervals. Likewise, more flexible hours mean tenants want the option to reduce the parking spaces they pay for – and perhaps increase them, if trends change.

force majeure

It is more important than ever to review force majeure provisions, as they must be coordinated with any new rental provisions described in this article.

First, each party to a lease must determine whether or not the force majeure clause grants relief from monetary obligations like paying rent. Landlords say “no” and tenants try (but almost always fail) “yes”.

Certain force majeure events, such as a hurricane, will also be covered by the loss provisions of the lease. Thus, the provisions on these two subjects, including the rent abatement, must be coordinated.

The force majeure provision should also clarify what does or does not constitute force majeure. Regarding an event like COVID-19, there are two questions a lawyer should ask. First, does it have to be a government-declared health emergency? Second, is it the existence of this emergency (the pandemic or epidemic) itself that is the force majeure event, or is it the government order (quarantine or stay-at-home order) that follows ?

A cautious tenant may also wish to add specific language defining force majeure to include utilities and access.

Here are two examples:

(1) “Utility disruption or failure preventing use of all or substantially all of the premises for XX consecutive days”; and

(2) “Physical conditions preventing access to all or substantially all of the premises for XX consecutive days.”

Conclusion

Leases are long term and should be flexible documents. The good news is that lawyers can incorporate provisions now that will give parties guidelines for determining their rights and remedies, regardless of changes in the future.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

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