Commercial tenants are likely to encounter the common triple net (NNN) lease; however, without negotiating more favorable terms, they risk accepting an agreement that most often favors landlords.
Commercial tenants should watch out for these ten clauses common in NNN leases. This articles discusses some opportunities to mitigate risks by negotiating more favorable terms.
1. Rent. Commercial rent usually comes in two forms in NNN leases. The first is base rent, which is typically quoted on a per-square-foot basis. The tenant is also responsible for additional rent, which typically includes a share of operating expenses, real estate taxes, insurance costs, and utilities.
Key negotiating points:
a) Additional rent estimate. Because everything but the base rent will be variable, it is important to get a more fulsome estimate. Consider asking the landlord for an additional rent estimate for up to two or three years into the future. At the very least, request a statement showing what additional rent, operating costs, and taxes have run in the recent past.
b) Audit rights. Similarly, negotiate for an annual statement showing actual additional rent costs, and for the right to examine the books if something seems irregular.
c) Cap on controllable operating costs. Every lease will outline the operating costs, some of which the landlord can control, such as wages for building managers and security guards or costs to update amenities. Consider negotiating an annual cap on such costs.
d) Base rent during extended term. If you have negotiated an option to extend the term of the lease, put in writing a mechanism by which you will have some negotiating leverage for determining the base rent for the extended term.
2. Security. A landlord will typically ask for some form of security in the event that the tenant stops paying rent, fails to perform maintenance or repairs for which it is responsible, or otherwise defaults under the lease. The three common types of security are a deposit, a personal guaranty, or a secured interest in the tenant's fixtures, furniture, and equipment (FF&E).
Key negotiation points:
a) Security deposit. The landlord may agree to refund some of the tenant's security deposit over time if the tenant is paying rent and abiding by the other terms of the lease. For instance, you may be able to negotiate a return of half of the security deposit after the first year, and the remainder after the second year.
b) Personal guaranty. Tenants are understandably nervous about signing a lease that puts their own personal assets on the line. It may be possible to negotiate a limited guaranty, a corporate (as opposed to personal) guaranty, or an agreement that the guaranty will expire after a certain period of time.
c) Secured interest in the FF&E. This provision is common in restaurant leases. If your lender already has a security interest in your FF&E, you should explain that to the landlord. It would typically be a waste of the landlord's effort to take a secondary interest.
3. Initial Premises Build-Out. Tenants need the build-out of their space to be suitable for their business, and they need the work to be done on time.
Key negotiation points:
a) Tenant improvement allowance. The landlord may agree to put some money toward the tenant's improvement expenses, since the work will add value to the property. The landlord can also factor the allowance into base rent to recoup the cost over the lease term.
b) Hiring and payment of contractors. The lease agreement should specify that the landlord is in charge of hiring the architects, engineers, and contractors doing the build-out and making sure those contractors get paid from the tenant improvement allowance.
c) Approval of plans. Ensure you are involved in the design and approval of final plans for the buildout.
d) Construction schedule and delivery dates. The schedule of work should be spelled out in the lease. However, construction delays are not uncommon. Consider building in terms that include free rent during the delay, an extension of the lease start date, and/or lease termination or a "drop dead" date.
4. Permitted Use. A typical lease will specify what the space may be used for, and landlords typically specify restrictions.
Key negotiation points:
a) Define the use. Because a tenant may decide to assign the space at a later date, it is best to define the use as broadly as possible, such as "general office use and ancillary uses."
b) Exclusive use clause. If it is meaningful, try to include a clause that prohibits the landlord from leasing to competitors in the same building.
5. Assignment and Sublet. Tenants may over time find that the space they leased no longer serves their purposes, either because they need a larger or smaller space or they need to relocate. But a typical lease will say that assignment or subletting is not allowed without the landlord's consent.
Key negotiation points:
a) Affiliated party transfers. The tenant may be able to negotiate a provision that allows for a transfer if its company is acquired or there has been a merger.
b) Release from liability. In the event the landlord approves an assignment, it is best for the tenant to have a guarantee that its liability will end. That is more likely if the original tenant can prove to the landlord that the new tenant is credit worthy.
c) Landlord's consent. Try for an agreement that states the landlord's consent will not be unreasonably withheld.
d) Definition of assignment. The lease should ideally say that a merger, a transfer of ownership of the company, or a sublease of less than half of the space should not be considered an "assignment" per the lease.
6. Repairs and Maintenance. Generally, the landlord will be responsible for repairs and maintenance of common areas and will pass along associated costs to the tenant as operating expenses, whereas the tenant will be responsible for work involving the leased space.
Key negotiation points:
a) Capital improvements. If large projects will be charged back to you as operating costs, ask that those be amortized over the useful life of the building.
b) Failure to repair. Build in remedies if the landlord fails to make necessary repairs. These might include the right to make the repairs and be refunded for costs, or a rent abatement for space that becomes less usable.
7. Indemnification/Limitation on Liability. Virtually every form lease will contain language that discusses the tenant's obligation to indemnify, defend, and hold the landlord harmless in the event of a problem. Landlords should have the same obligations.
Key negotiation points:
a) Mutual indemnity. Insert an obligation that the landlord indemnifies, defends, and holds the tenant harmless for events occurring outside the tenant's premises, such as in the parking lot.
b) Landlord's negligence. Insert a qualifier that states "except in the event of landlord's negligence or willful misconduct" wherever possible.
8. Subordination. The tenant will want to know that it will not be forced out of the building in the event the landlord defaults on its own loan. This is covered by Subordination Non-Disturbance and Attornment ("SNDA") and estoppel provisions, but it is important to negotiate the scope and form of these documents.
Key negotiation points:
a) Non-disturbance. Confirm that any SNDA clause requires the landlord's lender agree not to disturb the tenancy.
b) Lender approval requirement. Try to avoid any SNDA that requires the tenant to get the lender's approval before common actions like amending the lease or negotiating an extension.
9. Options. Common options offered to tenants include the option to extend, right of first refusal, and, with longer-term leases, termination.
Key negotiation points:
a) Notice period. Sometimes landlords offer a very short window, such as five days, for a tenant to exercise an option to expand or right of first refusal. Try to negotiate a more sufficient window to consider the option.
b) Termination fee. Keep in mind that in the rare instance when a landlord agrees to a termination option, it will often require payment of a fee and potentially a lengthy notice period.
10. Defaults and Remedies. The tenant will be in default if it fails to pay rent or comply with the other terms and conditions of the lease, and the landlord typically specifies remedies, such as accelerating rent due and forcing the tenant to vacate.
Key negotiation points:
a) Notice and cure periods. Make it clear that "default" requires the landlord to give notice about exactly how the tenant is failing to fulfill the terms of the lease, and an opportunity within a reasonable period of time to fix those failures.
b) Landlord default. Most landlord form leases do not include a provision for landlord default. Negotiate common tenant remedies like rent abatement and self-help in the event the landlord is not keeping with its obligations and covenants under the lease.
Your careful attention to these key clauses in triple-net leases can help ensure that your company's interests and rights are preserved.
Author: Matthew Loven is a real estate partner at Maslon LLP.
You may also be interested in