The Importance of a Commercial Lease Review (Part 2)

Posted on Apr 30, 2021 by Jean Louise

In my previous article, I discussed the importance of a lease review. The lease agreement is the binding agreement between the Lessor and Lessee and many important considerations exist. In most leases, the Lessor-Lessee relationship is known as the Landlord-Tenant relationship. There are many important considerations when reviewing a lease.  A few additional items we look at when reviewing leases include:

Does the lease allow for a sublease or assignment?

A sublease provision in a lease allows the Lessee/Tenant to sublet a portion of its right under the lease to a third party. This provision is found in most leases but requires the consent of the Lessor/Landlord before the sublease can be completed. A sublease is a new agreement between the lessee/Tenant and a third-party lessee/tenant. The benefit to the Lessee/Tenant is that if it chooses to sublet any portion of its leased space for any reason, it has the option to offset its rent owed to Landlord. If the third-party lessee/tenant meets the qualifications required by the Lessor/Landlord, the Lessor/Landlord will typically allow a sublease. This is because the Lessee/Tenant has a continued obligation to make payments to the term; however, the Lessor/Landlord will likely require the third-party tenant to also guarantee the lease.

An assignment of a lease completely transfers the obligations of a Lessee-Tenant to a third party. The original Lessee/Tenant is no longer the Lessee/Tenant, and the third-party lessee/tenant is now obligated by the original lease and remits its payments directly to Lessor/Landlord. Assignments of a lease often occur in the early stages of lease negotiations as the Lessee/Tenant will sign a lease under a then-existing entity, or in an individual’s name, and then later assign its interest in the lease to an entity it intends to operate under at a later time. A Lessor/Landlord may assign its interest in the lease in the event it restructures its ownership or sells the leased space, subject to a lease.

Does the lease grant Tenant exclusivity rights?

An exclusivity right is typically found in retail leases. A Lessee/Tenant will typically request this clause before entering into a long-term agreement with a Lessor/Landlord so the Lessee/Landlord can have the exclusive right to operate its business. A Lessee/Tenant will look to be the only business that provides a specific service or sell a specific type of product within the entire retail space owned/operated by Lessor/Landlord.  The Lessor/Landlord’s incentive to grant a Lessee/Tenant this right is that a Tenant is more comfortable knowing that if it enters into a long-term lease in this space, the Lessor/Landlord will help its business succeed by not allowing a similar competitor to also operate within the entire retail space owned/operated by Lessor/Landlord. The Lessee/Tenant is incentivized to request or demand exclusivity rights to ensure its business does not have immediate competition close to its business and give it’s business the best chance to succeed.

Is your Triple-Net (NNN) lease expenses capped?

A triple-net lease was discussed in my previous article. The triple-net portion of a lease is the additional rent owed to the landlord. Often times, these provisions will be open-ended and do not define the true cost of a lease to the Tenant. A good lease includes an estimate of the triple-net costs and an allowed cap on the triple-net expenses in the event the estimate is off. Regardless of which party we represent in a lease review, we stress the importance of defining the additional rent owed as specific as possible and the inclusion of a cap of what the expenses can be. The cap on the triple-net portion/additional rent is helpful so the Landlord can predict its true revenue and the Tenant can predict its true cost to operate its business.

A lease agreement is often very long and important considerations are frequently overlooked. A lease review allows us to make our client is aware of the full amount they will be receiving each month or are liable to pay each month, the amount is fair and not unilaterally controlled by either party, or the terms are consistent with what has been negotiated between the parties. This article will continue to be periodically updated to include additional considerations. If you have any questions or have a commercial lease agreement that you would like us to review, please contact our Business Transaction team at Patel Law Group.

Krishan Patel