COMMERCIAL LEASE TERM SHEETS IN TODAY'S SOFT MARKET

NYC TENANTS CAN ASK FOR MORE PROTECTIONS​

By: Robert C. Epstein, Esq.

In the current “soft” leasing market, tenants can expect to obtain more lease concessions than was typical during the pre-pandemic years. Most of these items are important enough that they should be addressed by the tenant in the lease proposal -- the so-called “term sheet” -- instead of waiting until the tenant receives the draft of the lease to discuss them. Once that document is issued and attorneys get involved, substantial costs will be incurred and that means the tenant will lose negotiating leverage since they will be less inclined to “walk.” Since only brokers are usually involved at the term sheet stage, it is less costly to decide to move on to another deal if the landlord refuses to compromise.​

The typical term sheet covers such key elements as: length of term; commencement of term; rent; free rent; security; delivery condition, including the work required to improve the premises for the tenant and the construction allowance to be provided to the tenant by the landlord; the permitted use of the premises; operating expense and property-tax payments; the landlord’s right to approve subleases and assignments (and transactions excluded from approval, like mergers and “desk licenses”), and profit sharing; along with rights to renew and expand. What follows is just a sampling of some additional items a tenant may want to include given the current environment.

1. Security Type and Amount: We often see term sheets provide that the security deposit is “to be determined.” That was fine when the market was strong, because tenants just wanted to get a lease sent to them so they would not lose their space to another tenant while the landlord was reviewing its financial statements. The amount of the security deposit is obviously a very important item to all concerned. Therefore, in today’s market, before a tenant begins to spend money on an attorney’s review of its proposed lease, it should require that the security for the lease be determined. This would include the amount and whether there will be a “burn down,” over time, and whether interest will accrue in the tenant’s favor. Further, if the tenant is not a public entity, the term sheet should also specify whether a guarantee, limited guarantee, or so-called “good guy guarantee,” will be required from the principals. If a limited guarantee is required, the amount of the cap, the obligations being guaranteed, and the term, should be specified (to the extent applicable). If a good guy guarantee is required, the notice period before the surrender of the premises is permitted and the obligations being guaranteed should be specified. If the landlord requires a letter of credit, instead of cash, that should also be specified.

2. Work Deadlines: Leases almost always contain language providing that the landlord will have no liability, and the tenant will have no right to terminate, if the premises are not delivered in the lease-specified condition by the commencement date. Landlords typically argue that there is no need for a delivery deadline since they are already motivated to get their work completed and the tenant into the space as soon as possible because the rent is triggered when the completed space is delivered to the tenant. Nonetheless, if a tenant needs to be in its new premises by a date certain, it should insist that the term sheet include deadlines and daily penalties (and termination rights) if such deadlines are missed.

3. Extra Pass-Throughs: Many leases provide for the passing through of costs which are not anticipated by tenants. That includes those over and above property tax and operating expense escalations, such as water and sprinkler charges, steam payments, common area electricity charges, capital costs incurred by the landlord due to future new laws, review and work supervision charges, and Local Law 97 emissions payments. It would be advisable to add language to the term sheet prohibiting or limiting those charges. If the landlord refuses to include such language, at least the tenant will know, in advance, of the presence of those costs and can attempt to negotiate them before proceeding with the transaction.

4. Nondisturbance Agreement: If a tenant anticipates investing a substantial sum into the improvement of its premises, or has negotiated a rent that it believes will be far below market as the term of the lease progresses, or if the tenant is concerned about the ability of its prospective landlord to make its loan payments or refinance its existing loan, it would then be advisable to require that the landlord’s lender provide a “nondisturbance agreement.” Since the lease will contain language subordinating it to the mortgage securing the loan, the lender will have the right to terminate or renegotiate the lease if it forecloses the mortgage. While a nondisturbance agreement prevents that outcome, it may need to be negotiated since, among other potential problems for a tenant, they typically provide that the lender is not responsible for completing the landlord’s improvement of the premises or funding the balance of the allowance that the landlord had promised the tenant for improvements. Therefore, the term sheet should require not only that the landlord provide a nondisturbance agreement but that it is in a form reasonably satisfactory to the tenant, or that it conforms to an exhibit attached to the term sheet.

5. Air Conditioning: Air conditioning is a service that is essential to the comfort of tenants. If the building provides central air conditioning, the tenant may want the term sheet to include the hours and days that air conditioning will be provided, especially if the tenant intends to use the office beyond “normal” business hours, and require that the landlord attach temperature specifications to the lease to ensure that the premises will be maintained at those temperatures. If the air conditioning is provided via units serving only the premises, the term sheet should indicate that the landlord will pay for the repair and replacement of those units. Tenants should not be exposed to the potentially sizable cost of replacing an expensive air conditioning system when the tenant will only be in occupancy for a finite period of time.

6. Recapture: If the tenant wishes to assign its lease, or sublease the premises, the landlord may require the tenant to instead sublease or assign the premises to the lessor. These rights are known as “recapture rights,” and if the term sheet requires the sharing of profits from a sublease or assignment, that type of recapture allows the landlord to keep all the profits even though the tenant remains on the hook for all obligations. Therefore, it would be advisable to anticipate this and for the term sheet to provide that the landlord may exercise its recapture right only by terminating the lease with respect to the portion of the premises to be sublet, or terminating the entire lease in the event of a proposed assignment. Further, the recapture right should not apply to an assignment of the lease in connection with a sale of the tenant’s business or a sublease or assignment to an affiliate of the tenant.

7. Clawbacks: Most agreements provide that if the lease is terminated due to a default by the tenant, the tenant must reimburse the landlord for the free rent, while some provide that the tenant must also reimburse the landlord for the cost of the landlord’s work or the amount of any construction allowance the landlord provided as well as any commissions the landlord had to pay in connection with the lease. The term sheet should provide that the lease will not include any such clawback language or, at most, that only the unamortized portion of such sums will be reimbursed.

8. Termination Right: In today’s soft market, Tenants should consider including termination rights in their term sheets. Those rights should include notice deadlines and the amount of any termination payment. A termination right reduces the risk that a tenant will be subject to exposure for the payment of the rent for the balance of the lease term should its business fail or should there be reasons the tenant may need to relocate.

9. Relocation and Demolition Clauses: Leases often contain provisions permitting landlords to move tenants to other space in the building or to terminate the lease if ownership decides to demolish, substantially renovate. or change the building’s use. (This kind of provision, typically called a “demolition clause,” is primarily found in leases in older, so-called “Class B” buildings since such structures are candidates for redevelopment.) In this current market environment, tenants should try to include in their term sheets prohibitions against the inclusion of such relocation and demolition clauses in their leases. If the landlord refuses to exclude such language, the tenant will know (before wasting too much time on negotiating a lease) that it may want to find a different building if it does not want to be subject to such a possibility.

10. Abatement Provision: Most leases require the tenant to pay its rent no matter what eventuality or possibility occurs, including if the premises cannot be occupied due to the landlord’s failure to provide any essential services required by the lease. Typically, the tenant is only permitted to enforce its rights by suing the landlord for damages. The only exception to this is if the premises are damaged by a casualty. In this market, some landlords are willing to add language to their leases providing for rent abatement if the tenant is unable to occupy its premises for a specified number of consecutive days due to the landlord’s failure to provide an essential service required by the parties’ agreement, such as water, electricity or elevator services. It would be advisable for tenants to ask for such abatement in their term sheet. Further, tenants who are concerned that there could be a future shutdown of buildings due to another round of COVID-19 virus or a different pandemic may want to consider adding to the term sheet that their rent will be abated if they are unable to access their space because of any government restrictions.

11. Prevailing Party Legal Fees: Most leases obligate tenants to pay the landlord’s legal fees and costs if the landlord is required to enforce the lease. The landlord should have a reciprocal obligation should the tenant need to commence litigation. Since landlords often have deeper pockets than tenants, without such protection a landlord may decide to violate the lease because the tenant is unwilling or unable to hire counsel to safeguard its rights. Therefore, tenants should consider adding language requiring that the prevailing party be reimbursed its reasonable legal fees and costs in the event of a dispute.

This is just a generic list of issues a tenant may wish to add to its term sheet before incurring the time and cost of proceeding with lease negotiations. Based on a party's needs and priorities, there may certainly be other matters one may wish to address. But unlike in years past, tenants should not be fearful that adding them to a term sheet will result in the landlord’s withdrawal of a lease proposal.