Five Ways for Commercial Landlords to Protect Themselves in Commercial Real Estate Leases
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Outside of Florida’s codified landlord/tenant laws, there are several ways a landlord can protect itself when involved in a commercial real estate lease. This blog post highlights some of the ways that commercial landlords may protect their personal and financial interests in commercial real estate leases.
1. Vet credit from tenant and guarantor at inception and then obtain your security
A landlord should always run a credit check to ensure the financial status of the entity and the individual prospective tenant. The credit check may reveal the tenant’s prior rental history and other obligations. Moreover, if a landlord is using a guaranty for the lease, a landlord should also be concerned about the guarantor’s credit as well. Aside from credit and trade references, a landlord should obtain known asset information and financial statements from the tenant and guarantor.
Most commercial landlords want security deposits. The amount of the deposit depends on the nature and scope of the particular lease and tenant’s business. One to two months is standard, but that will depend on market-based variables. Issues such as interest accrual and conditions triggering return of deposit should be negotiated on the front end to avoid litigation later.
Personal guaranties are the strongest collection tool a landlord has against a commercial tenant. Guaranties should be continuing in nature in order to avoid limitations on assignments or other transfers. Zero Food Storage v. Udell, 163 So. 2d 303 (Fla. 3rd DCA 1964). Crafting the language of a guaranty to comply with Florida law and ensure that the obligation is ongoing in nature is of the upmost importance.
Letter of credit
Another route to take to ensure credit of the potential tenant is to secure a letter of credit provided by a bank on account of the tenant. This letter of credit serves as a solid backup if the tenant finds itself in a cash flow bind. If a landlord is provided with a letter of credit, the landlord should keep in mind that the letter of credit should be irrevocable and transferrable, contain automatic renewal every year, and the landlord should be expressly stated as the beneficiary. Also, the landlord should be aware of the bank’s reliability and reputation in order to ensure the letter of credit is dependable. Absolute letters of credit are preferable to contingent letters of credit from the landlord’s perspective.
Landlords should also review the tenant’s business plan. Reviewing the tenant’s business plan is essential for the decision to enter into a long-term commercial real estate lease. If the tenant’s business plan is not well drawn out or is unconvincing, a landlord will want to think strongly before committing to a long-term lease. A business that is not going to succeed is a potential future problem between landlord and tenant. A review of the business plan will also reveal whether the location and space of the lease is suitable for the tenant’s business necessities. Moreover, it will review whether the tenant’s proposed occupancy is commensurate with any restrictions in other leases (for example, a restriction that Restaurant XYZ is the only tenant in the complex that is permitted to serve alcohol).
2. Identify specific uses and make sure tenant is not in competition with other tenants
Prudent landlords lease to tenants whose businesses are good matches for the space. Prudent landlords also ensure through lease language that the tenant cannot change their lease usage to something undesirable or otherwise prohibited by law, including zoning and land use regulations. Lease space use should be set forth expressly within the lease in detail to avoid future problems. For example, a tenant may start out with the desire to open a call center and then years later decide they would rather open a Mexican restaurant. Problems can arise with this example if the purposes for the leased premises are not specified. One problem can be that the zoning and land regulations may not allow for a restaurant. Another problem may be that a different tenant may have a restaurant which would create a conflict between two tenants. Discovering what the business does in detail during review of the tenant’s business plan is important if a landlord owns and operates adjacent properties or a multi-tenant property. Adjacent properties may not be affected as much as multi-tenant properties if the business proposition is similar or somewhat competitive. However, multi-tenant properties will be adversely affected if any tenant is in competition with another to make a profit. No tenant wants to voluntarily compete for business where its business is located. Assuring that each tenant’s purposes are different will increase stability and make tenants feel more comfortable leasing from a landlord.
If the landlord agrees to provide a representation that the uses are permitted, then the parties must still allocate the risk that a subsequent change in the zoning code or other applicable law adversely affects the tenant’s continued ability to conduct its business. While landlords should be flexible enough to consider zoning or other use changes that are associated with the property, use permits and licensure are not risks that landlords should readily take without informed consideration. The landlord must understand the relationship between the permitted uses clause and exclusive use provisions contained in other leases. Each lease that the landlord enters should prohibit any uses that would violate one or more existing exclusives granted to other tenants. Landlords generally use one of two approaches: (1) include a provision which states the restriction in general terms (that is, “tenant shall not engage in any use that violates any existing exclusive granted to an existing tenant at shopping center”); or (2) include a provision with an attached exhibit that sets forth the exact text of each exclusive granted to other tenants. ln addition to provisions intended to harmonize permitted uses with exclusive uses, the landlord will want to ensure that the tenant is not permitted to engage in any activity that will diminish the value of any other premises.
3. Plan the divorce when you are planning the marriage
The lease should set forth the condition in which the premises are to be vacated. The tenant must make sure that ordinary wear and tear damage by casualty are properly excepted from tenant’s obligation. The tenant and landlord should address what alterations and improvements must be removed by the tenant at the end of the term. A lease can be terminated for a variety of reasons, including:
- Expiration of term.
- Breach for monetary or non-monetary default.
- A surrender is judged by the intentions of the parties. If the landlord accepts a surrender of the premises, the landlord may waive its rights to seek any damages beyond the date of the surrender, unless it specifically reserves its rights under the lease. Landlords may want to include a provision in the lease that states that upon a surrender landlord does not waive any rights it may have under the lease for additional damages beyond the day of the surrender.
- The dissolution of a corporation does not terminate the lease unless specifically stated in the lease. Under Florida law, when a corporation dissolves the officers become personally liable for the corporation’s debts.
Landlords should be strict on the window for providing notice and curing a default and specific as to how days are calculated. The parties to a commercial lease can waive the three-day notice requirement pursuant to Florida Statute §83.20 so long as the waiver is unambiguously stated in the lease. See A.Z.3. Inc. v. Tampa Westshore Associates Ltd. P’ship, 869 So. 2d 42 (Fla. 2d DCA 2004).
A landlord generally has three options under Florida law when the tenant fails to pay rent.
- Option 1 is to treat lease as terminated and resume possession and collect past-due rents.
- Option 2 is to do nothing and sue as each installment of rent comes due or wait and sue when the entire amount is due.
- Option 3 is to retake possession for the account of the tenant, holding the tenant liable for the difference between the rent required by the lease and the amount the landlord recovers from re-letting. If the third option is chosen any rents received by the lessor from re-letting must be deducted from the balance of the rent due under the lease.
Landlords may also want to include the right to deduct leasing commissions, tenant improvement costs, and management fees in the event of a default. All landlords should be aware of the ongoing obligation to mitigate damages in the event of default. Leases should have prevailing party’s attorney’s fees provisions in them, as well as provisions setting forth a favorable venue and jurisdiction to the landlord.
4. Verify adequate insurance coverage
Confirming adequate tenant insurance is essential to minimize landlord liability. All contract liabilities should be contained within the lease, including indemnifications for liability of third parties. If a tenant is self-insured, that information should be expressly listed within the lease and considered in the credit underwriting. A landlord will want to make sure the tenant’s insurance carrier will cover any potential catastrophes that may occur.
Commercial general liability insurance (“CGL”) affords the insured landlord coverage against third-party claims. CGL also affords protection for contractual liability coverage, which extends coverage to losses for injury to property or person assumed in a contract by the insured, such as a lease agreement. Generally, only the named insured and those named as additional insured are afforded protection in a CGL policy. However, an additional insured is not protected for its own negligence. In other words, if the named insured is not liable the CGL carrier will not be responsible for the defense of the additional insured. Thus, it is important to understand the different coverage afforded the named insured versus an additional insured. Landlords will also want to write in a provision in the lease which subject the tenants to increases in insurance premiums that are directly related in tenant usage.
Landlords should have their risk management or insurance personnel review all tenant policies to ensure intended uses of the property are adequately covered by the tenant’s CGL. Landlord and tenant should release each other from claims relating to property damage that are (or are required to be) insured under the lease. In other words, the parties should look to their respective property insurer for damages caused by the other before looking to the assets of the party causing the damage. Since a property insurer is subrogated to possible claims of the damaged parry, the parties should insure that the relevant property insurance policies recognize the mutual waivers of subrogation. If they do not, each party should require the other to have its insurer waive its right of subrogation. An example of this clause is:
Notwithstanding anything stated in this Lease to the contrary, Landlord and Tenant, for themselves and for their respective insurers, do hereby mutually release each other from any and all claims, demands, actions and causes of action that each may have or claim to have against the other (including, but not in limitation of the foregoing, all rights of subrogation accruing to any insurers of the parties) for loss of or damage to the property of the other, whether real or personal, caused by or resulting from any casualty of the type covered by fire or extended coverage insurance, based on coverage for 100% replacement cost, without regard for whether such insurance is then in effect, and notwithstanding that any such loss or damage may be due to or result from the negligence of either of the parties or their respective officers, employees, or agents. Landlord and Tenant will each secure the inclusion in or an endorsement on any fire and extended coverage insurance policy insuring their respective property (whether real or personal) provisions by which a waiver of such subrogation is effected or authorized to be effected by the insured; provided, however, that a failure by either party to secure such inclusion or endorsement as aforesaid shall not in any manner affect the provisions of the above mutual release.
The lease should also have indemnity and exculpation clauses. The basic purpose of the indemnity provision is to allocate responsibility for defending claims between the landlord and tenant’s respective liability carriers. The goal is to allocate that responsibility in the most efficient manner so as to avoid a fight between the carriers as to who is responsible for the defense. Allocation of responsibility is generally made based on geography with the tenant being responsible for matters arising within the premises and landlord being responsible for matters arising within the common areas. Indemnity provisions should expressly survive the termination or expiration of the lease.
5. Maintain control of tenant’s right to transfer and incorporate annual rent adjustment
Maintaining control of the tenant’s right to transfer is key to ensuring that any potential transfer will conform to all provisions and requirements of the previous tenant’s lease. Keeping control reserves the right for a landlord to choose whether the potential transfer is a fit for the long-term lease relationship between landlord and tenant. If the lease expressly states that landlord consent is required for a tenant to transfer, odds are the landlord will maintain control of any transferring tenants.
In a long-term lease, a landlord should consider the timing aspect of the relationship. Starting a monthly or annual payment at one price could variably affect the landlord if the price does not change with the market. Incorporating an annual adjustment of rent provision in the lease according to an agreed upon benchmark can provide clarity and predictability to both parties and ensure that rents are consistent with market prices.
By no means is the above list an exhaustive list to avoid liabilities or problems within a commercial real estate lease. However, as a landlord, it is important to think about the above five ways as a step in the right direction to securing financial or personal interests within the landlord/tenant relationship. For lack of a better phrase, a landlord must dot the I’s and cross the T’s to ensure the long-term commercial real estate lease is drafted carefully and strategically for its own protection. Commercial landlords are encouraged to seek competent counsel to negotiate, draft, or revise complex commercial leases.