Commercial Real Estate

Commercial Leasing; Tenant's, Operating Expenses & The Simple NNN Lease.

     During my day to day, I draft and negotiate my fair share of commercial lease agreements.  They range from office leases, to retail leases and industrial leases but in almost every case, especially with new clients leasing their first space, the conversation begins the same; they say "I am going to send you a simple lease that my Landlord drew up, take a quick look and let me know it all looks good"; and I respond, "Send me the lease and I'll take a look."

     Most real estate lawyers are familiar with this elusive document, the simple lease, so often described by clients eager get their business up and running and turning a profit.  Unfortunately, Landlord leases are typically one sided at best and the clauses invariably tilt to the Landlord's advantage.  

     One example of a lease clause that can be surprisingly expensive for tenants is the clause governing operating expenses.  Most tenants understand the difference between a triple net lease and a gross lease; the former is structured so that in addition to base rent, tenants are responsible for a share of operating expenses (the landlord's real estate taxes, insurance and costs to operate the building in which the premises are located) and the latter is structured so that tenants pay a single rental payment that includes everything.  In the commercial setting, triple net lease forms are very common and tenants often sign these leases without legal review and counseling.  Operating expense provisions seem simple - the tenant pays its share of the operating costs, but, oftentimes the lease language is overly generous with what may be included in the operating costs.  An example of expenses that should be excluded or at least carefully limited are capital expenses.  Furthermore, its ordinary for tenants to ask for a cap on annual operating cost increases so they can budget for the worst case scenario during each lease year.  If there is no cap on operating expenses then they can expand and increase without limit and Landlords have little motivation to keep their costs down when they can be passed through to tenants without question.  Another important concept when it comes to operating expenses is language providing the tenant a right to audit the Landlord's books.  A good audit provision should provide that if the audit reveals overcharges exceeding a certain percentage, the Landlord will be responsible for paying the audit costs. A skilled real estate attorney understands which expense categories are inappropriate to pass through their clients and can help their clients limit ballooning expenses and excess expense pass throughs.

     The key to providing useful legal counsel to tenants in commercial lease negotiations involves picking one's battles.  A typical commercial lease agreement contains upwards of 50 clauses and its possible to negotiate each one, however sending proposed revisions to all or nearly all of the lease clauses is sure to cause delays (which neither side wants) and sometimes, it can blow a deal.  Evaluating which clauses will be most important to a client begins with understanding the nature of their business very well and then focusing on the clauses that relate to their business and those which may cost them additional money above and beyond rental payments.  The expense clauses in triple net leases certainly qualify there!  

     Before signing that next "simple lease" have an attorney take a look and help you try to balance the important terms.  Its very difficult to help a tenant after they've signed the document!

Restaurant Leases; Exclusive Use Clauses

Photo by fazon1/iStock / Getty Images
Photo by fazon1/iStock / Getty Images

     Earlier in my legal career I worked with a large law firm representing a popular and rapidly expanding restaurant chain; those years afforded me a baptism by fire in the negotiation of restaurant leases.  It may be related to those early years fighting for the big chain tenant, or maybe its because I spend so much time enjoying and relaxing in restaurants around Denver, but, I've always enjoyed working on restaurant leases.  In the universe of lease agreements, they are almost always the most interesting.  Since I just finished one up, this seems like a great opportunity to kick off a series of blog posts focusing on restaurant leases and issues tenants need to know about, especially new owners and entrepreneurs without a lot of leasing experiences.

     The issue of exclusivity is often at the center of restaurant lease negotiations.  In shopping centers or other multi-tenant environments,  tenants should try to lock down assurances they will not face harmful competition from other tenants.  The easiest way to do that is to include an exclusive use clause in the lease.  Its best if the broker helping a tenant find a space sets the expectation that exclusivity is a part of the deal by including the concept in the letter of intent (LOI).  In most cases, landlords and tenants agree on a non-binding LOI laying out the basic terms of the deal before proceeding to draft and negotiate the lease document. So, what level of competition is actually "harmful?"  In shopping centers or other retail settings with multiple buildings, tenants should consider whether an exclusive within the building their space is located in is sufficient, or is an exclusive covering the entire retail center appropriate? Further, many retail centers are governed by CC&Rs or Declarations and in such cases, its important to confirm nothing in those documents limits the new tenant's plans for its space or grants another tenant an exclusive use pre-empting the tenant's planned use.  Restaurant tenants should also carefully consider the nature and scope of the exclusive rights they desire; does the tenant want to be the only restaurant in the building/center or, is it acceptable (or even better) for them to allow other restaurants users so long as they have exclusivity based on certain food types (for example, Mexican food) and/or operational type (for example, fast-casual versus a sit down, full service restaurant with table service)?  Does the tenant want to be the only fast casual restaurant in the building serving alcoholic beverages?  A properly drafted exclusivity clause is very specific and leaves no room for argument or interpretation.  With respect to restaurants and bars, different types of operators can often co-exist and feed off of one another (no pun intended!) quite nicely, so it might not necessarily behoove one to be the "only" restaurant in a particular setting.  While thinking about exclusivity clauses for restaurants in multi-tenant settings, one frequently overlooked point is signage on the exterior of the premises; depending on the situation, it may be important for tenants to lock down the exclusive right to display their signage on the exterior of the space. 

     Another important consideration for restaurant tenants negotiating exclusive use clauses is the practical effectiveness of these clauses.  Often tenants focus on obtaining the exclusivity language they need but neglect addressing how they'll actually enforce that language if the landlord disregards it, or if another tenant disregards it and assigns or sublets their space to a competing business.  In addition to the exclusivity clause, its a good idea for tenants to try to push for language discouraging landlords from ignoring the exclusivity restrictions and also requiring them to take action in the instance of renegade tenants.  There are several ways to do that, including expressly providing that a tenant may pursue equitable remedies such as an injunction or even granting the wronged tenant a substantial rental reduction or abatement during the period their exclusive use protection is compromised.  If unaddressed, a tenant may be left with no recourse except for an expensive lawsuit against a landlord who may have deep pockets.  A tenant's ability to obtain adequate exclusivity protection is often proportionate to their bargaining power with respect to the landlord (is the tenant a highly desirable addition to the center?) and other tenants, and is also related to how the desired protective language relates to the overall negotiation of the lease.

    Next time this series of posts will address building out restaurant lease spaces and common issues surrounding landlord and tenant construction obligations.  Until then, contract safely and remember, everything is negotiable.

 

Commercial Real Estate Finance - Helping Borrowers Herd Cats.

Looking over Confluence Park April 2016.  Copyright: David C. Uhlig 2016

Looking over Confluence Park April 2016.  Copyright: David C. Uhlig 2016

     The reasons property developers and owners borrow money are as varied as the types of loans and lenders available: acquisition; rehabilitation; and re-financing are common.  A veritable buffet of lenders is available to those in need of funding, including: all sizes of conventional banks; pension funds; insurance companies; hard-money lenders and private individuals, just to name a few.  Loan rates, terms and structures vary greatly depending on the nature of the project as well as a borrower's financial picture and can become creative and complex, very quickly.   By the time a borrower is presented with a loan application or commitment letter, they've often spent a good deal of time and energy working with brokers, shopping various lenders, analyzing and negotiating loan terms, and are ready to get their project rolling forward.  Invariably, numerous other issues and ticking timelines demand attention.  One memorable client and I used to joke that the entire process is like herding cats!  It is at this point, where limited time and an ever expanding task list tempts one to 'just sign and move on', where it behooves one to slow down and proceed cautiously.  Before putting pen to paper on loan applications, loan commitments and loan documents, and then closing and pulling down funds, there is more to think about.  To ensure a smooth project, its essential for borrowers to have an attorney they can rely on to help ensure their interests are properly represented and protected in the loan documents, while paying attention to the loan closing timeline and its relation to other timelines.  

Borrowers should have their attorney review the loan application and loan commitment before executing.

     Most lenders require borrowers to provide a legal opinion certifying the enforceability of the loan documents but experienced borrowers understand they need counsel for more than the borrower’s opinion letter.  Wise borrowers involve their attorney early in the process and have them review the loan application and commitment before executing them.  Sometimes, lenders provide an abbreviated loan commitment and a dense loan application containing material terms and providing for substantial fees up front, when the application is executed.  Therefore, early and as often as necessary, borrowers should have a detailed discussion with their attorney concerning their project and plans for the funds, their overall timing requirements, and any burning questions or issues they have about the loan process.  Only then is it possible for the borrower’s attorney to effectively review the loan application and subsequent loan commitment with an eye toward confirming that the loan reflects the deal the borrower expects.  When representing borrowers my initial approach is to follow the money.  The application and/or the commitment addresses the fees, costs and expenses that the borrower will pay to the lender, such as application fees.  While its important for a borrower to understand when these fees are due, its essential that the triggers for non-refundability of the fees make sense.  Fees shouldn’t become non-refundable before studies such as environmental analysis and appraisals are approved and other approvals and conditions to closing the loan are buttoned up.  Loan applications and commitments are often vague or inconsistent concerning refundability of fees but if the loan doesn't close because the lender is dissatisfied with the results of post application due diligence or due to issues beyond the borrower's control, the borrower should receive a refund of advance fees.  Clients are very grateful when I'm able to remedy such refundability issues before they sign the application or loan commitment and it makes me feel great to add value early on.

Borrowers can best serve their own interests, and avoid delays, by involving their attorney in the conversation around the loan transaction as early as possible.

     One of the primary tasks a borrower's attorney performs is reviewing loan documents and providing a borrower's opinion letter that is satisfactory to the lender and lender's counsel.  Often, with commercial projects or even a straight forward re-finance, there are business entity structuring or restructuring tasks that must be completed.  That is another example of how borrowers can best serve their own interests, and avoid delays, by involving their attorney in the conversation around the loan transaction as early as possible.  Sometimes reviewing the loan documents for a borrower is a straight forward exercise confirming the documents match the business terms in the loan commitment, are compliant with Colorado law and don't contain any unwarranted or overly burdensome terms.  However, since the actual loan documents are almost always prepared by the lender's counsel, I never assume that will be the case and want to get my eyes on the draft documents as early as possible.  Invariably, the documents need help; sometimes its a little and sometimes, a lot.  The amount of work required at this point is usually directly related to the complexity of the loan transaction and the sophistication of the lender and their attorney.  I never cease to be surprised at this phase; even in the smoothest of transactions, often, lender's counsel is busy and working on several transactions at once and the draft loan documents contain incorrect or inapplicable terms and provisions.  While rare, sometimes large and sophisticated national or global lenders, with out of state counsel, are unaware of Colorado's public trustee systems and require input and help with the deed of trust and other documents referring to the security documents.  To my frustration (and horror), I've seen banks insist on using loan documents clearly designed for residential transactions and then balk at necessary changes to them.  In the end, my point here is that while I always hope for loan document review and finalization to proceed smoothly, invariably there are issues, and sometimes they are numerous!

     With the borrower's loan opinion, at a minimum, most lenders require opinions confirming enforceability of their loan documents, proper organization of any borrower entities and due authority of borrower signatories.  Lenders usually provide a form of opinion they'd prefer borrower's counsel to execute.  When representing lenders, from time to time I've seen borrower's counsel execute the suggested form opinion after merely confirming the accuracy of the listed loan documents and making a few minor changes.  Again, I realize practitioners become very busy but in such instances I always feel badly for those borrowers!   As is the case with legal negotiations over other standardized transaction documents, loan opinion letters usually warrant some borrower side revisions that come as no surprise when properly requested. In loan opinion letters drafted by lender's counsel, those include assumptions, qualifications and exclusions.  Its on the borrower's counsel to draft such changes to the opinion letter and its true that borrower's counsel is the one most exposed by signing legal opinions without requesting, and where necessary, insisting on the appropriate changes, but, from the client's perspective, one has to wonder what else the attorney missed if they didn't appropriately limit the borrower's legal opinion!

When borrowing funds it behooves borrowers to adhere to the maxim, Caveat Emptor!

     To conclude, while all parties in a loan transaction are eager to close and on a certain level, so long as payments are timely met there may be no problems, when borrowing funds it behooves borrowers to adhere to the maxim:  Caveat Emptor!  Whether a borrower is a seasoned and sophisticated real estate developer or an eager entrepreneur learning the ropes as they go with a smaller project, borrowers trying to pull a project together are pulled in several directions at once and even the most able cat herder can benefit from an attorney who understands their overall goals and who is well versed in helping facilitate loan transactions.  Luckily, fee structures at Summit 6, based on statements of work, allow me to engage in preliminary conversations with clients as early and as often as they desire, off of the clock, so that both of us can get a handle on the overall picture, what needs to happen and how to get there most effectively.  When representing borrowers my goals are: to be sure they are covered legally to the greatest extent possible, to shoulder the burden of nuanced legal issues in the loan documents to the extent my client is comfortable with that, and always keeping the transaction moving steadily toward a timely closing. Giddy Up, Cat Herders!


Just a Simple Lease? Think Again.

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Downtown Denver Early A.M. photo by David C. Uhlig

AFTER LANDING A POSITION WITH A 17TH STREET LAW FIRM I SPENT THE NEXT 5 YEARS FOCUSSED ON LEASING

     In May of 2000, after graduating from law school, I packed all my possessions into a Ryder truck and headed west. I’d recently turned down a generous offer with a reputable firm in Texas because, well, it was in Texas, and instead I started sending resumes to every law firm in Denver with over five lawyers; none responded.  It was a risky move but I was 25, full of confidence, ready for adventure and excited to finally execute on a dream I’d had since I was a kid, moving to Colorado.  I grew up around the oil business and was mentored by a couple oil and gas lawyers, so while I would’ve taken just about any job offer, in my heart I wanted to be a deal lawyer more than anything, like those early mentors.  Long story short, after a couple weeks I landed a part time job in the legal department of a national hotel company where my first assignment as a new lawyer was to draft a display window lease for a hotel. I'd arrived!  A couple months and hundreds of cover letters later, I landed a position with a 17th street law firm and then spent the next five years, day in and day out, drafting and negotiating leases: cell tower leases, office leases, storage space leases, retail leases, airplane hangar leases, trans-loading facility leases, and leases for national restaurant chains.  I used to dream about leases.  Former colleagues of mine from certain firms that shall remain nameless, who may be reading this, are currently nodding their heads – or maybe shaking them!  That story is the long way of circling back to the title of this post.  There is a statement every real estate lawyer has heard, probably more often than he or she cares to admit; “Its just a simple lease, take a quick look and let me know its okay.” As often as I’ve received the request, I’ve yet to see a “simple” lease. They may have short terms of duration, be for small spaces or involve low rental rates and I’ve definitely seem them drafted on short forms (short in both length and in thought), but leases are contracts, and like any contract, lease provisions, or lack thereof, can have serious consequences for both landlords and tenants.  Any lease, whether for a display window or several thousand square feet of space, involves many issues.  Parties proceeding on their own, without competent counsel, do so to their detriment.   

EACH CLAUSE IN A LEASE HAS AN OPTIMAL POSITION FOR EITHER SIDE AND USUALLY SEVERAL FALL-BACK POSITIONS

     Whether you are a landlord or a tenant, the lease you are considering was likely drafted, at some point, by a lawyer. While very desirable tenants may control the form of lease initially presented, its been my experience that the initial lease is usually prepared by the landlord’s attorney.  Love us or hate us, an important thing to remember about attorneys is we have an ethical duty to vigorously advocate for our clients.  That means the lawyer drafting the initial version of the lease, if competent, drafted it to their client’s ultimate advantage and in their client’s favor. Every clause in a lease has an optimal position for either side and usually several fall - back positions.  Whether representing landlords or tenants, a competent leasing attorney always asks for certain things and will know the appropriate counter-proposals to changes proposed by the other side.  So, when one chooses to go it alone, without a real estate lawyer involved, or if they engage a lawyer without leasing experience, the attorney who prepared the lease notices. The drafting attorney often reminds the soloist that they do not represent them (we always should) and asks if they have an attorney.  If the answer is “no, its just a lease”, their eyes light up!  It’s the small pleasures in life after-all.

     A few examples of leasing issues to think about follow below; it’s the least I can do if you’ve suffered my reminiscence this far.  Commercial landlords usually require personal guaranties from smaller, “mom-n-pop” tenants and its not an uncommon request of sophisticated and proven tenants.  Tenants with enough clout may be able to get around that requirement.  Even a smaller tenant may be able to negotiate some burn off or other relief in the guaranty agreement.  There are many possibilities and while it never hurts to ask; from a negotiation standpoint, it can hurt not to ask.  What does the lease say about assignment?  If a lease silent is silent about assignment and/or subletting, then the tenant is free to assign or sublet at their discretion.  Landlords don’t like that much.  Conversely, there are usually circumstances when tenants should be able to assign or sublet the space, perhaps with just an advance notice to the landlord and a copy of the documents. The landlord’s counsel won’t be surprised by the request.  What state will the landlord deliver premises to the tenant in?  When?  Is there an outside date for delivery? A landlord’s form lease is sure to specify that rent will commence upon delivery of the Premises but it might not provide for a pre-delivery inspection, not to mention consequences to the landlord for failing to deliver on time.   Landlords typically prefer to prevent dark space.  Post occupancy, what if the tenant pays rent but doesn’t open for business or ceases operations in the premises?  What if the tenant doesn’t operate during the hours the landlord prefers?  Form leases typically describe the tenant’s maintenance obligations but often contain sparse, if any, details about the landlord’s obligations.  If the landlord fails to satisfy its obligations does the tenant have any recourse other than a lawsuit for breach of contract (an expensive and thus, impractical solution for many tenants)?  I could go on but suffice to say, for nearly each of the 35 to 55 clauses in a proper arms length commercial lease there are several negotiation points and changing one clause often requires conforming changes to other provisions in the lease.  If a commercial lease is on 1 to 3 pages, or only has clauses addressing term, rental amounts and identifying the parties, such a state of affairs, while it is certainly “sloppy” is far from “simple.”  Believe it or not, I see those from time to time and when they are already signed its always bad news for the client.  Fixing such leases, or getting out of them, if possible, invariably costs the client more than it would have to negotiate an appropriate document in the first place.   

     See, not so simple, right? You should feel sorry for your real estate attorney.  Real estate attorney training is grueling and by all accounts, is similar at most big law firms: i. partner hands new lawyer a lease document and informs them whether the client is the landlord or tenant, ii. new lawyer revises the lease and returns it to partner, iii. depending on partner’s mood, new lawyer is either mercilessly berated on each counter they missed, or walked through every point he or she missed with the stern admonishment, “don’t make me show you this again” before being handed a fresh lease to review, and iv. new lawyer stays up all night and is extra careful to catch all of those changes, only to be admonished for missing a whole new set of points.   Once you start catching all of the negotiation points, you are rewarded with more leases at once and shorter deadlines!   It goes on like that for a few years, until you are dreaming about leases between being awakened by the dinging crackberry on the nightstand; remember those?  Eventually, usually after the partner observes a dangerous glint in an associate’s eye, they’ll take the associate off lease patrol and give them something more complex and humbling. However, there is always leasing work, its part of a real estate practice.

A REAL ESTATE ATTORNEY CAN IDENTIFY THE PERTINENT ISSUES AND HELP YOU FOCUS ON THOSE

     If the other party hands you a “simple” lease to execute, whatever you do, don’t go it alone, even if your budget is limited.  It’s a better use of resources to make sure the lease you sign is properly balanced than to try to fix it after the fact.  Negotiating a lease doesn’t have to be a protracted process.  If nothing else, a seasoned real estate attorney should be able to identify which issues are most pertinent to you and your business and help you focus in on those.  Regardless of how simple the space may be, or how complex the negotiations prior to the lease, there are always issues to think about in the lease, even the “simple” ones.

Thanks for reading!

Dave