By Robert Koury
As businesses grow, from home- or garage-based to their first leased space, tenants often rush to sign the landlord’s lease with little to no review or thought as to the provisions in the lease. Often, a tenant is presented with a “pre-printed” form lease and assumes that a form lease must be even-handed and therefore acceptable to sign without further consideration. While not intended to be a comprehensive list of issues that should be considered when signing such a lease, this article will highlight many of the hidden issues in pre-printed lease forms that tenants need to think about.
Assignment and Subletting. Many leases treat transfers of equity (change in control or ownership interests of the tenant), or transfers of a material portion of tenant assets, as an “assignment” for lease purposes requiring that the tenant obtain the landlord’s consent to any proposed transfer (usually along with a fee to the landlord). Tenants, especially as they grow and add new partners, often assign an interest in the lease without realizing that the landlord’s consent was required. Beyond the issues that can arise with seeking the landlord’s consent, an “assignment” (including “assignments” by change of control) can often trigger a right by the landlord to recapture the leased space, which often prompts renegotiation of the lease. In addition to the economic impacts, seeking the landlord’s “prior” written consent to any change in the tenant’s equity structure is often an unwanted procedural step. Given the growth strategies of many early stage companies, the provisions regarding equity transfers and assignments need to be given special consideration and attention during negotiations.
Options. Options to terminate, expand, and renew leases are key considerations requiring careful analysis of the tenant’s long-term requirements during negotiation of the letter of intent and lease. Tenants often desire the option to renew their lease as a means of maintaining control over their space for a longer period of time than the original lease term (especially in a retail lease). Furthermore, expansion rights can be critical for growth in numbers. Termination rights are equally important for a number of reasons. In this scenario, unexpired portions of leases can impede the completion of a merger or acquisition. Pre-printed leases typically do not include these options. If a tenant wants any of these options, they must be negotiated prior to lease execution.
Default. Of particular concern to a startup company are provisions in leases requiring continuous occupancy, and those prohibiting insolvency of the tenant. During the life cycle of a startup, there may be times when temporary (or permanent) vacation of leased space is prudent. Vacating may constitute a technical default, which will often create a legal impediment to what may otherwise be a sound business decision. Furthermore, as part of the financial growth of a startup, a tenant may be technically “insolvent” under many of the definitions set forth in the lease agreement. In any event, give due consideration to this language in a lease and do not simply assume that because it is part of a standard form, it is acceptable.
Expiration and Surrender Obligations. Two issues of concern with expiration and surrender obligations in leases are the condition of the premises and the holdover provisions. Many leases require the tenant to return the premises in the “same condition” it was received. In some cases, this may mean the tenant could be obligated to remove tenant improvements installed at, or prior to, lease commencement–often at a substantial cost. Furthermore, the tenant needs to understand the ramifications of remaining in the space after expiration of the lease term, often called a “holdover.” If a tenant is moving into a new space, the timing of the buildout of that space and expiration of the term in the old space is difficult to coordinate. During a holdover under many leases, a tenant’s rent often doubles, and a tenant may become responsible for consequential damages to the landlord on account of the holdover (i.e., the loss of a new lease with a new tenant taking the old space).
Lien Waivers. When negotiating a lease, it is important to know the type of security (collateral) the tenant’s lender may require for equipment, working capital, or other financing needs. For example, SBA lenders, whose loans are secured by personal property, typically want a landlord to waive statutory (possessory) lien rights and afford them (the tenant’s lender) a reasonable opportunity to either cure any lease default or enter the premises and take possession of the collateral. These issues are best addressed in advance of lease execution. Once a lease is signed, the tenant looses most of its leverage to have a landlord grant a tenant’s lender any rights.
Given the importance of a lease in satisfying a growing company’s needs, it is advisable to become well informed about leasing issues before it is too late. It is never too early to ensure that the lease adequately suits the tenant’s current and future requirements. As with any transaction, it is recommended that you consult with your broker or legal representative about issues that are important to your specific situation.