Understanding and Navigating the Commercial Lease Negotiation Process
Prior to getting into details about what I look for when reviewing a commercial lease agreement, I would like to take moment to describe how the commercial lease negotiation process works. I believe a better understanding of the lease negotiation process will empower the parties to effectively negotiate the terms of the lease agreement. Negotiating a commercial lease usually involves a preliminary phase where parties discuss and sign an “offer to lease” followed by a “lease agreement”. However, this process can vary. Sometimes the offer to lease is skipped, and there may be additional stages like negotiating a non-binding “letter of intent” or “term sheet”. The steps to a typical lease negotiation are often as follows:
Engagement of a real estate agent (optional) – Most businesses looking for commercial lease space will engage the services of a real estate agent who guides them through the commercial lease negotiation process and helps them find a suitable property. Although engaging the services of a real estate agent is not mandatory, having an experienced real estate agent can be highly beneficial. A knowledgeable real estate agent has a firm grasp of the market and can assist with identifying suitable properties that meet your requirements. They also provide support during negotiations and help alleviate the stress associated with the leasing process for you. Personally, and despite being a commercial lawyer, I would not lease commercial space without the assistance of a real estate agent unless I was highly familiar with both the property and the landlord.
Preliminary Discussions and Letters of Intent (LOI) (optional): Prior to discussing letters of intent, I want to clarify that while LOIs are similar to offers to lease, they are not exactly the same. LOIs are typically not binding, whereas offers to lease are meant to be binding. Before starting lease negotiations, the parties usually have preliminary discussions to establish the basic terms of the lease agreement. Sometimes a letter of intent is exchanged between the parties setting out the key provisions agreed to between the landlord and the tenant. The purpose of a letter of intent is to demonstrate serious intent by the tenant, outline preliminary terms which allows for efficient negotiations down the line. My experience is that LOIs are usually used in larger commercial leases, and they are generally non-binding with the exception of the clauses related to confidentiality and exclusivity included within them. Most commercial lease negotiations do not include LOIs, instead relying on the offer to lease to layout the basic terms of the lease agreement.
Preparation of the offer to lease – An offer to lease is generally prepared by the landlord or his or her representative and it works as a written proposal outlining the primary terms under which the tenant is willing to lease to the tenant. An offer to lease is a binding agreement between the landlord and the future tenant. Some of the terms set out in an offer to lease are set out below:
- Identification of the parties;
- The lease term and renewal options, if any;
- Identification of the premises;
- Rent payment, frequency of payment and type of lease;
- Responsibility for repairs and maintenance;
- Details about the security deposit to be paid by the tenant;
- Assignment and subletting rights, if any;
- Indemnities or personal guarantees required;
- And other terms as required by the parties.
I highly recommend that you engage an experienced business lawyer to review the offer to lease prior to signing it. Many tenants might overlook the importance of the offer to lease, perceiving it as a simple and straightforward document, and may sign it without fully understanding its implications. An experienced lawyer will identify not only the terms and conditions stipulated but also any potential gaps or omissions that could pose risks to the tenant.
Negotiation and Signing of the Final Lease Agreement – Once both parties agree on the terms in the offer to lease, they often move to draft and execute the lease agreement. This formal lease agreement will delve deeper into the terms and conditions of the rental arrangement and will supersede the offer to lease. In the last section of this article, you will find more information about what I look for as a commercial lawyer when I review commercial leases.
What we Look for when Reviewing a Commercial Lease Agreement
Parties Involved: While this may sound common sense, the lawyer confirms that the correct parties have entered into the lease agreement. A common mistake we see on commercial leases is that the lease is prepared to have the director of the tenant corporation as the tenant. This is usually not correct or the intention of the parties. It is the corporation who should be tenant and if a personal indemnity (otherwise known as a personal guarantee) is required from the director(s), that should be done separately by way of an indemnity agreement made as a schedule to the lease agreement or by making the director a party to the lease agreement as a personal guarantor.
Term and Renewal: We review the lease to confirm that the specified lease term is correct, and that any agreed-upon renewal terms are properly documented. Ideally, we advocate for a clause that mandates the parties to negotiate the financial terms of the renewal based on the fair market value of similar properties at that time. Most commercial leases incorporate a provision stating that if the landlord and tenant are unable to reach an agreement on the fair market value of the lease during the renewal period, the dispute will be resolved through arbitration.
Rent and Additional Costs: We calculate the base rent, additional rent, and Harmonized Sales Tax (HST), as applicable, to confirm that the correct figures are incorporated into the lease agreement. We review these details with the tenant, as the tenant is better familiar with the expected lease costs, and we scrutinize the lease to uncover any hidden costs that could potentially inflate the monthly payments of rent and additional rent.
Permitted Use: This term defines the acceptable purposes for which the leased premises can be utilized and outlines any limitations. In our review of the lease, we verify that the stipulated permitted use aligns with the tenant’s anticipations. For instance, if the tenant operates a restaurant with plans to offer live entertainment, we ensure that the permitted use of the commercial space explicitly permits both the sale of food and beverages, as well as the provision of live entertainment for patrons.
Maintenance and Repairs: We examine the lease terms to clarify the division of responsibilities concerning repairs and the specifics of what those repairs encompass. This information is then thoroughly communicated to the tenant, as it is crucial for them to be aware of their potential future liabilities. Inadequate understanding of these responsibilities may lead to unexpected and undesirable surprises for the tenant down the road. Unless otherwise negotiated by the parties, the tenant is typically responsible for all repairs except structural ones related to the foundation, walls, and ceilings.
Assignment and Subletting: This is one of the most important negotiation points in a commercial lease. We review the lease to determine whether the tenant can assign the lease or sublet the space, and under what conditions. We want to ensure that the tenant has the right to sublet or assign the premises with the landlord ‘s consent which consent shall not be on reasonably withheld. This is very important as failure to include such a clause may lead to the tenant’s inability to sell the business later. Overly cumbersome assignment or subletting clauses are dangerous can cost the tenant their business if they are not properly negotiated prior to execution of the lease agreement.
Insurance and Liability: We review insurance requirements included in the lease for both parties. We bring insurance and liability provisions included within the commercial lease to the tenant’s attention and ask that the tenant copy and paste the insurance provisions of the lease to their insurance broker. This is to ensure that the insurance broker is able to fully comply with the insurance provisions of the commercial lease by providing a comprehensive insurance policy.
Other important matters:
- It is our standard procedure to compare the finalized lease agreement with the initial offer to lease or letter of intent. This comparison ensures that the content and terms outlined in the preliminary agreements are accurately reflected in the final lease document, safeguarding the interests of both the tenant and landlord.
- Our review process includes a thorough examination of the rules and supplementary schedules attached to the lease. This step is crucial in identifying any uncommon or potentially unfavorable terms or conditions that could impact the tenant or landlord.
- We diligently search for any demolition or termination clauses that could pose a burden on the tenant. For instance, clauses that grant the landlord the right to terminate the tenancy with a specific notice period, such as three months, are carefully scrutinized to assess their implications on the tenant’s business. Many tenants to do not wish to invest hundreds of thousands of dollars into a business if the landlord has the ability to require them to vacate the premises in case he wishes to demolish and rebuild the premises. Some landlords have the negotiating power to include demolition and termination clauses within their lease because they own real estate in prime locations. Deciding whether to enter into a lease agreement that has a termination or demolition clause is a business decision that requires careful consideration by the tenant. Our job as lawyers is to ensure that the tenant has all necessary information in this regard to make an informed decision.
- Our review process encompasses a search for other unusual or non-standard clauses embedded within the final lease. These could include clauses that are not commonly found in commercial lease agreements but have been included to address specific concerns or requirements of the parties involved.
- Lastly, we ensure to identify any normal or customary clauses or essential information that may have been omitted from the commercial lease. The absence of such standard clauses could potentially lead to misunderstandings or disputes between the tenant and landlord in the future.
In conclusion, prospective tenants and landlords must approach negotiations with a thorough understanding of their business needs armed with research on local market conditions and legal requirements. Landlords and tenants alike must strive for a balanced agreement that serves the long-term interests of both parties. By engaging in informed and thoughtful negotiation, parties can lay a strong foundation for a successful and enduring business relationship.
This article is intended solely for general informational purposes and does not constitute legal advice. The information provided here is not a substitute for professional legal counsel. Importation and trade regulations, as well as legal requirements, can be complex and subject to change. It is strongly recommended that individuals and businesses seeking specific guidance on legal matters related to importing goods into Canada consult with an experienced lawyer or qualified legal professional. Only through personalized consultation can one receive advice tailored to their unique circumstances and ensure compliance with the latest legal regulations and requirements.
About the Author:
Shahriar Jahanshahi is the founder and principal lawyer at Jahanshahi Law Firm with a practice focus on representing business star-ups and investors in the province of Ontario. For further information about Shahriar Jahanshahi, click here.