True Confessions of a Landlord’s Counsel: What a Commercial Tenant Needs to Know When Negotiat
Part III: The Letter of Intent.
A letter of intent (“LOI”) is generally considered a nonbinding acknowledgement between the parties that they have reached a tentative understanding of some the material business points that are to be contained in the lease, so that they feel comfortable enough to expend additional time and expense towards negotiating a definitive lease that will incorporate the terms acknowledged in the LOI, and other terms to be negotiated by the parties. Once the LOI is signed, the parties may then want to get their attorneys involved, and perhaps space planners, architects, engineers, and contractors to begin planning the build out of space as the lease is being negotiated.
When putting together the deal points for a LOI to lease space, the commercial tenant will typically know how much space it needs and, with the help of a good broker, will know how much rent it should pay for such space. Length of term, options to extend the term, and expansion rights within the building will depend on the tenant’s business plan. If the space is not a “turnkey” situation (i.e., the space is not set up for the tenant to move right in), then issues concerning tenant improvements will also need to be addressed in the LOI. Beyond that, and any other special needs a tenant may desire for its business (e.g., extra trash service, after hours lighting or HVAC, etc.), the tenant will typically not have any further deal points to address upfront in the LOI, but the landlord certainly will.
The landlord will want to include in the LOI a whole laundry list of items for which it will want the tenant to be responsible, such as a security deposit, first and last month’s rent, financials of the tenant, and if the tenant is an entity, the owner’s financials and perhaps a personal guarantee. The landlord will want to restrict the uses the tenant can make of the premises, limit the tenant’s ability to assign or sublease its lease, require the tenant to obtain and maintain certain insurance policies throughout the lease term, and be willing to execute landlord’s “standard form lease” or an “industry standard form lease.” But beware, any “form lease” will be drafted in favor of the party who presents it, i.e., the landlord, and it will be the tenant’s challenge to neutralize it.
It is also becoming more common that a landlord will have a form letter of intent prepared by its attorney that will be based on the landlord’s form lease, incorporating into the LOI many terms from the lease that are not generally discussed by the “business people”, but left to the attorneys. Though LOIs are not intended to be binding documents, it is still generally considered that any terms set forth in the letter have been accepted by the parties, subject to other terms to be negotiated in the lease. If the tenant later learns from its attorney what certain terms in the LOI mean, and then finds them unacceptable, the tenant may be considered to be reneging on the LOI, thereby jeopardizing all the otherwise agreed to terms, and putting the parties back to square one in the negotiations. If there is any provision in the LOI that a tenant doesn’t understand, have the attorney review it. Then, even if the term is understood and it is putting a burden or potential obligation on the tenant, still ask the attorney if some, if not all, of the burden should be shared by the landlord.
For many new commercial tenants, their leasing experience may only be that of when they leased an apartment or home. They must remember that California is a consumer-oriented state in that it provides many protections for the residential tenant that are provided by statute and common law. Such is not the case for commercial tenants who need to be aware that many of their few rights that are created by statute only exist if the parties have not otherwise agreed in writing to modify their rights. Many form leases attempt to do just that and modify these rights in favor of the landlord.
The landlord’s deal points in a letter of intent, and the lease itself, are where the eyes of a commercial tenant often haze up, and as a result, the commercial tenant will either accept all of the landlord’s terms as being standard industry practice, or consider the terms as just legalese for the attorneys to hash out. Granted there are many industry standards for commercial leases, but there are also many terms that are negotiable between the parties. You can be sure that a landlord’s standard form will put them all in the landlord’s favor. And as far as “legalese” is concerned, sure there are terms like “indemnification”, “subordination”, “covenants”, and “estoppels”, but all they are are fancy shorthand words for determining which party, landlord or tenant, is going to assume a certain risk or bear the cost of a particular occurrence. In fact, that is all that a lease does assign risk to one party or the other. If the tenant is reluctant to pay attention to these items, the landlord will make the tenant responsible for as many as the landlord can get away with. A good broker can help the tenant sift through many of these issues, but at the end of the day the broker is only paid if the lease is signed. When the parties come to a tipping point, a broker will always be able to say “other tenants have accepted similar terms,” which will be true. But the question will still remain: “Did they have to?” This is where a tenant will need a good lease attorney to separate the wheat from the chaff.
The following parts of this series will address certain aspects of lease negotiations and lease provisions of which the tenant should be aware so as to better appreciate the risks that it will be assuming under the lease and which might be shifted back to the landlord, or at least shared with the landlord in certain situations. In any lease transaction there are multiple factors that effect the parties’ position in negotiation. Leasing space is a landlord’s business. A tenant’s business is always something else, but its lease and rental obligations are usually a major line item for its business, and one that should not be taken lightly. If a tenant has a solid business and credit worthiness that brings value to the landlord’s project, it should be entitled to some concessions in the lease beyond a fair rent and a tenant improvement allowance.
Though the tenant may know that if it does not ask for anything it will receive nothing, the tenant must also appreciate that if it asks for too much, it could be characterized as a potential problem tenant, and if it is a landlord’s market, a landlord may feel that there will be another tenant just as good around the corner who will not know better to ask for all the concessions you may be demanding. It is in walking this fine line that a good tenant’s broker and lease attorney can assist the tenant with a fair list of concessions. It will be the purpose of the following articles to give the commercial tenant a heads-up as to some of the more common pitfalls that can be avoided, and to those lease terms that can be negotiated for a more balanced sharing of certain risks that can arise during the term of the lease.