What do I need to know before leasing retail space in California?

A client recently requested me to provide a summary of the primary issues of concern to a tenant leasing space for a retail use in a shopping center or mall. Although this is not an exhaustive analysis of all of the issues involving a retail lease from the tenant’s perspective, the following are my thoughts.

What issues are involved with negotiating leases?

Commercial Landlord Issues – Economic

• Common Area Maintenance Charges. The primary economic issues regarding the amount of rent and any percentage rent are generally business issues negotiated by the tenant with the landlord.  However, there are other economic issues that also affect the tenant’s bottom line.  Probably the most highly negotiated is how Common Area Maintenance charges (CAMS) are calculated and billed to the tenant.  For example: (i) how is the tenant’s pro rata share of the CAMS determined; (ii) what amounts are included and excluded from CAMS; (iii) is any estimate of CAMS based upon actual expenses or a pro forma projection; and (iv) what are the rights of tenant to audit CAMS.  The ability of the tenant to control and/or limit CAM charges will benefit the tenant throughout the term of the lease by reducing the tenant’s operating costs.
• Tenant Improvements.  A second economic issue is what are the respective obligations of the tenant and the landlord involving the construction of the tenant improvements? If it is a build-to-suit-lease, the lease should define the exact tenant improvement work landlord is to perform, including the completion date for the landlord’s work. The tenant should have certainty as to both the time and cost for the landlord to perform the landlord’s work. Certainty regarding the performance of the landlord’s work will allow the tenant to timely perform its improvement duties and obligations pursuant to the lease, including opening for business.

Other Commercial Landlord Issues

• Sign Rights. What are the sign rights of the tenant (monument, building, directional and retail center signage)?  Since retail tenants highly value sign rights, the tenant should negotiate and the lease should provide for the maximum sign rights attainable by the tenant.
• Use. What are the exact rights of tenant regarding the use of the premises?  What are the exclusive use rights of the tenant?  What are the remedies of the tenant if another tenant in the retail center violates the tenant’s exclusive use rights?  What are the limitations on the tenant’s use? Does the tenant have any rights to use areas outside of the premises? For example, what are the rights of a restaurant tenant to use an outdoor dining area or food court? A tenant favorable use provision protects the business interests of the tenant and eliminates or restricts competitive uses in the retail center.
• Assignment/Subleasing. What are the rights and obligations of the tenant with respect to an assignment of the lease or the subleasing of the premises?  If the tenant wants to assign the lease or sublease the premises, will the landlord have the right to recapture the premises, or a portion thereof? Does the landlord have the right to increase the rent in connection with an assignment of the lease or sublease of the premises? Restrictions on the tenant’s right to assign the lease or sublease the premises will inhibit or limit the ability of the tenant to sell or restructure its business.
• Operating Covenants. What are the obligations of the tenant to operate a business on the premises?  What days and hours is the tenant required to operate?  What are the rights and obligations of the tenant if the tenant “goes dark” (ceases operations)?  For example, does the tenant have the right to go dark in connection with the remodeling of the premises? Does the landlord have the right to recapture the premises if the tenant goes dark? The tenant must protect itself from any default or violation of the lease, as a result of its failure to comply with the operating covenants in the lease.

• Relocation of the Premises In retail center or mall space leases, the landlord may require the right to relocate the premises.  This is a major issue of concern for the tenant, as it could disrupt or interfere with the business operations of the tenant. Additionally, any relocated premises may be less preferable than the location of tenant’s existing premises.  In general, to protect the business interests of the tenant, any right of the landlord to relocate the premises should be eliminated or severely restricted.
• Options to Extend.  Does the tenant have any rights or options to extend the term of the lease?  If so, what are the rights and duties of the tenant involving the exercise of an extension option?  What rights does the landlord have to nullify an extension option of the tenant?  Are any options to extend transferrable to an assignee or sublessee of the tenant? The ability of the tenant to extend the term of the lease allows the tenant to continue its business operations without disruption or having to negotiate an extension of the lease term with the landlord.
•       Brokers.  Are there any brokers involved in the leasing of the premises? If so, who are the brokers, and what is the agreement between the tenant and the landlord regarding the payment of any commissions? To avoid any dispute, any brokers to the parties should be identified in the lease and the lease should address the payment of any commissions.
•       Guarantor.  Will the landlord require a guarantee of tenant’s obligations pursuant to the lease from a third party guarantor?  If so, what are the terms of the guarantee? Will the guarantee provide for the release of the guarantor upon the satisfaction of certain conditions (for example, the tenant performing its obligations pursuant to the lease for a stated period of time)? Since any guarantor of the tenant’s obligations will have recourse against the tenant if the tenant breaches the lease, it is in the best interest of the tenant to limit the terms of any required guarantee.

Commercial Lease Agreement Repairs and Maintenance

Who pays repairs in a commercial lease? What are the obligations of the tenant and the landlord regarding the maintenance and repair of the premises?  What are the tenant’s duties involving the disposal of trash and maintenance of a grease interceptor by a restaurant tenant?  What are the rights and remedies of the tenant, if the landlord fails to perform its maintenance or repair obligations? Will the landlord provide the tenant with any warranty involving improvements to the premises performed by the landlord? What is the current condition of the premises, including the roof, HVAC system and compliance with ADA?  The lease should specify the exact obligations of the tenant and the landlord involving the maintenance and the repair of the premises. 

There are numerous other issues a retail tenant should consider and evaluate. It is suggested a prospective retail tenant obtain the advice of an experienced commercial real estate lawyer before entering into a lease.

William B. Brinckloe, Jr. is a Martindale-Hubbell AV-Rated lawyer in California who practices in the areas of commercial real estate and business transactions. If you require the services of an experienced commercial real estate and business transactional lawyer in California, please email William at Contact@TransActionLaw.