THE COMMERCIAL LEASING PROCESS-A PRIMER

Whether you are a landlord or a tenant (or represent either), the best way to help ensure success in a commercial leasing transaction is to look at the lease as a process not just a legal document. The following summarizes the basic steps in the process with a few helpful tidbits along the way.

I. Determine the Players and their Positions. Often, in a commercial setting, the “landlord’s lease team” consists of the owner-landlord, property manager, broker and attorney. The “opposing (tenant) lease team” may include the tenant, a tenant broker/”tenant rep”, a space planner and attorney. As you might imagine, in order to perform well, all players on a lease team should, before “going on to the field”, open and define the lines of communications and know what position they are to play.  For example, on the “tenant side of the line”, many national tenants engage tenant brokers/tenant reps to do the negotiation for them. Landlord based negotiations seem most often directed by the landlord “in-house” or by the landlord’s attorney, though broker and property manager-led negotiations are also common. While lease drafting/negotiating should be a team operation, naturally, the tenant and landlord should each select their “quarterback” early on and clearly define everyone’s responsibilities before the game begins. Be wary of brokers who suggest to stay away from attorneys because they “kill the deals”, or attorneys who tell brokers to stay out of the way until it is time for them to collect their commission check. Brokers can be extremely helpful regarding defining “market rents”, negotiating business points and commenting on local custom. Attorneys are essential to make sure the lease complies with Ohio law, is enforceable, and to poke holes through “boiler plate language” to minimize unbudgeted for expenses and unexpected liability. The “fantasy lease team” consists of all of the above players working together well in clearly established roles.

II. Establish a Game Plan and Negotiate. Regardless of whether you are (or represent) the tenant or landlord, the next step in the process is to internally discuss and determine your/your client’s desired position on basic business issues such as rental rate, term of lease, degree of build-out, who performs and who pays for the work, and target completion and rent commencement dates. Thereafter, the parties directly, or through brokers will typically discuss, negotiate and hope to come to a meeting of the minds on basic lease terms and conditions. If both sides agree upon the basic issues in these early negotiations, the usual next step is preparation of a Letter of Intent (although sometimes, on smaller deals, or in situations where the parties are familiar with or comfortable with each other, the “LOI” stage will be skipped, and one party will present the other with a draft lease).

III. The Letter of Intent. Since the time from handshake to signed lease can range from weeks to months, many commercial landlords/tenants feel the need for some written semblance of a deal in the interim. Typically, an agreement in principle, or “letter of intent (LOI)” is signed which details agreed basic terms (e.g. rent, term of lease, improvements) but conditions the parties’ obligations on preparing/executing a formal, definitive lease. Frequently, the LOI is crafted without legal assistance or review (although that is ill advised), and ranges from paragraphs to pages in length. Other considerations such as outlining the deal for lenders, avoiding full disclosure requirements or establishing an exclusive negotiation period may also dictate the need for a LOI.

The question landlords, tenants, brokers and their attorneys must answer before utilizing an “off the shelf”, form letter of intent is: what is the intent of their letter of intent? Some parties intend to be bound by the letter of intent, while others utilize same merely for initiating or monopolizing negotiation with the other party. Under Ohio law, both parties must have a clear understanding of the terms of the agreement and an intention to be bound by its terms before an enforceable contract is created. See Arnold Palmer Golf Co. v. Fugua Industries, Inc. 541 F.2d 584 (6th Cir. 1976); Normandy Place Assoc. v. Beyer, 2 Ohio St. 3d 102, 105-106 (1982). Unless absolutely clear in the LOI, however, the intent of the parties will be based on a fact finder’s (judge or jury’s) evaluation of not only the language itself, but the circumstances surrounding the language. The problem is that juries, for example, may not be familiar with the difference between final agreements and letters of intent. The fact finder certainly will not have a better idea of the parties’ intentions than the parties themselves, but will have the power to nonetheless, make the call.

In the Arnold Palmer case, the initial agreement in question clearly had as a condition, a later, definitive agreement to be prepared between the parties. The district court (lower court) in Palmer found for the defendant, reasoning that there could be no breach of contract claimed by the plaintiff, because no final contract was created by signing their conditional, agreement to agree. The Sixth Circuit in Palmer reversed the district court’s decision, determining that the initial agreement was a six page, detailed contract, with enough contract language to send the issue back to the lower court to determine intent. Clearly, the defendant in Palmer intended the initial agreement to be no more than an “agreement to agree”, and the plaintiff intended the contract to have been virtually finalized at the initial agreement stage.

Courts will often look to determine whether or not essential terms of the deal are spelled out in an LOI (or other initial agreement) to help determine the undeclared intent of the parties re: enforceability. In the context of leases, the fact that terms such as maintenance and repair obligations, buildout obligations, indemnity provisions, default provisions and insurance terms were missing from a letter of intent led the Court in Joseph v. Doraty, 77 Ohio L. Abs. 381 (1957) to the conclusion that since material lease terms were missing, no final lease agreement was reached at the LOI stage. See also Cannon Rd. LLC v PSC Metals, 2002 Ohio App. LEXIS 5876 (8th Dist.).

As a result of these cases, parties intending to be legally bound by a letter of intent should: (a) include all material terms of the deal; (b) make a clear statement of intent to be bound; (c) sign the document; and (d) provide for an exchange of money or other consideration. Why a “binding LOI”? A party believing that it is making a fabulous deal will want to “seal the deal” as early as possible. Any mention of a later agreement should clarify that such agreement is merely to memorialize the terms agreed to in the letter of intent.

Parties not intending to be legally bound by a letter of intent should consider not utilizing same and going right to the lease stage. If abstinence is not a practical option, the risk of the letter having binding effect may be minimized by the following, nonexclusive drafting suggestions:

(i)         Draft, in bold, a provision containing clear language, indicating that the document is not binding and should not be relied upon as such, and the parties do not intend to create legal obligations unless/until a formal, written lease is later prepared and executed by the parties;

(ii)        Do not provide a signature block (or have signature indicate receipt only, not assent);

(iii)       Make sure the proposed terms in the document contain any contingencies that would appear in the formal lease (e.g. acquisition of title by the landlord, or receipt of financing by the tenant). If the document is held to be binding, but the contingencies do not occur, the result should be that performance obligations are excused due to non-satisfaction of the contingencies.

Finally, parties that desire their letters of intent to be no more than agreements to agree re: the substance of the deal, but want to clearly agree on an exclusive negotiation period, or deal with preliminary due diligence and confidentiality matters can easily do so. In such instance, a simple, clear declaration to the effect that: “this LOI is non-binding and subject to a final definitive lease between the parties hereto, EXCEPT FOR the provisions contained in Section___, which the parties hereto agree shall be binding upon them, from and after the Effective Date …” would be in order.

IV. The Lease.  The lease is one of the most underrated (in perceived importance) real estate transactional documents. Many tenants believe that since they don’t own the property, they will have little responsibility and that the “standard lease form” they received will reflect that, and perhaps also contain unenforceable “boilerplate” (one-sided protective provisions). Many landlords believe that their form boilerplate leases, even if created by an attorney years ago will remain valid and protect them indefinitely. The opposite is true, in both cases. The rights and obligations of a purchase agreement usually end upon the transfer of title, or after a short term warranty period. Leases, on the other hand can define landlord-tenant relationships for many years (and accordingly should be carefully scrutinized by a real estate attorney trained to recognize lease issues and “language traps”).

(i)         Advice for Tenants.  In a True Triple Net Lease, for example, tenants may be unpleasantly surprised to find out that they are responsible for virtually every expense and obligation. Furthermore, absent a few contract law defenses (such as illegality, contrary to public policy), “boilerplate” is enforceable. Commercial leasing in Ohio (and many other states) is different from residential. First, the Ohio Landlord-Tenant Act does not apply. Second, the deference given to residential tenants (often in an unequal bargaining position from their landlords) in courtrooms does not exist with regard to commercial tenants. Courts assume (rightly or wrongly) that commercial tenants and landlords are on equal footing with equal sophistication in business and lease matters. Generally speaking, courts will typically uphold language in a commercial lease, unless it is contrary to statutory law or public policy. Consequently, commercial landlords and tenants have a lot of leeway in allocating the risk and responsibility of issues inherent in commercial leases. Because of this deference to lease language in a commercial lease, tenants (and landlords) should analyze and understand everything contained therein.

(ii)        Advice for Landlords. Landlords need to understand that lease forms need to change with the times. For example, new laws are constantly being enacted/modified (e.g., ADA, Environmental Laws) and factors such as inflation rates and insurance products (e.g. “all risk” vs. fire and extended insurance”) change frequently. The other inherent problem with “standard forms” is that there is little that is standard about a real estate transaction. Every lease is unique since there are different types of property, different tenants (with different levels of motivation and sophistication) and different circumstances in each transaction.

Typically, the landlord will offer to create the first lease draft, to utilize, as much as possible its standard form. Many national tenants, however prefer to open with their form based lease. The commercial lease attorney’s optimal role can be analogized to that of a clothing store tailor. If the off the rack suit (lease form) does not fit, you must alter it. Most software programs these days make it very easy to “redline” a lease showing the other side your advised additions and deletions to their lease. With lengthy, one-sided lease forms, or initial drafts that present a handful of seemingly insurmountable issues, a “Memo of Material Issues” is often advised to help determine if a deal is possible, before a lot of needless hours are spent.

VI. The Abstract. Finally, many landlords and tenants find it beneficial to prepare an “abstract” or summary of the key lease terms (which is especially helpful for the parties and their attorneys, lenders, managers and brokers) to quickly locate notice addresses, rent numbers, dates and other material terms. Most important is to docket dates for rent increases and exercise of options to extend, expand and/or purchase.

VII. The Pitch. If you would not think twice about insuring your property to protect against the risk of casualty, you should not think twice about “insuring” (or at least reducing) the risk of boiler plate lease language coming back to haunt you in the form of non-budgeted for expenses and unexpected liability down the road. An ounce of prevention will always cost a heck of lot less than a pound of cure.