commercial lease – Dickinson Law's Inside Entrepreneurship Law Blog

By: Dharvi Goyal

Business owners operating a business out of commercial space will either buy the property or opt for leasing it. The terms of the commercial lease can profoundly impact the ability to run a business and earn profits. Commercial leases are complex, and each one looks different.

A lease is a contract that is legally enforceable and can be valid even if it is not in writing. However, in Pennsylvania, a written and signed lease agreement is required for any lease that is longer than three (3) years. If it is not written and signed, a “tenancy at will” is created, which means the lease can be terminated at anytime by the landlord or tenant. Business owners should always demand a written lease to safeguard against any misrepresentation of the lease terms and to avoid being abruptly evicted in case of a tenancy at will. The good news is commercial lease agreements typically provide greater flexibility to negotiate than a standard residential lease agreement. But any negotiation will be fruitless if the business owner does not understand key terms. Therefore, a commercial tenant should keep in mind the following legal considerations while negotiating the lease.

What Will You “Use” The Property For And What Will Be Your Hours of Operation?

It is essential to define “use” in the commercial lease to adequately define the business activities that the tenant intends to conduct. If the lease does not define “use,” the business could be exposed to legal consequences.

If the tenant is leasing property for retail purposes, the commercial lease will likely have an operation covenant, a section that outlines the operating hours of the leased property. There might be situations when the tenant is unable to meet this requirement because of renovations, repairs, holidays, etc. It is important to address these situations in the commercial lease to avoid defaulting on the lease.

What About the Improvements on the Leased Property?

Generally, in Pennsylvania, one of the components of a commercial lease is the Work Letter. It states the expected work that each party should do and the expected deadlines to complete the work to prepare the premises for occupancy. Most tenants overlook the Work Letter while negotiating and signing the lease and do not understand their work share because architectural drawings are costly and time-consuming to produce. A tenant should negotiate the work allocated or secure the preliminary drawings to get the price estimates. Also, a tenant may be able to convince the landlord to bear the cost of some improvements. However, most commercial leases will require the landlord’s prior written approval if the tenant wants to make any alterations to the premises. Therefore, it is in the tenant’s interest to address the tenant’s requirement for improvement in the lease itself.

What About the Regulations and Zoning Compliance?

Most commercial leases state that the tenant will accept the leased property “as is.” However, commercial properties are not zoned for any commercial uses. Even though a landlord might state that the property can be used for intended purposes, the tenant bears the risk of any zoning or permit violations. In Pennsylvania, about 57% of the townships and boroughs have zoning ordinances. The permitted uses will vary for each zoning ordinance. To avoid breaking the zoning rules or operating without the required permits, the potential tenant must perform their due diligence in investigating the property’s zoning laws and should ask for the municipal, county, or state-required permits before committing to a commercial lease.

It is also essential for both landlord and tenant to discuss all the improvements or repairs required to ensure that the commercial property complies with the environment, labor, and industry-specific regulations. Any violation can potentially create enormous complications and liability for the tenants, which causes harm to the business.

Should you Negotiate a Long-Term Lease?

Most commercial landlords prefer long-term leases with automatic renewal terms because they secure long-term rent. Long-term leases greater than 3 years also ensure the business’s continuity and stability. However, such long-term commitment comes with risks for tenants in Pennsylvania. Many landlords require a personal guarantee from business owners when it comes to leasing commercial spaces. Such a long-term lease can be risky because most start-ups have a high failure rate, which means that the commercial lease might last longer than the business itself. If this happens, the business owner is liable for rent even if the business has ceased occupying the property.

Pennsylvania landlords are not required to take affirmative steps to mitigate the damages after the tenant defaults unless there is a mitigation provision in the lease.

Therefore, tenants should negotiate for an out clause – a clause that allows tenants to get out of the lease early – or a mitigation clause. In the alternative, tenants should also negotiate assignment or subleasing clauses in the lease. Even if the tenants do not have much negotiating power, they should be aware of all the fees incurred in case of default because of failure to pay the rent or leaving the leased property early.

Additional Provisions That You Should be Aware of

Every commercial lease has Common Area Maintenance Costs (CAM) which are usually tacked onto the rent. Examples of CAM costs are snow removal, landscaping, parking lot lights, etc. Tenants should carefully budget for these additional costs.

Most commercial lease agreements have an indemnity clause that requires the tenant to indemnify the landlord if a third person gets injured on the rented property and brings a claim against both the tenant and the landlord, or if there is property damage in the leased space. This clause also covers the injuries that occur in common areas or even because of the landlord’s negligence. Tenants should carefully negotiate the indemnity clause.

Landlord’s Legal Powers That You Should Be Aware Of

Once the tenant has defaulted, the landlord has the right to invoke the acceleration clause. This clause initiates legal proceedings against the tenant and the tenant’s guarantors for all the unpaid rent owed for the remainder of the lease’s term. One way to avoid these devastating consequences is to negotiate a business-failure escape clause in a commercial lease.

Another detrimental legal tool available to most landlords in Pennsylvania is Confession of Judgment. This is a legal way through which a landlord can secure a quick judgment against an allegedly defaulting tenant without any requirement of proving the tenant’s default at a hearing. The landlord can repossess the leased property and get the alleged unpaid rent from the tenant. Then, it is the tenant’s burden to prove to the court why the confessed judgment should be reversed. The Pennsylvania Supreme Court still implements this legal provision for some commercial leases. Tenants starting their business should reasonably bargain to remove this clause from the lease agreement.

Moving Forward

Potential business tenants must carefully negotiate lease terms, keeping the business goals in mind. However, the COVID-19 outbreak brought a new range of issues to the parties’ contractual abilities, which will lead to new legal considerations for future lease terms. Going forward, tenants should include a reasonably broad force majeure clause. This clause dictates the circumstances that are not within the party’s reasonable control, which caused the contract’s violation. The pandemic experience might change the rent provisions. Tenants may also assert the legal clauses of impracticability (or impossibility) of contractual performance and frustration of the contractual purpose.

It is important to note that this article only addresses some of the many legal issues involved in commercial leases. Because of the complexity and high stakes of commercial leases, a lawyer should be consulted for help.

This post has been reproduced with the author’s permission. It was originally authored on March 28, 2021, and can be found here.

Dharvi Goyal, at the time of this post, is a third-year law student at Penn State Dickinson Law. Dharvi is from India and is interested in pursuing a career as an in-house counsel. Dharvi has recently finished her internship at Dickinson College OGC office and is about to begin her internship with a law firm.