Any business owner operating a business out of commercial space either buys the property or opt for the inexpensive alternative of leasing it. The terms of the business’ 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 longer than three (3) years. If it is not written and signed, a “tenancy at will” is created, which gets terminated anytime when either the landlord or the tenants want. Business owners should always demand a written lease to safeguard against any misrepresentation of the lease terms or abruptly getting evicted in case of tenancy at will. The good news is commercial lease agreements provide greater flexibility to negotiate than a standard residential lease agreement. Any negotiation will only be fruitful if the business owner understands and avoids common mistakes. 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 tenants intend to conduct. Suppose the lease does not define the “use” terms. In that case, the tenants could be held to default the lease and expose the business to legal consequences.
If the tenants are 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 tenants are unable to meet the operating hours’ requirement because of renovations, repairs, holidays, etc. It is important to address these situations in the commercial lease to avoid defaulting under 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 without understanding their work share because architectural drawings are costly and time-consuming to produce. The tenants should negotiate the work allocated or secure the preliminary drawings to get the price estimates. Also, tenants 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 tenants want to make any alterations to the premises. Therefore, it is in the tenants’ interest to address the tenants’ requirement for improvement in the lease itself.
WHAT ABOUT THE REGULATIONS AND ZONING COMPLIANCE?
Most commercial leases state that the tenants accept the leased property “as is.” However, commercial properties are not zoned for any commercial uses. Even though a landlord might commit that the property can be used for intended purposes, the tenants bear the risk of any zoning or permit violation. In Pennsylvania, about 57% of the townships and boroughs have their zoning ordinance. The permitted uses will vary for each zoning ordinance. To avoid the uncertainty of breaking the zoning rules or operating without the required permits, the potential tenants must perform its due diligence investigation of the property’s zoning laws and ask for the municipal, county, or state-required permits before committing to a commercial lease.
It is also essential for both landlord and tenants 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 intend to get long-term leases with automatic renewal terms because it secures them long-term rent. Long-term leases of three to five years or more also ensure the business’s continuity and stability. However, such long-term commitment comes with its risks for tenants in Pennsylvania. Many landlords require business owners’ personal guarantees when it comes to leasing commercial spaces. Such a long-term lease can be risky because most start-ups have a high failure rate. It means that there are high chances 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. This problem worsens in Pennsylvania because landlords are not required to take affirmative steps to mitigate the damages after the tenants default unless there is a mitigation provision in the lease. Therefore, tenants should negotiate for an out clause, the 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, tenants should be aware of all the fees incurred in case of defaulting the lease 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 tenants 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 tenants have defaulted, the landlord has the right to invoke the acceleration clause. The clause initiates legal proceedings against the tenants and the tenants’ guarantors for all the unpaid rent owed for the lease term’s remainder. One way to avoid these devasting 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 Judgement. It is a legal way through which a landlord can secure a quick judgment against allegedly defaulting tenants without any requirement of proving the tenants’ default at a hearing. The landlord can repossess the leased property and get the alleged unpaid rent from the tenants. 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 the 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, the tenants would like to include a reasonably broad force majeure clause. The 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 will also assert the legal clauses of impracticability (or impossibility) of contractual performance and frustration of the contractual purpose. There can be more focus on cleaning issues. In the end, there are many more issues than outlined in this article.
SOURCES
https://www.wolfbaldwin.com/articles/real-estate-articles/commercial-leasing-when-you-can-t-buy/
https://www.macelree.com/commercial-real-estate-leases-let-the-tenant-beware/
https://www.lexology.com/library/detail.aspx?g=210d2ac6-46cf-44db-84d0-2487c616fd19
https://blog.thebrokerlist.com/challenges-commercial-leasing-central-pennsylvania/
https://www.dhbusinessledger.com/business/20190417/top-ten-mistakes-in-commercial-leases
PHOTO SOURCES
https://housing.com/news/tips-negotiate-commercial-leases/
https://snonoco.com/en/blog/show/prm/6285/Commercial-negotiation.html
https://cdcloans.com/commercial-lease/
Great work. This post would be so helpful to someone negotiating for a commercial lease space (which is a vast majority of business owners). I think it is also really awesome that it is PENNSYLVANIA specific and not just generic to any state, because–as you pointed out–Pennsylvania has some unique property laws (confession of judgment). You also did a great job breaking this into clear headers.
-Zoe
Hi Dharvi,
This was a very informative post. I was impressed by the level of detail in your explanations of the different considerations for commercial tenants. For instance, the concept of a “work letter,” was largely new to me. While I generally knew that these are important terms for a lease, I had not thought of them as an opportunity for a tenant to save costs by negotiating that the landlord cover some of the renovation costs. I also thought that it was a great point to discuss that a tenant still needs to be diligent in checking the zoning laws of the property. My thoughts would be that if the landlord says a business is permissible, then it is good to go; however, after reading this blog, I realize that is a very risky way to start a business and that both the landlord and the tenant should be certain that the proposed business complies with all ordinances.
Overall, this was a great post with information that was new to me and useful.
Thank you!
Anne
Great post. I think this was a great topic to go into because it is one of the first things a new entrepreneur will need to get a handle on, and also one of the hardest. Landlords tend to have far more power and far more knowledge in the subject (especially if it is a real estate investment group) so it is easy for entrepreneurs to sign something without fully understanding it. So great topic, especially considering it explains the unique little ideas that exist in PA that might not exist elsewhere because property law is often so local.