Leasing Commercial Real Estate

By Peter J. Anderson, Shareholder and expert in Commercial Real Estate, Boughton Law Corporation, Vancouver, BC.

It has been stated on a number of occasions that negotiation is an art, not a science.  The implication is that successful negotiators are born with the ability to negotiate.  However, even great artists study to improve their skill, and even those without an artistic bone in their body can learn to develop skills in areas where they are lacking.

In short, while there may be a few “born negotiators”, most will come by their skill through diligence and hard work.  While certain of the concepts and ideas which follow may appear basic, and in some cases trite, it is never a bad idea to add a few new skills and techniques to your practice.  And while this paper focuses on commercial lease negotiation, many of the following comments and observations are of broader application.

Preliminary Considerations

Typically the first involvement most lawyers have with a commercial lease transaction comes when the client requests a review of a “lease agreement”.  Time is often short, and the client also has an expectation that the cost of the review will not be too significant.  The client desires to invest in the business enterprise being started, rather than in a detailed review of the document which may govern the client’s life for the next five or ten years.

Often the “lease agreement” will be nothing more than an offer or agreement to lease.  In many cases, particularly with shopping centre leases, it will be even less than an offer.  Many landlords use short, non-binding documents such as letters of intent, expressions of interest and tenant proposal forms as an initial document.  These simply sketch out the basic terms of the proposed tenancy – premises, term, rental rate and so on – and are expressed to be non-binding.  The formal lease may not even be available for review at this stage.  Although the client desires to keep legal fees to a minimum, there are a number of issues that should be considered at this point:

1. Does the document intend to create a binding agreement, or is it merely an expression of interest?  This is not as simple a determination as it sounds, for even a document which is stated to be non-binding may, under certain circumstances, give rise to enforceable rights, if all of the essential elements for a binding lease are present.
2. If the intent of the document is to create a binding agreement, are there conditions precedent that need to be satisfied before the parties are bound?  If there are, you will need to review these conditions carefully, including the time periods involved.  Many offers contain time periods that are impractical, or worse, impossible to meet.
3. Does the document indicate that a formal lease will be entered into, or is the intent that the initial document will be the final document?  The latter is often the case with subleases, where the offer to sublease becomes the sublease itself.
4. If a formal lease is intended, whose form of lease will be used?  Who will be controlling the drafting of the lease?  If the other side will be preparing the lease, what right of review does your client have before execution?

Assuming the transaction is not yet binding, are there issues which should be addressed at this stage which will improve your client’s position?  This is a case where a bit of experience can be of assistance, particularly where you are acting for a less than sophisticated landlord or tenant:

1. Do the numbers look right?  Your client is hopefully not relying on you to know all of the current market conditions, but you should have a general view of whether the basic rent should be in the $10/square foot range, or the $100/square foot range.
2. Are there “special provisions” which should be added, amended or removed?  Issues like landlord’s improvement work, tenant allowances and inducements, fixturing periods, free rental periods, and renewal options may all be of concern to tenants.  Landlords may be more concerned with security deposits, letters of credit, personal guarantees and rights to terminate if certain conditions are not met.

In many cases, the initial form of agreement (offer, letter of intent, or whatever) is driven by the wishes of the more powerful party to the transaction.  Major landlords usually have their own specific forms of initial agreement, which may or may not be intended to be binding.

Most landlords have their own standard form of lease for the property in question, and may be very reluctant to move to a different form.  On the other hand, many of the major retail tenants, be they supermarkets or “big box” stores, have their own forms of documentation which they require to be used throughout the transaction.  It is important to reach agreement at the outset as to whose form will be used, and who will control the drafting of the documents.

Understanding Client Needs and Desires

Every client will have its own list of concerns when entering into a lease.  Often these concerns may arise out of past history in other lease transactions.  A client may have experienced a problem at some time in the past, and wants to be certain that it will not arise again.  Unless you know the client’s business and lease history with a fair degree of intimacy, it is unlikely that you will be in a position to identify these types of issues on a casual review of the lease.  One of the most important aspects of the initial client consultation is to determine what is important to this client.  What type of business operation is the client involved in?  Why is this particular property suitable, and what could happen to put this suitability into jeopardy?  The more you understand your client’s goals and objectives, the better you can represent your client in the negotiation with the other side.

In some cases, the documentation does not adequately reflect the transaction in question.  Perhaps the lease form is designed for a multi-tenant situation, but your client is leasing the entire building.  Or the lease may provide for payment of utilities on a proportionate basis to the landlord, but all of the premises in the building are separately metered.  The lease should reflect reality, not the other way around.  In short, you need to ask questions to determine what the client’s business issues are, and you will then need to review the documentation to ensure that it is adequate to the task of reflecting those business issues.

No discussion of business terms would be complete without a quick discussion of “sacred cows” (or “deal breakers”) and “gimmees” (or “give aways”).

“Sacred cows” are terms or negotiation points which are, in one party’s view, inviolate.  They are not negotiable, and the implication is that if these terms are not accepted, the deal will not proceed.  Clearly, from a tenant’s point of view, any such terms should be expressed in the offer.  Even where the tenant has a right to negotiate the lease, it is typically subject to a duty to act reasonably.  If the desired provision is not found in the offer the tenant may find itself unable to insert it into the lease, unless the provision in question is “reasonable”  As tenant’s counsel, you need to know up front what these specific issues are, so that you can ensure that they are raised early, and protected throughout the negotiation.

From a landlord’s point of view, the situation may not be much better.  Unless the documentation states otherwise, the landlord is again typically subject to a duty to act reasonably.  As such, unless the landlord can show that the provision in question is reasonable, the landlord may be forced to negotiate its “sacred cow”, with the only alternative being to walk away from the transaction (assuming it is still conditional).  As landlord’s counsel, you need to know up front what issues your client is not prepared to give way on, and if necessary, protect these issues by raising them at the offer stage.

“Gimmees” are points which either party may be prepare to give way on, with a minimum of effort from the other side.  These often come up when reviewing the terms of the documents with your client, or when responding to comments from the other side.  Knowing what you can give in on can be a great asset in negotiation.  Sometimes these issues can be used to build rapport with the other side.  Other times they are used in trade – conceding one minor point in exchange for a similar concession from the other side.  In still other cases, there may be “step down” provisions.  Your client may not be prepared to concede the entire point, but there is a pre-arranged “step down” to a compromise position, which can be used to advance the negotiation.

By understanding your client’s position on “sacred cows” and “gimmees”, you will be better prepared, once the transaction enters the negotiation stage.

In Part Two, Mr. Anderson will lay out the “brass tacks” of the negotiating process and give tips for closing negotiations favourably. Watch for it next week on Monster Commercial.

By Peter J. Anderson, Shareholder and expert in Commercial Real Estate, Boughton Law Corporation, Vancouver, BC. http://www.boughton.ca/

Related Article: Negotiating a Commercial Lease – Part Two

Tags: commercial lease, commercial lease negotiation, commercial real estate leasing, lease commercial real estate

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