Understanding Commercial Leases - Top Five Legal Issues Facing Tenants

By Kenneth Chung, Esq.

The fine print lurking in commercial leases may often have a significant impact on a tenant's rights. One should not assume that a lease must be fair simply because it is a standardized form lease. Rather, the lease should be reviewed in its entirety to ensure that there are no surprises down the road. The following are some of the lease provisions which require careful review and consideration.

1. Lease Extension Option. The existence of an option to extend the lease term is often critical in maintaining the value of your business. The mere existence of a provision which purports to provide an extension option for a specified term may be insufficient. For example, some option provisions will specify that the option is personal to the tenant and is not subject to assignment or conveyance. Such a restriction is generally enforceable and will not permit any subsequent tenant from exercising the option. In such a situation, the new tenant should seek to obtain a specific written assignment of the option directly from the landlord before signing the lease. Another example where an option may be held invalid is if the option provision does not set forth an ascertainable standard for determining the rent for the renewal period. For example, if the provision simply provides that the "amount of rent will be mutually agreed upon by the parties" and does not specify any standards on how such an agreement will be made, then the courts have held that such a provision is too indefinite and is therefore unenforceable.

2. Assignment and Subletting. The ability to freely assign or sublease may be of significant value in a subsequent sale or sublease transaction. There are a myriad of issues which can be negotiated as they relate to assignment or sublease provisions. Among other issues, the tenant should seek to negotiate an assignment provision which provides as much flexibility to assign the lease; to ensure that the landlord cannot unreasonably withhold its consent to the assignment; and to attempt to phase out or eliminate the tenant's potential obligations under the lease upon assignment or at some time shortly after the assignment.

3. Payment of "Key Money" Prohibited. In order to curb abuses by some commerciallandlords who charge a significant fee ("key money") as a condition to renewing the lease, Civil Code Section 1950.8 was enacted on January 1, 2002 which, with some exceptions, prohibits a landlord from charging a fee ("key money") to renew the lease. Hence, if you believe that an unreasonable fee is being demanded as a condition to renewing your lease, your attorney should be consulted to find out your rights and remedies.

4. Non-Disturbance Agreement. Almost all leases will set forth a Subordination and Attornment provision which are designed to benefit those lenders in place prior to the execution of the lease. If the landlord defaults under the loan, the lender may take ownership of the property through a foreclosure and thereafter extinguish the lease since the lease is deemed subordinate to the loan. A "Non-Disturbance Agreement" provides that the lender who takes over the property must recognize the lease and continue the tenancy without any disruption. A Non-Disturbance Agreement is critical to ensure that the tenant does not lose its lease in the event a lender takes over the property after a foreclosure.

5. Waiver of Subrogation Rights. In the event of loss or damage which is covered by insurance, the insurance company may pay for the loss and thereafter file a "subrogation" lawsuit against the party, other than the insured, who caused the loss or damage. For example, if as a result of the landlord's neglect, the tenant's property is damaged by fire, water or other peril covered under insurance, the tenant's insurance company would pay the tenant for the loss and pursue the landlord under subrogation. Some leases will require the tenant to release and waive its subrogation rights. Although there are some benefits in obtaining a mutual release and waiver of subrogation rights (i.e. the landlord's insurance company cannot pursue the tenant for damages caused by the tenant), the tenant must be cautious before signing such a provision. Some insurance policies will terminate coverage if its subrogation rights were waived by the insured. Hence, the insurance company may have no obligation to pay for an otherwise covered loss if its right of subrogation was released by the insured in the lease. Any lease provision which bears upon insurance matters should be reviewed in conjunction with the insurance policy in order to maximize the tenant's protection.

The foregoing is not an exhaustive list of issues which should be considered prior to signing the lease. A real estate attorney should be consulted at the outset of the lease negotiation process in order to maximize the tenant's rights.

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Kenneth W. Chung is a senior partner with the law firm of Kring & Chung, LLP where he heads the firm's Business & Real Estate Department. For more information about commercial leases or with questions about this article, please contact Mr. Chung at (949) 261-7700.

** The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change with time. Applicability of these same legal principles may differ substantially in individual situations. Please consult an attorney before making a decision in a particular area using only the information provided in this article.