The Letter of the Law: November 2012
IN THIS ISSUE:
Leasing a retail or commercial space to start up a new business requires a significant investment of money and time. Regrettably, many new business owners speed through the leasing process and discover later the harmful lease provisions to which they had unknowingly agreed. The following are some of the important lease provisions and issues that should be identified and carefully negotiated:
- Rent Commencement Date: In leasing commercial space, the tenant often needs time to complete construction and tenant improvements from the date that the lease is signed. In most situations, a tenant should be provided a reasonable period of time (i.e. 90 to 120 days) to complete such improvements. The tenant should negotiate a reasonable term and confirm in the lease that the tenant is not obligated to pay rent during this construction period. Leases may often provide that Base Rent is abated during the construction period. This means that the tenant is still required to pay NNN expenses (i.e. tax, insurance and maintenance charges). Tenants should seek to abate all Rent, including NNN expenses, during the construction period.
- Tenant Improvements: When tenant improvements are required, a tenant improvement allowance should be requested to help pay for necessary construction or remodeling.
- Common Area Maintenance Fees: In addition to rent, a commercial tenant pays a share of the maintenance fees for the shopping center or office building. The fees are generally calculated based on the pro rata occupancy percentage of the tenant. Some points to consider are: (1) imposing a cap on the annual increase in CAM charges, (2) including a right to audit CAM charges, and (3) when calculating CAM, exclude certain charges such as landlord’s administrative overheard charges, landlord’s reserve account payments, and other unreasonable charges.
- Amortize Capital Improvement Charges: If the landlord decided to build a parking garage or replace the roof during the last year of the lease, you would be required to pay your pro-rata share of the entire expense even though your tenancy will be expiring soon. For such reasons, and also to avoid significant increases in CAM charges when capital improvements are made, the lease should state that capital improvement expenses should be amortized over the useful life of the improvement which would significantly decrease the expense payable by the tenant for such costly capital improvements.
- Gross-Up Provision: Tenants are required to pay pro-rata NNN expenses. If there is a 50% vacancy in the shopping center, each of the remaining tenant’s NNN expenses may nearly double since the same expenses would then be payable by a fewer number of tenants. A gross-up provision should be inserted stating that tenant’s pro-rata payment will be calculated as if the shopping center is 100% occupied regardless of the actual vacancy rate.
- Co-Tenancy Agreements: The success of many smaller retail tenants is dependent upon the amount of traffic generated by anchor tenants in a shopping center, such as a supermarket. With a co-tenancy agreement, you would have the right to terminate your lease or trigger a pre-negotiated reduction in your rent in the event that anchor tenant vacates the shopping center.
- Exclusivity Clause: The placement of a competing business in the same shopping center will likely decrease your sales. To protect sales revenue, obtaining an exclusivity provision would ensure that no other competing business will be permitted in your shopping center.
- Personal Guarantee: Although personal guarantees are required by most landlords, the nature and scope of the guaranty may be negotiated. For example, the guarantee may be limited to the first 5 years of a 10 year lease, or the extent of the personal guarantee may be reduced by 10% each year so as to reduce your personal exposure.
- Lease Transfer: Unreasonable limitations and restrictions to the tenant’s right to assign or sublease must be removed or minimized. It is crucial to state that the landlord will not unreasonably withhold, delay or condition its consent. Otherwise, a landlord may deny your request to assign your lease, thereby effectively restricting your ability to sell your business.
- Options to Extend Must be Transferrable: Many standard form leases state that options to extend are personal to the original tenant. This means that even if the landlord authorizes the assignment of the lease to your buyer, the option to extend the lease term does not automatically transfer to the buyer. Such a situation may significantly impede the ability to sell your business.
- Relocation: A relocation provision allows the landlord to relocate your business from the current location to some other less desirable location in the shopping center. These provisions often allow the landlord to pay nominal relocation costs to the tenant. If the landlord will not remove the relocation provision during lease negotiations, then the tenant should attempt to negotiate and identify the specific spaces in the center to where the tenant may be relocated. The tenant should also reserve the right to terminate the lease if the tenant is not satisfied with the proposed new space or the terms of the relocation.
The guidance of an experienced real estate attorney may help tenants to avoid the significant consequences of harsh provisions lurking in many leases. Since many of the above identified terms should be negotiated at the letter of intent stage, the best time to consult with an attorney is prior to finalizing the letter of intent. For tenants who are purchasing a business and therefore assuming an existing lease, it is equally important to have an attorney review the lease as the existence of certain provisions may impact the value of the business being purchased.
Kenneth W. Chung is a Managing Partner with Kring & Chung, LLP’s Irvine, CA office. In addition to his extensive experience in handling both real estate transactions and litigation, Mr. Chung has maintained a California real estate broker’s license for over 26 years. He can be contacted at (949) 261-7700 or firstname.lastname@example.org.
Consider two typical scenarios in construction defect litigation:
Scenario A: In a 35-home construction defect lawsuit arising from a large project in Sacramento, plaintiffs’ expert picks six windows at six separate homes for spray testing. Our insured is the stucco subcontractor. Our expert attends plaintiffs’ testing. Our expert reports that none of the windows selected for testing showed any evidence of water leakage in the past. There are no stains on the window sills or on the drywall below the windows. When the plaintiffs’ expert removes the drywall below the windows, there are no stains on the framing. The plaintiffs’ expert runs the spray test. At two of the six homes, water from the spray rack enters into at least one of the stud cavities below the window. Plaintiffs’ expert uses this result to claim that 1/3rd of the windows at the litigated homes will require repair, due to the 1/3rd “failure rate” observed during investigative testing.
Scenario B: In a 40-home construction defect lawsuit arising from a large project in Fresno, plaintiffs’ expert picks ten windows at ten separate homes for spray testing. Our insured is the stucco subcontractor. Our expert attends plaintiffs’ testing. Our expert reports that none of the windows selected for testing showed any evidence of water leakage in the past. There are no stains on the window sills or on the drywall below the windows. When the plaintiffs’ expert removes the drywall below the windows, there are no stains on the framing. The plaintiffs’ expert runs the spray test. None of the windows leak. However, at each window, plaintiffs’ expert sees unsealed staple penetrations through building paper. He also sees reverse laps of sill flashing paper at two of the windows. He uses these observations to claim that 100% of the windows at the litigated homes will require repair due to “defects in building paper installation” observed at 100% of the windows inspected.
In defending against either claim, you will of course argue that the absence of water stains on the drywall and framing below the windows means the windows do not leak in a real rainstorm and therefore do not require repair. This common sense argument may be bolstered by referring to ASTM (American Society for Testing & Materials) Standard E2128-12, “Evaluating Water Leakage at Building Walls.” This standard was first published in 2001 and most recently updated in 2012. It is a 36-page page technical manual which details how to carry out a window leak investigation. Of most immediate importance to construction defect practitioners, the standard states that investigative testing, such as the spray testing described in our two scenarios, should not be carried out absent evidence of prior leaks at the window to be tested. ASTM E2128-12 provides, at paragraph 188.8.131.52:
“The primary purpose of investigative testing is to recreate leaks that are known to occur. Investigative testing is not intended to demonstrate code compliance or compliance with project documents unless such deviations are actually related to the leakage problems.”
In our two scenarios, there is no evidence that prior leaks have occurred at any of the windows tested. Rather, the plaintiffs’ experts conducted blind experiments to see if they could make the windows leak or, at the very least, uncover technical violations of building code or project standards. ASTM E2128-12 states, however, that “investigative testing is not intended to demonstrate code compliance.” It should only be used to recreate leaks “that are known to occur.” Accordingly, in defending against plaintiffs’ claims in this case, we would argue that the investigative testing carried out by the plaintiffs’ expert violated ASTM E2128-12.
ASTM standards are considered the gold standard for building investigation. For instance, plaintiffs’ window experts typically testify at deposition that they conduct their window spray testing in “strict compliance” with ASTM Standard E1105, “Standard Test Method for Field Determination of Water Penetration of Installed Exterior Windows.” However, ASTM Standard E1105 merely explains how to conduct spray testing. It does not discuss when to conduct it. ASTM E2128-12 makes clear that spray testing should not be conducted absent evidence of prior leaks at the window to be tested. Accordingly, in both scenarios described above, defense counsel may wish to file a motion in limine to prevent the plaintiffs’ expert from testifying as to the results of his investigative testing on the grounds that the investigative testing violated ASTM E2128-12.
Copies of ASTM E2128-12 may be downloaded for $59 here.
Paul T. McBride is a Partner with Kring & Chung, LLP’s Sacramento, CA office. He can be contacted at (916) 266-9000 or email@example.com.
Laura C. Hess attends 10th Annual Bar Leaders Conference and the Presiding Justice Breakfast
Kring & Chung Partner, Laura C. Hess, attended the 10th Annual Bar Leaders Conference in Monterey, CA on October 11, 2012, presented by the State Bar of California. This conference teaches attorneys in leadership positions in their local bar associations how to effectively lead their Board of Directors, how to manage finances of nonprofit organizations, and management of staff. The current and incoming Presidents of bar associations from around the state all attended. Hess will be the President of the Orange County Women Lawyers Association in 2014.
Hess also attended the Presiding Justice Breakfast with Orange County Superior Court Presiding Justice Thomas Borris and Assistant Presiding Justice Glenda Sanders on October 16, 2012. The purpose of the meeting was to provide local bar leaders with information regarding some of the current challenges the Orange County Superior Court is facing, and to engage in a round table discussion regarding how those challenges have effected lawyers and their clients. The justices also discussed the court’s conversion to e-filing, which will become mandatory effective January 1, 2013.
Michelle Philo Awarded OCWLA’s Bar Stipend Award
On October 23, 2012, Michelle Philo was awarded the Orange County Women Lawyers Association’s Bar Stipend Award. Each year, OCWLA recognizes outstanding law school graduates who represent the advancement of women, give to their communities through community service and have a commitment to Orange County. Ms. Philo is devoted to seeing more women in leadership positions. She was recognized for her many leadership roles in law school, including two terms as Student Bar Association President at Whittier Law School and the Vice Chair Student Bar Associations for the American Bar Association Law Student Division. Through these positions she was able to coordinate philanthropic activities such as an annual toiletry drive benefitting Mercy House, volunteering at Hope 4 Hanna benefitting autism research, and fundraising for breast cancer research. Ms. Philo also served for over two years as the Whittier Law School representative to the OCWLA Board of Directors, assisting OCWLA with its programming throughout the year. This past summer, Philo took the July 2012 California Bar Exam. She is currently working as a law clerk at Kring & Chung, LLP while she waits for her results.
Kring & Chung 4th Annual Thanksgiving Food Drive
November 12th – 20th
In the spirit of Thanksgiving, our firm is collecting donations for our 4th annual Thanksgiving Food Drive benefiting the families of the South Orange County Family Resource Center. The South Orange County Family Resource Center is committed to improving family and community life. Their Family Resource Center brings together services and activities that educate, support and provide resources to families with children. We will be putting together Thanksgiving meal baskets with all of the items donated and would greatly appreciation your contribution. We hope to provide 40 families with a complete Thanksgiving dinner.
Click here for more information about the organization and their partners.
Items needed: Stuffing, mashed potatoes, gravy, cranberry sauce, yams, marshmallows, an assortment of canned vegetables, sparkling cider, rolls, pies and $20 gift certificates to a major grocery store for turkeys. Please bring perishable items on the final day of the food drive (Tuesday, November 20th).
There will be a place to drop off items on the first floor of our office building at 38 Corporate Park, Irvine, CA 92606.
Contact Courtney Kring at firstname.lastname@example.org if you have any questions.
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