Commercial lease is required when the property in question is purported to be used for official or business purpose. In technical terms, commercial property is property that derives its income from non-residential sources such as offices, retail space and industrial tenants, and are bought and sold strictly for their ability to produce income.
Unlike a residential lease, a commercial lease tends to cost many times more than a residential lease and is made for a longer duration, often lasting 5 years (can be less as well) or more vis-a-vis an average of 11 months as is the case of residential lease.
So, how do we go about commercial lease?
Types of Commercial Lease
In India, commercial leases are usually term based – and would have a specific time limit after which the lease will expire. In old times, some leases used to be perpetual, but this is a rare practice now given steadily increasing property value and consequent increase in rent. However, apart from straight forward leases, there is another category you should know about is Master-lease/sub lease – where the lessee has the right to further lease the property to others.
- Master Lease: The original leaseholder/tenant with become the Master tenant when a sublease is created.
- Sublease: The original tenant assigns some or all of his interests in the premises to a third party. The original tenant becomes the master tenant and the new tenant becomes the subtenant. The original is not replaced and is responsible for rent and damages for the term of the lease. The only way to release him from any liability is through Novation, with the landlord’s consent, in the original lease.
However, in other countries there are various types of leases, and some of these (with or without the terminology) are slowly being adopted in India in case of specialised transactions. Go through the list if you are interested.
- Net Lease: The tenant is responsible for rent plus property taxes for the premises.
- NN or Double Net Lease: The tenant is responsible for rent plus property taxes plus insurance.
- NNN or Triple Net Lease: The tenant is responsible for rent plus they pay for their share of property taxes, insurance and operating cost.
- Gross Lease: The tenant pays the landlord one set rent amount and the landlord has to make payment for insurance, real estate taxes and maintenance expenses. These are most common in multi-tenant buildings.
- Modified Gross Lease: In addition to the rent, the tenant is responsible for janitorial services provided in their space.
- Industrial Gross Lease: In addition to the rent, the tenant is responsible for paying for their share of utilities and janitorial services.
- Full Service Lease: All services, including utilities and janitorial services, are included in the rent.
- Index Lease: The amount of rent depends on a price index such as the Consumer Price Index (CPI). This is considered neutral percentage rate, because neither the landlord nor the tenant is picking the increase rate.
- Percentage Lease: This is a percentage of gross of sales. It will vary from year to year based on the success of your business.
- Graduated Lease: The amount of rent for future years can vary depending on certain factors, like gross income or an annual percentage increase.
- Step up Lease: Rent is increased by a pre-set rate or set amount, to be paid on a set schedule.
- Straight Lease or Flat Lease: The amount of rent is fixed for the Lease Term.
What are the main issues that are faced while drafting a commercial lease document?
The usage can vary considerably in case of commercial lease depending on the specific purpose it is used and needs to be tailored keeping in mind the specific needs of the tenant.
Here is a checklist for tenants to ensure an effective commercial lease deed.
Identify Party and Premises
Due care must be taken to correctly identify the parties to the agreement along with the premises that is the subject matter of lease agreement. The space the tenant leases is known as ‘premises’ and it becomes important for both the tenant and the landlord to clearly define the precise square footage of the premises. The premise defined in the lease often does not match the premise that the tenant expects to receive. Thus extra care must be taken to ensure that there exists no ambiguity in this respect. This is most important when you are entering into a lease contract with the builder himself – in case of a mall or office building. The space you are actually supposed to get should be mentioned in the agreement in an identifiable manner.
Term and Commencement
The term of the lease is the time period during which the tenant has exclusive possession and obligation to pay rent for the premises. The dates of commencement and termination of the lease needs to be unambiguously mentioned in the lease deed. The tenant’s needs must be known in advance to determine the length of the lease. Sometimes tenant make capital investments in making the leased space operational (think: setting up manufacturing units/ office fixtures/ interior decoration of substantial value) – and it makes sense only if the lease is sufficiently long term. This should be addressed in the agreement, and if the owner of the property wants to terminate the lease prematurely leading to losses – such losses should be calculated and recovered under the agreement by the tenant.
The date of lease and its commencement are often the same, but sometimes the commencement date is which coincides with the completion of improvements that the landlord agreed to. Hence, if the lease date and commencement date are different then the tenant must ensure that the improvements (if any) must be finished as per his requirements before paying the rent and also make clear whether tenant’s non-rent obligations begin before the commencement date to prevent any sort of problem.
Rent and Additional Rent
The rent forms a basic element of the lease agreement and must be clearly discussed by the tenant and the landlord. The mode of payment, the rate at which it will increase, due date etc. must be clearly stated in the agreement. Usually a significant sum is taken as security – and this has to be specifically dealt with in the agreement. It should be clarified whether there will be any interest on the deposit – in India, usually the deposit is interest free. A monthly due date for rent payment should be fixed – which is usually 4th or 5th of every month – but the parties are free to determine any date.
The grace period before a penalty is charged must be subject to negotiation. The penalty amount must also be discussed. Further, the tenant must carefully review the method in application for the rent increase during the term of the lease agreement. They should ensure that the increases must be based on the Consumer Price Index or a fixed percentage. It can also be a fixed amount of money – considering that a percentage increase leads to compounding related rapid increase during later period of the lease.
Expenses and Common Area Maintenance (CAM)
Review the expenses the landlord asks you to pay for diligently and make sure that they are reasonable, and related to building’s operations and consistent with the lease agreement.
Certain costs, like the landlord’s staff’s salaries, capitalized expenses (including major repairs), taxes on income and costs related to landlord’s violation of any governmental regulations are not the tenant’s responsibility and should not be allowed to creep into the agreement.
Common area maintenance (CAM) charges are also and important of concern to tenants. These are certain percentage share of the costs of the landlord’s for maintaining, operating, replacing and repairing the components of the building (eg. lift for the building or common area electricity usage), which the tenant must shell out for. Thus all CAM charges must be pre-determined and agreed upon by both the tenant and the landlord.
Repairs and Maintenance of Premises
Often the tenant is only responsible for keeping the premises in good condition and the landlord is responsible for most if not all maintenance and repair obligations.
However, in some cases these obligations may be evenly divided between the landlord and tenant. If so, it is needed to specify clearly which party is responsible for what repairs and maintenance. It is a good idea to put a cap on the expenditure the tenant must incur for such repairs.
Another significant factor that tenants must not overlook is to obtain exclusive rights to sell goods or provide services. For instance, you may want to operate the only movie theatre in a mall, as two such theatres may lead to loss of business. For this reason, you may want to prevent other tenants or the landlord from leasing out his other properties located nearby or in the same building to anyone carrying on a competing business. To ensure performance by the landlord, the tenant ought to ensure guarantee of an exclusive right in the agreement.
The tenant must know their rights to sublease/ assign the premises. Often there are strict prohibitions on subleasing or assigning the premises unless the landlord’s consent is obtained but whether it is to be granted or withheld is entirely the landlord’s prerogative. Many safeguards can be introduced in the lease deed in relation to this to prevent the landlord to use this power against the tenant. These may include creditworthiness or financial strength of the proposed assignee or demonstrating that the proposed tenant does not violate any exclusives that the landlord has set. Further, the tenant may also add a provision in the agreement setting a time bar on the landlord to give consent and any delay will waiver the landlord’s right to object.
Non Use or Misuse of Property
In case of commercial properties, in the event of non-use for more than 6 months of the premises can give a right to the landlord to file a suit for eviction against the tenant under certain laws in India. Ref: Section 13 of Rent Control Act of Bombay
Also there is a Public Premises Act – for premises leased or rented by public or governmental bodies. In case of any misuse or lack of use, or even use which is not covered by the lease agreement, the government body may be able to evict the tenant on basis of this Act.
Compliance with Applicable Law
The provisions in many leases call for tenant’s compliance with ‘all applicable laws’ during the term of the lease may seem innocuous at first. What could be unreasonable about a requirement to comply with the law? Such a clause in the agreement may make the tenant responsible for matters that are already not in compliance at the commencement of the lease term. This could be fault of a previous tenant or the landlord, and the new tenant should be made to suffer the consequences. This should be specifically addressed in the agreement. In such situations the tenant may either agree to comply with all applicable laws relating only to the tenant’s use or business at the premises during the term or they could obtain a representation and a warranty from the landlord that premises are in compliance with all applicable laws as of the commencement date. Taking such a representation is a good idea in any case.
Landlords ask for a right to prematurely terminate a tenant’s lease, by way of notice and in case of breach. However, this is a very sensitive issue for the tenant, as this can lead to huge losses. One must ask for a very long notice (6 months and 1 year notice period is common for commercial leases), and if possible entirely exclude such a possibility. Many commercial landlords are often fine with giving up this right in return of small amounts, which is a good idea for a commercial tenant. At least, the tenant can ask for a period during which the landlord can not exercise this right. Even the scope for termination for breach should be limited as far as possible as it is a serious commercial threat. Mutual terminations should be fine at any time.
Insurance is usually not dealt with in Indian lease contracts, but in high value leases and properties this can be very important. Insurance matters in the lease agreement must be diligently reviewed by both the tenant’s and landlord’s insurance agent, if any, to make sure that:
a) They are reasonable and
b) They can be satisfied.
Business/Operational Needs of the Tenant
The tenant must be clear about all his operational needs and must include terms that ensure his ability to carry out his business successfully and to his satisfaction. Such operational needs include parking space, location of the premises, environment around the premises, etc.
Damage or Destruction of Premises
In case of damage/destruction of premise, many leases contain a very pro-landlord provision leaving the tenant to adjust with the repairs being made which may not be to his liking or requirement or he may not know how long the repairs will take. This will adversely affect his business in all respects. Hence there should be a time limit set by the tenant wherein the landlord must complete all repairs.
If the first draft comes from a landlord, especially mall owners and major developers, there may be clauses that give the landlord the right to relocate the tenant to a new location within the building or locality. This affects the tenant’s business as location is a significant factor in building the repute of a business. It is not a standard clause in India and most parties manage to remove these clauses successfully through negotiation.
Thus the above mentioned are certain issues that the tenant must keep in mind before entering into a commercial lease agreement and ensure that his best interests are realised to be able to expand his business. Knowing these issues in advance will ensure the most effective representation of the tenant’s business.
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