Essentials of Commercial Lease
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This article is written by Eho Menjo, an alumnus of Arunachal Law Academy, Lekhi, Naharlagun and pursuing an Advanced Criminal Litigation and Trial Advocacy course from LawSikho. This article deals with the essentials of a commercial lease agreement.

Introduction

A lease agreement is a contract which outlines the terms under which one party agrees to rent the property owned by another party. The agreement bounds the lessee to pay regular payments for a specified period in exchange of property of the landlord. Both the lessor and lessee have to face consequences if they fail to obey the terms of the contract.

The Commercial lease agreement is an agreement between landlord and tenant to rent property with the intention to operate a business.

When is this Document Needed?

A lease deed is a written contract between the landlord and the tenant. Lease deed is generally required when the property is leased for a long time, ranging between 1-5 years or even for a longer period. In such cases, a lease deed agreement plays an important role in maintaining the relationship between the landlord and the tenant and lays down provisions that legally bind them.

Types of Commercial Lease Agreements

There are several kinds of Commercial Lease Agreements. Following are some important types:

Full Service or Gross Lease

Full service or Gross Lease Agreement is that lease agreement which generally includes Expense Stop. Expense Stop is a mechanism of Full service or Gross lease agreement in which the lessee agrees to pay fixed operating expenses and landlord is responsible for paying all operating expenses below the Expense stop.

Expense stop can take the form of an agreed amount, typically expressed in an amount per square foot or per square meter or base year stop. A base year stop sets the expense stop equal to the actual operating expenses in the first year of the lease. For instance, if the actual operating expenses in the first year amounted to $100 per square foot, the expense stop would be set at $ 100 per square foot and the tenant would be responsible to reimburse the landlord for any expense above $ 100 per square foot in any subsequent year. 

Net Lease

Net lease is a contractual agreement where a lessee pays all or a portion of the taxes, maintenance costs and insurance fees for a property in addition to the rent fees. Net lease agreement is commonly used in a commercial real estate business.

Net lease is one of the most popular tools for commercial real estate investors who buy the property for income and don’t want to take any headache for maintenance, taxes and insurance etc. Generally, Lessor uses the Net lease contract to shift his/her burden to the tenant and take the benefit from the leased property without any administration of the property.

Following are the various types of net lease agreement: 

  • Single Net Lease Agreement: 

Single Net lease agreement is a commercial real estate lease agreement where the tenant agrees to pay all the taxes related to property in addition to rent cost. A Single Net lease agreement permits the tenant to take all the responsibilities of the property from the landlord. A single Net lease agreement is a less common commercial lease agreement.

  • Double Net Lease:

Double net lease is an agreement in which the lessee or tenant is responsible for both, premium of insurance of the building and property taxes of the leased property. In a single net lease, tenants are required to pay property taxes despite the rent cost. However, a double net lease is different from a single net lease and passes larger expenses in the form of insurance payment. The landlord is still held responsible for overall maintenance of property. Each month, tenants have to pay an additional payment in spite of the rent fees. Double net lease is commonly used in commercial real estate business.

  • Triple Net Lease: 

Triple Net Lease agreement is one of the commonly used commercial lease agreements. A Triple Net Lease agreement is an agreement where the tenant promises to pay all expenses related to the property including real estate taxes, insurance and maintenance, and all this payment is in addition to the rent cost. In absence of Triple, Double, and Single Net lease agreement, all this payment has to be paid by the landlord.

Modified Gross Lease

A Modified Gross Lease Agreement is a type of real estate agreement where the tenant or lessee agrees to pay the fees from the inception of the agreement. Modified Gross Lease is used for commercial spaces such as office buildings and it is usually used in an agreement where there is more than one tenant for a building or property. In this lease, the tenant or lessee has to pay all the taxes related to the parts of the building room he or she possesses.

Modified gross lease is a combination of gross lease and net lease. In modified gross lease tenant directly takes over the expenses related to his or her unit, including utilities, maintenance and janitorial costs, while the owner or lessor has to pay all other operating expenses of that building or property.

Percentage Lease

Percentage lease is a commonly used commercial real estate lease, in which the lessee or tenant agrees to pay a minimum rent fee and share a percentage of the revenue with the landlord.

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Essential Elements of a Commercial Lease Agreement

Definitions

The term ‘lease’ is defined under section 105 of The Transfer of Property Act, 1882 and it states that, a lease of immovable property is transfer of a right to enjoy the property or a specific or certain period to the transferor by the transferee. The transfer is made in consideration of the price paid or promised to be paid. 

Term

Commercial leases usually include the following terms:

  • Lessor and Lessee

According to section 105 of the Transferor of Property Act, 1882, one who transfers the property is known as the lessor or transferor and the one who receives the property is known as the lessee or transferee.

  • Premium

Premium is defined under section 105 of the Transfer of Property Act, 1882. According to the section, the price paid for obtaining a lease of immovable property is called premium.

  • Base Rent

Tenants have to pay a predetermined amount to the landlord every month for the office space. Base rent is different from the operating expenses and revenue. It is almost fixed and is usually fixed on a square foot per year basis.

  • Additional Rent

Additional fees is an amount that a tenant has to pay to the landlord for the extra expenses like after house service, maintenance of building and percentage rent (are often considered as additional rent expenses and not included in the base rent).

  • Use Clause

Many lease agreements will include use clause to define the activity the lessee or tenant can participate in or on the premises. These clauses protect the property from damage and limit the liability of the property owner or landlord. If possible, ask for a maximum usage clause just in case the business expands into other activities.

  • Free Rent

Free rent is also known as abated rent, free rent refers to the specified amount of free rent which is provided by the landlord to the tenant for specific month, usually at the beginning or at the conclusion of a lease. However, these offers are rare.

  • Turnkey

The word turnkey is one of the most popular words in real estate business and industry, turnkey is used to describe space that is ready to move into. If there is no time and you have less chance to choose new office space, agree to the terms or provisions, and move into the new space or area, a turnkey property can save time and aggravation, particularly if you do not need to make any of your own upgrades to the area. In a turnkey property, all of the fixtures, wiring, flooring, and design or decorative items like carpet and paint are already in place.

  • Usable square feet

Usable square feet is the space of square feet used directly and solely by lessee, including private restroom available to the lessee along with closets, storage and any other space to which only the lessee has access.

  • Rentable Square Feet

Rentable square feet is a term that refers to common spaces that are shared among multiple lessees along with usable square feet. More concisely, rentable office space is calculated by adding the usable square feet of the office space and a prorated share of any common space or area. Such common spaces typically incorporate shares, hallways, lobbies, restrooms and common areas.

Security Deposit

A security deposit amount is a payment a tenant makes to the landlord before the inception of a lease agreement. The security payment does not go towards rent, but rather it is held by the landlord as “security” against future loss that may occur during the lease term. 

Security deposit amount is refundable amount, when a tenant moves out from the office space landlord deducts the deposit amount if he found some defaults in the space. However, if there is no major damage that occurred during your lease, you will likely be refunded the entire deposit amount within 30 days.

Property Use and Occupancy Details

The lease should clearly describe the property under lease. It is important to determine exactly what space you are renting including the area, address, location, structure, restrooms, elevators and hallways, etc. Lease is typically paid at a square foot rate. Often commercial lease deeds are old and not updated and the actual space being leased is less due to remodelling, repairs or simple measurement practices. The actual space being leased needs to be determined to avoid overpaying for the lease.

Improvements

A lease should address what modification or improvements can be made to the space, which party will pay for the improvements, and whether the lessee or tenant is responsible for giving back the unit to its original condition at the end of the tenancy.

Property Damage

Most of the commercial leases commonly include one or more provisions dealing with the subject of who is liable for wear and tear to the leased property during the time of the tenancy. Tenants need to keep the space in the same condition in which they were received, and in the condition in which the lessee was obligated to keep during the lease. The landlord obtains insurance over the buildings/premises. Thus, a lessee is required to surrender the area or space in good condition at the end of the term.

Duties and Obligations

Duties and obligation of the landlord

If you are renting out a residential property to tenants, it’s your legal obligation to ensure that the facilities are “habitable” by maintaining the plumbing, repair of building and keeping it structurally sound. Following are some important duties and obligations of the landlord:

  • Maintenance

According to section 108(f) of Transfer of Property Act, 1882, one of the important duties and obligations of the landlord is to maintain or repair a building property and make sure that the tenant always gets the necessary items like running water, electricity, and so on, and if such repairs are done by lessee then he has right to deduct such expenses from rent fees. Landlords must also maintain common areas, keep up with repairs and follow all health and building codes.

  • Deliver the possession of unit

According to section 108(b) of Transfer of Property Act, 1882, since tenants sign the lease agreement, it is the landlord’s obligation to deliver the possession of the unit or office space. If tenants move into the unit or office space after the inception of agreement and finds that the unit is not vacant then the tenant may take legal action against the landlord for the same.

  • Rent Receipt

A landlord is obligated to issue a rent receipt to the tenant who makes payment of rent. Receipt must contain the details of tenants such as name of the tenant, month and year of rent paid, the amount received and sign of the landlord or his authorized person upon receipt. 

  • Safety

Landlords must ensure the safety and maintenance of the tenants of the leased property. As a landlord, it’s a duty to maintain and inspect the leased property and provide a free and safe environment within the leased property.

Duties and obligation of tenants

  • Rent

The first and foremost duty of a tenant is to pay rent on time. Rent is defined under section 105 of Transfer of Property Act, 1882, as the money, share, service or other thing to be rendered. The amount of rent is fixed on the lease agreement. If, tenant defaults in rent payment then the landlord may deduct the amount from the security deposit and take legal action on the regular defaults.

  • Refrain from using the property for illegal purposes

The tenant has a duty to the landlord to avoid the illegal use of the leased property. The tenant must be honest about his or her intentions for using the premises. Suppose, tenants enter into a lease agreement with a landlord by saying that he would use the property for office space but in actual, he is using the leased property for some other illegal purposes. In this case, the landlord has the right to terminate the lease.

  • Duty not to commit nuisance

The tenant must not unreasonably interfere with the use and enjoyment of possessors of other adjoining premises. It is very difficult to define unreasonable because it differs from case to case. For this reason, landlords define the restriction by putting terms in the lease that prevent tenants from causing disturbance and committing a nuisance to the other tenants by making too much noise, etc.

  • Allow the landlord to enter the premises

Since the landlord is responsible for the premises, he/she has all right to the tenant’s or lessees dwelling. However, the landlord can not enter the tenant’s office space without prior notice.

Extension of Lease

Lease is a legal agreement and is binding upon the lessor and lessee for a certain period. After the lapse of the period fixed in the lease agreement lessor and lessee have few options available. The lessee may vacate the property or agree to renew the lease agreement. The terms of the original lease are still in force and only the duration is extended for a certain period.

Waivers

According to the Cambridge dictionary waivers means an agreement that you do not have to pay or obey something. Waivers are defined as follows: when the landlords know that the tenant is breaching the lease, yet conducts the landlord-tenant relationship in the normal course, then the court may infer that the owner has waived the breach. For example, landlords did not accept the security deposit of the tenants during lease agreement and allow him to stay without any security deposit then later on he or she can not claim security deposit from lessee or tenant.

Disputes resolution

Many times serious disputes arise between landlords and tenants. The lease will provide alternative methods such as mediation, arbitration or filling an action in court through which they can settle the dispute. However, landlord-tenant disputes are usually resolved out through representation of counsel from dispute resolution lawyers from each of the involved parties.

Following are the popular means through which landlord tenant dispute can be resolved.

  • Arbitration

Arbitration is one of the dispute resolution processes where parties can resolve their disputes. A neutral third party is appointed to negotiate the disputes. The neutral third party is known as the arbitrator and the parties have to submit their disputes to arbitration. The arbitration can decide the resolution and the parties are bound by the decisions. Arbitration is more formal than mediation.

  • Mediation

Unlike arbitration, mediation is not binding on the parties. Mediator is a neutral third party which helps the disputed parties to resolve the disputes. Arbitration and mediation are faster and less expensive than litigation in the regular court.

  • Court

If the dispute is not resolved through the alternative dispute resolution then the parties may go for regular litigation in the court.

Miscellaneous

Apart from the above mentioned points, landlords and tenants must follow some miscellaneous rules or laws which are very important in a lease agreement.

  • The terms of the lease shall be construed in accordance with the laws of India.
  • The lease agreement shall be executed in two counterparts and the counterparts shall be deemed to be original. The lessee shall retain one set and the lessor shall retain another set.
  • Lessee shall always observe and follow all the terms and conditions of the lease agreement. 
  • Lessee shall not keep any good which is not permissible to be kept as per law.
  • Any claim arising out of lease deed, or any breach or alleged breach thereof, shall be settled as per the terms in lease deed or through regular court.
  • The lease agreement shall amend with the consent of both parties.

Do’s and Don’ts of a Commercial Lease Agreement

The right space for your office or business can make or break your success, especially if it is your first time lease agreement. You need to know the do’s and don’t of leasing before you hit the streets in search of a location for your business or office.

Commercial leasing do’s

  • Consult Your Attorney: 

Commercial lease is a complex legal document containing several details and conditions. Unless you have a legal background, there is a big possibility you will miss something important in your lease deed, therefore, you must have your attorney’s review before you sign the lease deed.

  • Negotiate:

Commercial space landlords always negotiate with tenants. In fact, most of the landlords intentionally inflate rental quotes to negotiate with tenants or lessees and to get good rent fees. So from a tenant’s perspective, it’s important to negotiate the landlord until it reaches an agreement.

  • Check references: 

Many landlords will inevitably check your references, but you should also check your landlord’s references as well. If a landlord doesn’t live up to his responsibilities, he can become an albatross around your company’s neck. Therefore, before entering into an agreement you should verify the track records of the landlord.

  • Value flexibility: 

Unlike residential leasing, flexibility must be the primary consideration for growing companies. Most of the time location will influence rental costs, a business on the move can’t afford to lock into a long term lease deed. If the business really takes off, you could find yourself stuck in an area that you have outgrown long ago.

  • Location: 

Location is one of the factors responsible for the success of the business or office. Therefore before selecting a location for your business, things to consider are; will this location attract customers and employees? Is there any competition nearby? Does it make financial sense?

Commercial Leasing Don’ts

  • Over lease: 

Often first time lessees make the mistake of leasing more space than they actually need. Space depends on the nature of your business therefore without any specific idea one must not lease a space. However, in most cases, it is better to have less space for a short period and retain the option of moving on as your business grows.

  • Neglect lease details: 

One must not sign the lease in a hurry because, for a fixed duration, your activities will be limited to the conditions as per your lease agreement. In your eagerness to move into new space, don’t overlook the details of the lease. If a condition could potentially harm or restrict your activities at any point in the near future, discuss it with your lessor and amend the lease as per both’s convenience.

  • Be discouraged: 

Landlords or lessors tend to view first time tenants or lessees with a certain amount of scepticism, particularly if this is the first time they have leased a commercial space. From a landlord’s perspective, due diligence requires them to check references and request credit reports about your business’ financial status. But don’t let the process bring you down. Compliance with the process is a necessary step toward finding a perfect location for your company.

Conclusion

A commercial real estate lease agreement is a binding legal agreement, the terms of which are pivotal in the survival of a business. The lease shall be prepared with careful consideration and ample time should be allowed for all stages of the lease negotiation and draftings. The lease agreement is the primary document referred to in the event of any dispute or disagreement between the parties to a lease. Therefore, a real estate attorney with significant leasing experience must be appointed to overcome many of the potential pitfalls that lurk within commercial leases. 

References 


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