That lease agreements are getting fatter is not a bad thing — quite the opposite, in fact, according to a recent panel of commercial leasing lawyers and a litigator. The rising page counts of these contracts reflect the addition of provisions made to prevent problems that have arisen in the past.
Clarity of leases was an over-riding theme in the session Renewal Options and Resets last week at the Real Estate Strategy & Leasing Conference in Toronto. The session had several takeaways for parties on either side of the table.
Here are five tips for commercial tenants as they review, negotiate and exercise lease extensions and renewals.
1. Distinguish between extensions and renewals
Melissa McBain, partner, Daoust Vukovich LLP, cautioned against using the words “extension” and “renewal” synonymously in lease agreements. This occurs frequently, because the options have much the same effect in continuing the relationship between the landlord and tenant. In the eyes of the law, however, an extension extends the existing contract, whereas a renewal creates a new contract — a subtle but important distinction.
For example, under an extension, the landlord can cite violations of the agreement that pre-date the current term as grounds to end the lease, as the contract continues uninterrupted. As another example, under a renewal, unless otherwise stated, the tenant bears no responsibility for defaults by a third party to which it has assigned its rights, thanks to the clean break between contracts.
“Obligations on the tenant to restore are theoretically triggered on a renewal,” added McBain, highlighting yet another example. “And while that’s interesting and theoretically true, it’s probably at odds with what the parties intended when they’re renewing the lease.”
2. Leave time to satisfy pre-conditions
Sonja Homenuck, partner, Dentons Canada LLP, recommended that tenants who plan to exercise an option to extend or renew their lease talk to their landlords as soon as they’ve made that decision. Tenants should leave themselves enough time to make different arrangements should the need arise, she said.
“Depending on the size and uniqueness of the premises you’re in, how long would it take you to find alternative premises?” Homenuck asked rhetorically.
Tenants should also leave enough time to address outstanding issues, ahead of the hard deadline for providing notice, in case the landlord asserts that its pre-conditions have not been met.
“You may not be able to exercise your option properly until you have complied with them,” said Homenuck. “In the worst-case scenario, you may have lost your option entirely.”
Common pre-conditions include that the tenant is in good standing, the tenant personally is exercising the option and the tenant is actually occupying and using the premises.
3. Define fair market rent upfront
Comparable buildings, geography and use are some of the qualifications to consider using to define fair market rent, said Yael Bogler, partner, Owens Wright LLP.
For example, she said, landlords may want to specify that buildings have to possess certain features, such as LEED certification or parking, to be considered comparable. Within comparable buildings, there’s the question of whether to look at deals for extending and renewing tenants, deals for new tenants — whose rates tend to be lower — or deals for both groups.
Added Bogler: “If, for example, the tenant has spent a great deal of their own money, and they’re not getting their tenant allowance and they’re the ones building out the space, they don’t want the landlord to use comparably improved premises in looking at comparables in fair market rent, because they’re then effectively paying twice — or paying interest on their improvements.”
As for geography, mapping out boundaries with street names is one way to create a common definition of the “area” between tenant and landlord. What constitutes a comparable use is also subject to interpretation without further refining, such as specifying “market rent for a financial institution.”
4. Avoid and expedite arbitration if possible
Some options to extend or renew a lease provide for arbitration if the tenant and landlord can’t agree on what is fair market rent. However, Sharon Addison, partner at McLean & Kerr LLP, said it’s advisable to avoid arbitration, citing the cost and time it takes to complete the process, as well as the potential strain it will put on the ongoing relationship.
Failing that, the litigator recommended a number of strategies for expediting the process. For one, agreeing to select one arbitrator instead of three arbitrators will simplify scheduling. For another, defining the geographic area that will be examined as each party builds its case as to what is fair market rent will narrow the distance between tenant’s and landlord’s positions.
“If you can come to agreement as to what your appraisers are going to look at — what area, streets — that helps,” said Addison. “You have them looking at apples to apples.”
5. Understand the alternatives to options
Lydia Pilch, partner at Goldman, Sloan, Nash & Haber LLP, said that in cases where a landlord does not provide an option to extend or renew a lease, tenants could ask for the right of first option or the right of first refusal. The right of first option requires the landlord to ask the tenant whether it’s interested in meeting the terms on which the premises are going to be offered before taking them back to market. The right of first refusal requires the landlord to give the tenant an opportunity to match any third-party offer for the premises.
“These are things you don’t see often, because tenants are typically getting renewal options and there’s a lot of business planning that goes around the timeframe that they’re prepared to stay in the space,” said Pilch.
The rarely used alternatives demand the same kind of clarity as clauses containing an option to extend or renew a lease. For example, a right of first refusal should set a deadline for the tenant to match a third-party offer.
“It all comes down to drafting … which is why leases have grown,” said Pilch. “There’s a horror story behind every little bit of expansion of language.”
Michelle Ervin is the editor of Canadian Facility Management & Design.