April 23rd, 2023
April 23rd, 2023
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4.5 - 1 vote
Once a business owner finds an appropriate commercial real estate space in which they can conduct their business, it is essential that the landlord and the business tenant formally spell out their landlord/tenant relationship using a Commercial Lease Agreement. The lease should include descriptions of how long the lease will run, how much rent will be paid, and other important elements of the deal that will be binding on both of the parties. It is vital that the parties understand the meaning of these provisions. This guide will walk through the most common and important elements that are included in a commercial lease agreement so that the parties can avoid future misunderstandings and disputes, as well as helping them bargain for favorable modifications. For more information about how to negotiate a good commercial lease, please see the guide Leasing a Commercial Space: Find the Best Fit for your Business.
Important basic terms to understand in this guide include:
-- Commercial Lease: a contract between a business tenant and a landlord for use of a commercial property to generate a profit through the sale of goods, services, or manufacture of a product.
-- Landlord: the party who owns the rental space and is renting it out to the tenant
-- Tenant: the party who will be conducting business in the rental space that they are leasing from the landlord
All leases usually begin by naming the parties to the lease, also known as the landlord and the tenant or lessor and lessee. It is crucial that these parties are named thoroughly and accurately. For example, if the business is an LLC or corporation, the name on the lease should be the legal name including the "LLC" or "Inc." end designator. If an error is made in writing the accurate legal name of any of the parties, there can be serious and long-lasting repercussions that affect the landlord/tenant relationship going forward. For example, if the owner of an LLC or corporation lists their own name rather than their official corporate name, they may be held personally liable under the lease, frustrating the main purpose of incorporating the business or becoming an LLC in the first place.
Generally right after the parties are listed, a commercial lease includes a clause that identifies and describes the space that the tenant will be occupying. This clause is known as the "Premises Clause." The length and detail of this clause depend on the space that is being rented. If the tenant is renting an entire building, the address of the building along with a description of any parking or outdoor spaces that come along with the building are usually sufficient. However, if the tenant is renting a space inside of a building, the premises clause provides a much more detailed and precise description. The lease should specify what is included within the space to be rented, including common areas such as hallways, restrooms, and elevators.
In addition to describing the building or area to be leased, there should be a determination of whether there is a distinction between the space leased and the actual space that is usable. Often, tenants are required to pay rent on a commercial space measured from wall to wall, also known as a "vanilla shell," even though, after the area is built out for commercial purposes, the resulting useable space may be significantly smaller. Further, some leases measure the space including the thickness of the walls.
A use clause works to limit how the tenant is allowed to use the space they are renting. These limitations can range in scope and can be as broad as limiting what sort of business will be conducted in the space to as specific as detailing the individual services and products that will be offered. A landlord may wish to impose these use restrictions for many reasons including:
Though most commercial leases include a use clause, they are generally brief and do not place an unreasonable number of restrictions on the tenant.
Usually, the beginning of a commercial lease has a clause known as the "Term Clause." This clause provides a description of the length of the lease and provides the starting and, if known, ending dates of the tenancy. Commercial leases can be arranged to last for different periods of time, known as the term, depending on the situation. A commercial lease agreement can create a short-term tenancy, for example, renting a booth for a trade show. Leases can also be created so that they last for a longer specific period of time, usually a number of years. A longer-term arrangement is often preferable for businesses that plan to put down more permanent roots and advertise their business. No matter the arrangement, it is critical that the rental agreement is specific about the term of the tenancy. This clause also includes information about when and how the parties can renew the lease if they decide to continue renting after the initial lease term expires. To renew an expired lease at the end of its term, the parties may use a Lease Renewal Agreement.
Especially for commercial leases, it is important that the lease set out the exact date when the lease starts and the tenant becomes responsible for paying rent. For example, some leases start as of the date the lease is signed by the parties even though the tenant has not yet begun to conduct business. Commercial leases can, and often do, have multiple start dates that correspond to when the tenant can enter the property to begin setting up, when the rent is due, when the tenant becomes responsible for securing insurance, when the business may open to the public, and so on.
For most businesses, the amount of rent obligation that must be paid to a landlord is an extremely important issue. Having a manageable rent can make or break a new business as renting a space is usually one of the biggest initial expenses that the business will take on. The section of the commercial lease which outlines the rent arrangement should be thorough and specific, including the amount of rent that will be paid, when and how the rent will be paid, which parts of the landlord's operating costs will be passed along to the tenant, and how rent interacts with other parts of the agreement, such as the provision of a tenant improvement allowance that will give the tenant some funds to prepare the space. This section should also describe allowable rent increases, known as escalations, how often they can occur, and how they will be computed. Commonly, rent increases are less frequent for leases that are for longer periods of time due to the additional stability that the landlord has of having a guaranteed tenant for a longer period of time. If the landlord wishes to change the rental price after the lease has been signed, they may use a Change of Rent Notice to document the change in writing.
Many leases include a clause requiring that the tenant pay the landlord a security deposit to ensure that cash will be available if they later fail to pay the rent or don't make other payments as required by the lease. Unlike residential landlords, who are limited in most states in how much rent they may as for as a deposit, commercial landlords may demand whatever amount they need as a safety net to cover rent, damages, and other tenant financial obligations.
In place of a security deposit, some commercial landlords require that the tenant provide a letter of credit from their bank. This document is used so that the bank will set aside an agreed-upon amount of money for use by the landlord should the tenant not meet their financial obligations as outlined by the lease.
Often, commercial spaces must be customized or remodeled to fit the needs of the commercial tenant, so a large part of the commercial lease addresses this issue. The lease should memorialize the landlord and tenant's agreements about who will do the designs, who will do the remodeling work, when this will be done, and who will pay for it. It is also crucial to specify whether the tenant will be responsible for returning the space back to how it was originally if and when the lease ends and they leave the building. This can be expensive and, in some cases, impossible depending on the improvements and the premises itself, so it is especially important to have a clear understanding of this obligation ahead of time.
Commercial leases nearly always include a maintenance clause concerning the tenant's duty to care for the rented space and maintain its condition. For tenants renting a space that has multiple tenants, the lease should also make clear how the utilities will be billed and paid for. The utilities clause and maintenance clause are usually near each other in the lease as they cover related issues. Finally, also related to maintenance, commercial leases often have a provision regarding the tenant's responsibility to keep the space up to code. This is often known as the "compliance" or "compliance with law" clause. For more in-depth information about the duty to maintain a commercially leased space, please see the guide "In a Lease Agreement, who has the Duty to Maintain and Repair?", which discusses the maintance of both commercial and residential leased properties.
Most commercial leases include a clause specifying the types of insurance that the tenant is required to carry while renting the space. There are many different types of insurance that are available to cover the risks associated with renting a commercial space. Some of the most common types of insurance include property and liability insurance, rental interruption insurance which covers if the business is unexpectedly interrupted, and leasehold insurance which covers the tenant if the lease is canceled due to circumstances beyond their control and they must rent a different location for a higher rent. The landlord and tenant should negotiate to decide which forms of insurance would be most necessary depending on the context of the lease, the landlord's requirements, and the needs of the business and then memorialize this in the lease itself for clarity going forward. Business owners often use insurance brokers to be sure they select an adequate level of coverage for their business.
There are a number of other clauses that are frequently included in commercial leases depending on the context of the lease and the type of business being operated. Some of the other important clauses include an Option to Renew or Sublet (also known as a Flexibility Clause), Breaking the Lease, Disputes, Attorney's Fees, Foreclosures, and Guarantors. The landlord and tenant should both carefully evaluate the situation to decide which additional clauses apply to them and should be included in the lease.
An unclear commercial lease can lead to a frustrating, and potentially expensive, experience for both a landlord and a commercial tenant. By creating a clear and thorough commercial lease, the parties can ensure that their business dealings will be free from misunderstanding, miscommunication, and future disputes. These are the most important elements that a commercial lease should address:
1. Information about the parties to the lease, specifying the legal names of the landlord and tenant, being sure to include any applicable end designators.
2. A thorough description of the premises that is being rented, including the address, square footage, and any necessary distinctions between the rented space and the usable space in the property.
3. A clause limiting the sorts of commercial activity that are allowed to be conducted on the property.
4. The term, or length, of the tenancy, as well as spelled out dates for when the tenancy begins and when the tenant is obligated to begin paying rent to the landlord.
5. The amount of rent that will be paid and when/how the tenant will make those payments.
6. A security deposit that the tenant must pay to the landlord upfront to cover the cost of any future unpaid rent or damages that must be repaired.
7. A clause addressing remodeling that may occur in the space, who will pay for it, and how the space will be returned back to how it originally was at the termination of the tenancy.
8. Clauses describing the tenant's duty to maintain the property, pay utilities, and keep the space up to code.
9. A description of the forms of insurance the tenant is required to maintain while renting the property.
10. Other important clauses, such as options to renew or sublet, break the lease, attorney's fees, and guarantors, depending on the specific circumstances of the business and the lease itself.
About the Author: Malissa Durham is a Legal Templates Programmer and Attorney at Wonder.Legal and is based in the U.S.A.