Leasing Nightmares: Avoiding Lease Problems Before Opening for Business
7 Min Read By Daniel S. Brozost
Blackacre LLP is a boutique fixed fee real estate law firm with a restaurant leasing specialty. From its experience serving as counsel to numerous restaurant clients, Blackacre’s attorneys know that a good lease is crucial to a restaurant’s success, while a bad lease can doom an otherwise successful restaurant to failure. In the coming articles, Blackacre’s attorneys will write on how to prevent a restaurant lease from becoming the next “Leasing Nightmare."
While much thought and consideration during lease negotiations is given to protecting a tenant from its landlord’s acts or omissions during the lease term, some of the most commonly-encountered issues after lease execution pertain to the earliest stages of the landlord-tenant relationship, specifically the phase where the parties are preparing and exchanging plans for the premises, obtaining construction and use permits, and building out the space for the tenant’s use – all of which should occur well before a tenant actually opens for business at the premises and begins paying rent.
If a tenant’s lease is not carefully negotiated …
If a tenant’s lease is not carefully negotiated, a tenant may find itself bound by lease for premises in which it can’t successfully operate or it may be required to start paying rent well before it’s open for business and generating revenues. As discussed in this article, in order to avoid this potential Leasing Nightmare, it is critical to negotiate adequate protections in the lease for issues that may arise during these early stages of the relationship – such that a tenant has adequate recourse if it can’t obtain building or use permits or the landlord fails to timely and/or properly deliver possession of the premises to tenant – all to ensure that rent does not commence until tenant is truly ready and able to open for business to the public.
Tenant’s Plans and Specifications
Once a lease is executed by the parties, typically the next step for a tenant is to prepare its plans and specifications for its build-out, obtain the landlord’s approval for such plans and obtain all necessary permits for such work. Most landlords will have approval rights over tenant’s plans and specifications and will require a tenant to provide draft plans within a certain time period following lease execution.
… a tenant may find itself bound by lease for premises in which it can’t successfully operate or …
In order to successfully navigate this earliest stage of the relationship, it’s important that the lease contain very clear deadlines and requirements with respect to tenant’s obligation to provide plans for landlord’s approval. Given that there may be penalties in the lease for a failure to timely prepare plans, it’s critical to ensure that the tenant can realistically meet such deadlines (in consultation with tenant’s architects and designers), and that it has the necessary materials to commence preparation of plans. The lease should specify whether the tenant requires certain “base building plans” from the landlord as a pre-condition to tenant commencing its plans, and any deadline for tenant’s plans in the lease should not commence until tenant has received landlord’s plans.
Following tenant’s preparation of plans, a landlord will normally have some time to review and approve (or disapprove, as the case may be) tenant’s plans. Assuming that the tenant may have a tight schedule for construction and opening, the lease should indicate precisely how long a landlord has to review and provide comments to tenant’s plans. For example, the lease should state that landlord has up to 10 days to review tenant’s plans, after which tenant has 10 days to respond with revised plans, and so on, until the plans are approved.
In order to avoid a landlord dragging its feet on reviewing plans, or not providing any response whatsoever, a lease should also specify that the plans are “deemed approved” if the landlord hasn’t responded by its review deadline. This helps to ensure that both parties are motivated to review and respond to their respective submissions in the interest of having plans finalized as quickly as possible.
Building and Use Permits
Following landlord’s approval of tenant’s plans, the lease will often require the tenant to apply for building permits with applicable local authorities. Again, the lease should be specific regarding the deadline for tenant to apply for such permits, and for the avoidance of any disputes as to whether such applications were timely submitted, tenants should keep records of all submissions and keep the landlord apprised as to all communications with the municipality.
… it may be required to start paying rent well before it’s open for business and generating revenues.
Some tenants are keen to get through the planning and permitting processes as quickly as possible. Accordingly, tenants often submit their plans to both the landlord and the municipality concurrently, such that both parties are reviewing and commenting on the plans simultaneously. While doing so could result in a tenant having to deal with two sets of comments at the same time, it can also help avoid multiple rounds of revisions later in the process and significantly shorten the time period for obtaining approvals and permits.
One of the worst nightmares a tenant can experience is having its plans or use applications rejected by applicable authorities without having any recourse under its lease. In this situation, a tenant could find itself bound by a long-term lease – with obligations to pay rent, maintain the premises and otherwise perform under the lease – without being legally permitted to operate its business or to build the space as tenant desires. In order to avoid this particular nightmare, it’s critical to insist on having a permit contingency in the lease, such that the tenant can terminate the lease if, despite its good faith efforts, it’s unable to obtain its building permit for the approved plans or is unable to obtain any necessary use permits or licenses (including any permits which may be required for alcohol sales, building signage or other operational aspects of the business).
Landlords, however, are typically reluctant to agree on any tenant-oriented permit contingencies, as any landlord wants a binding long-term agreement without any “outs” for the tenant. Accordingly, a tenant should be prepared to negotiate with the landlord over this provision, with the understanding that it may be difficult to ultimately obtain a permit contingency. Without a permit contingency, a tenant should make sure it’s absolutely certain that it can obtain all required building and use permits and licenses without issue before executing the lease.
Landlord Delivery Failures
Another potential nightmare involves a landlord’s failure to timely deliver the premises to a tenant in the condition required by the lease. Unless a lease contains specific penalties for such failure, a tenant could find itself in a position where it is waiting indefinitely for its landlord to perform, without any recourse. In order to avoid this particular nightmare, it is critical for the lease to include certain protections for the tenant. First, the lease should specify an “anticipated” delivery date for the premises. Second, in the event that landlord fails to deliver possession by the anticipated date, the lease should include specific penalties.
A well-negotiated lease will often enable a tenant to receive rent credits and/or late fees if the landlord fails to deliver on time, as well as a termination right with reimbursement of tenant expenses if landlord fails to deliver by some further outside date. Third, and probably most importantly, the lease should delay rent commencement until landlord has delivered the space and provided an appropriate build out period.
Ultimately, the landlord’s main goal throughout the early stages of the lease relationship is to have the tenant commence paying rent as soon as possible. Accordingly, landlords will often attempt to negotiate rent commencement provisions that require rental payment to begin on a specified date, or solely following landlord’s delivery of possession of premises.
From a tenant’s perspective, rent should not commence until tenant has a fair chance to complete its plans, permits and build-out and open for business in the premises. Most tenants will agree that it would be a major nightmare to be required to pay rent prior to opening for business. The best way to mitigate this nightmare is to negotiate a rent commencement provision that accounts for both landlord’s delivery obligation and tenant’s permit risk, such that rent will not commence until both the premises has been delivered (in the condition required by the lease) and tenant has obtained its required permits. Rent commencement provisions are often drafted such that tenant will have a specified period of time (often between 90 and 150 days depending on the complexity of the improvement work) following both delivery of possession and receipt of permits. Most landlords will also insist that rent commence on the date tenant opens for business if earlier than such specified build-out period, but that’s typically not a problem for tenants since at that point presumably revenues are being generated.
The early stages of the lease relationship can be fraught with issues if a lease is not carefully negotiated. It’s difficult enough for a tenant to generate plans, obtain governmental approvals and build out a space (and pay for all of it) without also having to deal with the landlord failing to do its part.
Accordingly, it’s critical that any lease include protections for tenants such that both parties’ obligations are clear, with specific remedies available if the landlord fails to perform. Without such protections, tenants may find themselves in very difficult situations – including paying rent before opening for business, having to accept possession of space that doesn’t match expectations, or being bound by a long-term lease for premises that don’t work for the intended uses. Most of these potential nightmares can be appropriately mitigated by including protections and remedies in the tenant’s lease.