Te nant s Checklist of Sile nt Lease Issues, Se cond Edition

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1 Te nant s Checklist of Sile nt Lease Issues, Se cond Edition (Part 2) S.H. Spe nce r Compton and Joshua Ste in Some things may be better left unsaid, but that s rarely a good idea in the commercial lease. S.H. Spence r Compton is vice pr eside n t and special counsel at Fir st Amer ican Tit l e In s ur ance Company of New Yor k in New Yor k Cit y. Joshua Stein is a r eal est at e and f in ance par t ner at Lat h am & Wat kin s LLP., a member of t he Amer ican Col l e ge of Re al Est at e Lawye r s, and aut hor of A Pr act ical Guide t o Re al Est at e Pr act ice (ALI-ABA 2001). He is Secr et ar y of t he New Yor k St at e Bar Associat ion (NYSBA) Re al Pr oper t y Law Sect ion. Ear l ie r ver sion s of t his checkl ist f ir st appear ed in t he New Yor k St at e Bar Associat ion s New Yor k Re al Pr oper t y Law Jour nal, 30 N.Y. Re al Pr op. L.J. 184 (2002) and 27 N.Y. Re al Pr op. L.J. 123 (1999). Th e checkl ist was conceive d, in it iat ed, and edit e d by J os h ua St ein. Ot h e r member s of t he Te n ant s Sil en t Le ase Is s ue s Subcommit t e e in cl uded David Badain, Joel Bin st ok, Har ve y Bon e par t h, Mor de cai Br aunst ein, Robe r t Br in g, Phil ip Br ody, St eve n Coh e n, Nancy Con n e r y, Kat h l e e n Cook, Samuel Gil be r t, Hol l y Gl adst one, Bar r y Gol dbe r g, Gar y Goodman, James Gr os s man, Andr ew Her z, Jonat han Hof f man, Gar y Kah n, Lawr en ce Kobr in, Andr ew Lan ce, Br uce Le uzzi, Be n j amin Mah l e r, Me l vyn Mit zner, John Ol e r, Huck Qavan augh, Robe r t Re ichman, Rh on da Schwar t z, Robe r t Sh ansky, Kar e n Sh er man, Bar r y Sh imkin, David Te l l, Mich ael Ut evsky, Wil l iam Vie t s, Be n j amin We in st ock, and Al l en Wie de r. Th e checkl ist does not r epr esent a posit ion st at ement or r ecommendat ion by t he publ ish e r or by t he New Yor k St at e Bar Associat ion or it s Re al Pr oper t y Law Sect ion, Comme r cial Le asin g Commit t e e, or any of t heir subcommit t e e s, or any or ganizat ion wit h wh ich any aut hor or ot her subcommit t e e member is af f il iat ed. If you have suggest ion s f or t his checkl ist or woul d l ike t o r epr in t it, pl ease send t o joshua.st w.com or shcompt on@f ir st am.com. Copyr igh t 2003 New Yor k St at e Bar Associat ion. THIS CHECKLIST, f or at t or neys who r epr esent comme r c ial space t enant s, is in t e n de d t o hel p t enant s at t or neys ide n t if y and (if t hey ch oos e t o) r ais e sil e n t l ease issue s when t hey r evie w a t ypical l an dl or d s pr oposal f or a comme r c ial l ease. Th e sil e n t issue s can be some of t he mos t impor t an t t hat a t enant s counsel may want t o r ais e in negot iat in g a l ease. Par t 1 of t his ar t icl e, which appear ed in t he Ma r c h 2003 issue, cover ed 23 of t he mos t impor t an t sil e n t issue s t hat a t enant s l awye r migh t want t o conside r. Th is Par t 2 wil l examin e t he r ema in in g Opera ting Exp e nses Ca lcula tion and Auditing 24.1 Statement by Professional. An in de pendent man agin g agent or (be t t e r ) a cer t if ie d publ ic account ant shoul d pr epar e t he st at eme n t of

2 oper at in g expe n s e s. At t a c h as a l ease exh ibit t he l andl or d s o per at in g expe n s e st at eme n t s f or t he pr ecedin g f ew ye ar s. As k t h e l andl or d t o conf ir m t hat : (a) t hese wer e t he st at eme n t s a c t u a l l y used f or pass-t h r o u g h s t o exis t in g t enant s; and (b) f ut ur e oper at in g expe n s e s wil l be cal cul at ed t he same way Time for Revision. Set a t ime l imit f or t he l andl or d s r evision s t o oper at in g expe n s e st at eme n t s an d make t hat l imit subj ect t o a t ime is of t he essence qual if ie r Gross-Up. In any ye ar t he buil din g is not f ul l y occupie d, oper at in g e xpe n s e s ar e of t en gr ossed up as if t he buil din g had been f ul l y or near l y f ul l y occupie d dur in g t he ent ir e ye ar. Con f ir m t hat t he base ye ar and adj ust me n t ye ar ar e t r eat ed consis t e n t l y and t hat t he gr oss-u p cal cul at ion s make sense Timing of O perating Expense Statement. Th e l andl or d shoul d pr ovide t he annual oper at in g expe n s e st at eme n t wit hin a r easonabl e t ime ( days ) af t er ye ar -e n d, especial l y when t he t enant pays mo n t h l y oper at in g expe n s e escal at ion est imat e s on account New Expense Items. If t he l andl or d l at er in cur s new cat egor ie s or it e ms of expe n s e t hat wer e not bein g in cur r e d when t he l ease was sign e d (e.g., a new ear t hquake in sur an ce pr ogr am or expan de d s e cur it y), ask t he l andl or d t o gr oss up t he base ye ar t o r ef l ect what t his expe n s e woul d have been if t he l andl or d had al r eady be e n in cur r in g it t he day t he l ease was sign e d Right To Review and Challenge. Th e t enant shoul d have t he r igh t s t o examin e and quest ion t he l andl or d s oper at in g expe n s e cal cul at ion s. Th os e r igh t s shoul d sur vive t he t er min at ion of t he l ease. Th e l ease shoul d give t he t enant r easonabl e t ime t o: (1) n ot if y t he l andl or d t hat it want s t o audit expe n s e s ; (2) conduct and compl e t e t he audit ; and (3) specif y if, and how, it cont est s t he l andl or d s cal cul at ion s. Avoid any schedul e t hat r equir e s t he t enant t o pr ovide mor e det ail t han is r easonabl e at any par t icul ar st age of t he pr ocess. If t he t enant dis cover s egr egious er r or s, l et t he t enant r eopen oper at in g expe n s e s f r om e a r l ie r ye ar s, even if t he t ime t o do so has ot her wise expir e d Books and Records. Re quir e t he l andl or d t o keep books and r ecor ds, f or a specif ie d numb e r of ye ar s, in a sin gl e pl ace under a unif ie d s ys t e m Base Year. Th e audit r igh t shoul d in cl ude t he base ye ar, expir in g no ear l ie r t han t he expir at ion dat e f or t he r igh t t o audit t he f ir s t oper at in g ye ar. Th e t enant may wish t o audit t he base ye ar at t he same t ime t hat it audit s t he f ir s t oper at in g ye ar Landlord s Responsibility for Audit Cost. Th e l andl or d shoul d pay t he cost of audit (cr e dit it again s t t he next mon t h s r ent ) if t he audit dis cl os e s an over char ge of mor e t han per cent Most Favored Nation; Landlord s Discovery of Error. If some ot her t enant s a u d it dis cl os e s a dis cr e pancy, t he l andl or d shoul d aut oma t ical l y give t his t enant t he benef it of any r esul t in g adj ust me n t t o oper at in g expe n s e s e ven if t his t enant does not ask f or it. If t he

3 l an dl or d f or get s t o do so, t he l andl or d mus t pay in t e r e st at a penal t y r at e. Al s o, if on a par t icul ar issue t h e l andl or d make s a bet t er deal wit h any ot her t enant, t his t enant shoul d get t he benef it. If t he l andl or d f ail s t o t ime l y dis cl os e t he bet t er deal t o t his t enant, t he l andl or d shoul d pay a penal t y (but don t cal l it t hat ) Choice of Auditing Firm. Th e l ease shoul d not l imit t he t enant s r igh t t o engage a f ir m of it s own choosin g (e.g., a cont in ge n t f ee l ease audit or ) t o examin e t he l andl or d s books and r ecor ds Parking Lots. Tr e at t he cost of f il l in g pot hol es and r est r ipin g as an oper at in g expe n s e, but r esur f acin g as a capit al expe n s e t o be bor ne by t he l andl or d wit hout r eimbur s e me n t. Re quir e r e s ur f acin g at l east once ever y ye ar s. Excl ude any par kin g l ot ma in t e n an ce cost s f or at l east ye ar s af t er t he comme n c e me n t d a t e Tenant-Specific Exemptions. Look f or j ust if icat ion s t o suppor t exe mpt ion f r om par t icul ar expe n s e s (e.g., el evat or expe n s e s f or a gr ound f l oor t enant ) Confidentiality. If t he l andl or d r equir e s t he t enant t o agr ee t o sign a conf ide n t ial it y agr eeme n t r egar din g any f ut ur e l ease audit, in s is t t hat t he f or m of agr eeme n t be at t ached t o t he l ease, or t hat t he agr eeme n t be buil t in t o t he l ease. Eit h er appr oach avoids t he r is k of ext e n de d del ays in t r yin g t o negot iat e a conf ide n t ial it y agr eeme n t when t he need ar is e s Credit. Tr y t o get cr edit f or any in come t he l andl or d der ive s f r om c o mmo n ar eas (e.g., sign age ) New Buildings. Par t of t he busin e s s negot iat ion of a l ease in a new buil din g wil l be t he negot iat ion of a f air base ye ar. Th e par t ie s ar e bot h at gr eat er r is k sin ce t her e is no oper at in g his t or y. Th e par t ie s may need t o adj ust t he base ye ar t o a ye ar (or aver age of sever al ye ar s ) in which t he l andl or d has achie ved a cer t ain occupancy l evel (e.g., 100 per cent ). 25. Opera ting Exp e nses Exclusions Th e t enant may desir e t o excl ude at l east t he f ol l owing f r om o per at in g expe n s e s : 25.1 Above-Standard Cleaning. Cos t s of cl eanin g por t ion s of t he buil din g t h at have cl eanin g r equir e me n t s high e r t han t he t enant s (e.g., cl eanin g some ot her t enant s empl oye e caf et er ia) Americans with Disabilities Act. Ame r ican s wit h Dis abil it ie s Ac t ( ADA ) compl ian ce cost s, par t icul ar l y when t r igge r e d by t he oper at ion s of ot her t enant s Advertising. Ad ver t is in g expe n s e s, in cl udin g t he cost of main t ain in g an y We b sit e Art. Th e pur chase or main t e n an ce of any ar t wor k or scul pt ur e Breach of Lease. Cos t s in cur r e d because any par t y br eaches any l e as e Capital. Cos t s t hat under gener al l y accept ed account in g pr in cipl e s

4 ( GAAP ) consis t e n t l y appl ie d woul d be conside r e d capit al or ar e ot her wise out side nor ma l cost s and expe n s e s in connect ion wit h t he oper at ion, cl eanin g, man age me n t, secur it y, main t e n an ce and r epair of simil ar buil din gs ; or as an al t er nat ive, per haps al l ow capit al expe n dit ur e s if (1) t he t enant appr oves any expe n dit ur e above a cer t ain l evel, or (2) an expe n dit ur e is j ust if ie d by t he cost of r epair s or under t aken t o r educe oper at in g expe n s e s, and t hen onl y t o t he ext e n t t hat t he l andl or d demo n s t r a t e s act ual r educt ion Collateral Source. An y cost r eimbur s e d by in sur an ce pr oceeds (or t hat woul d have been so r eimbur s e d if t he l andl or d had car r ie d cus t oma r y in sur an ce ), any condemn a t ion awar d, or an in de mn if icat ion f r om any t hir d par t y Construction. Th e cost t o per f or m in it ial const r uct ion and t o cor r ect in it ial const r uct ion def ect s (an d such cost s f or any f ut ur e al t er at ion s or addit ion s ) Contributions. An y char it abl e or pol it ical cont r ibut ion s t he l andl or d migh t decide t o make Development-Related Payments. Exact ion s paid t o any gover nme n t a l b o d y or commu n it y or ganizat ion, in cl udin g t hose f or in f r as t r uct ur e, t r af f ic impr oveme n t s, cur b cut s, r oadway impr oveme n t s, t r ansit cost s, impact f ees, and so on Environmental. Cos t s of t est in g f or, handl in g, r eme d iat in g, or abat in g asbest os and ot her hazar dous mat e r ial s or el ect r oma g n e t ic f ie l ds, or t he cost t o r emo ve chl or of l uor ocar bons ( CFCs ) or accompl is h ot her f ut ur e r et r of it t in g dr ive n by as-ye t -u n k n o wn f ut ur e envir on me n t a l c o n c e r n s, or t he cost t o pur chase envir on me n t a l in sur an ce Excessive Management Fees. Man ag e me n t f ees in exce s s of t hose char ged in compar abl e buil din gs, par t icul ar l y when t he pr oper t y ma n a g e r is an af f il iat e of t he l andl or d Executive Salaries. Sal ar ie s f or of f ice r s above t he l evel of buil din g ma n a g e r Fines. Fin e s and penal t ie s t he l andl or d mus t pay as a r esul t of f ail ur e t o compl y wit h l aws, or din an ce s, mun icipal codes, and t he l ike Food Court. Cos t s r el at ed t o f ood cour t t enant s t o t he ext e n t t h e y exce e d nor ma l cost s (or al l ocat e f ood seat in g ar ea as t enant space) Holidays. An y hol iday decor at ion s or gif t s (or impos e a r easonabl e l imit ) Mall Advertising. Re t ail t enant s shoul d conside r t r yin g t o opt out of any mal l adver t is in g pr ogr am, or cap t he amo u n t of t heir con t r ibut ion Negligence. Cos t s in cur r e d as a r esul t of t he l andl or d s n e g l ige n ce Other. Ne xt ye ar s newest ar ea of l egal concer n (f or in spir at ion, check t he l at est new and impr oved car ve-o u t s f r om nonr ecour se

5 t r eat me n t in mor t gage f in an ce t r ansact ion s ) Other Tenants. An y cost s f or a ser vice not pr ovide d t o t his t enant and in cl ude d in it s r ent (f or exampl e, t he in cr e me n t a l cost of a high e r l evel of ser vice pr ovide d t o of f ice or r et ail t enant s); r e imbur s e d or r eimbur s abl e by specif ic t enant s ot her t han t hr ough pr o r at a r ent escal at ion s (e.g., f ees f or exce s s ive use of ut il it ie s ); or caused by t he act s or omis s ion s of par t icul ar ot her t enant s Ownership-Related Costs. Gr oun d r ent ; mor t gage in t e r e st, pr in cipal an d t r ansact ion cost s; buil d-o u t of t enant space; cl ean-u p of t he l andl or d s const r uct ion pr oj ect s of any kin d; and gener al and admin is t r at ive expe n s e s (over head) Payments to Affiliates. Fees and expe n s e s paid t o t he l andl or d s a f f il iat e s in exce s s of mar ke t r at es. (But what s mar ke t and how do you know? Th e t enant may want pr eappr oval r igh t s.) Professional Fees. Br oke r age f ees and commis s ion s ; l egal f ees and expe n s e s t o negot iat e and enf or ce l eases; account in g f ees Telecom Installation. Eit h er excl ude cost s or of f set again s t t he in come t he l andl or d r eceive s. 26. Options 26.1 Additional Space. Th e t enant may want an opt ion, r igh t of f ir s t r e f us al, or r igh t of f ir s t of f er f or addit ion al space Sublet Excess Space. As a f al l back, conside r negot iat in g a wide-o pen r igh t t o subl et exce s s space unt il needed (if t his make s busin e s s s e n s e under t he cir cums t a n c e s ) First Refusal Mechanics. For a r igh t of f ir s t r ef usal, seek a second bit e at t he appl e if t he l andl or d l at er decide s t o mar ke t t he space in sma l l e r pie ce s or on dif f e r e n t t er ms t han or igin al l y con t e mpl at e d. Al s o, scr ut in ize t he condit ion s t hat t r igge r t he r igh t of f ir s t r ef usal. Lan dl or ds f or m l eases of t en l et t he t enant exe r cis e a f ir s t r ef usal r igh t onl y if t he space has become vacant and avail abl e. Wh at does t his me an? If t he l andl or d negot iat e s a new l ease f or t he space bef or e an ol d l ease expir e s, does t hat new l ease me an t he space is not vacant and avail abl e? Th e t est shoul d be whet her an exis t in g l ease wil l expir e or t er min at e, or has expir e d or t er min at e d. Th e l andl or d shoul d agr ee not t o negot iat e any ext e n s ion or r enewal t hat coul d impair t he t enant s cl aims t o t he space Excess Space Notices. Wh e t h e r or not t he t enant has pr eempt ive r igh t s t o ext r a space, t he l andl or d shoul d agr ee t o advise t he t enant r egul ar l y of any space t hat become s avail abl e, givin g as mu c h not ice as r easonabl y possibl e under t he cir cums t a n c e s Early Termination O ptions. Th e t enant may want ear l y t er min at ion opt ion s, eit h e r compl e t e or par t ial ( sh e d r igh t s ) Renewal O ption. Of t e n t enant s wil l seek a r igh t t o r enew t he t er m. In such cases, t he t enant mus t scr ut in ize and conf ir m t hat it can l ive wit h what ever condit ion s, r equir e me n t s, and pr ocedur es t he

Te nant s Checklist of Sile nt Lease Issues, Se cond Edition

Te nant s Checklist of Sile nt Lease Issues, Se cond Edition (Part 1) S.H. Spe nce r Co m p ton and Joshua Ste in Silence is g old en b ut not necessarily in a lea se. S.H. Spence r Compton is vice pr