Five Lease Clauses That Might Cause Downstream Trouble for Landlords

Most lease clauses are written to solve an immediate problem. The landlord wants expenses reimbursed, pets controlled, a tenant committed for the long term, or a retail tenant satisfied that a competitor won't move in next door.

The trouble sometimes doesn't appear until years later. By then, the person who negotiated the lease may be gone, circumstances have changed, and a perfectly reasonable-sounding provision has acquired consequences nobody anticipated.

Here are some lease provisions worth thinking about not just in terms of what they accomplish today, but what they might do later.

1. Operating Expenses That Aren't Clearly Defined

Commercial leases frequently require tenants to pay a proportionate share of operating expenses or common area maintenance expenses—CAM. That's straightforward enough until somebody asks exactly what those terms include.

Can the landlord include management fees? Administrative expenses? Insurance deductibles? Major repairs? Capital expenditures? Legal expenses? Costs associated with vacant space? If capital improvements reduce future operating costs, can some or all of the cost be passed through?

If the lease doesn't answer those questions, the problem may remain invisible for years. The landlord sends annual reconciliations, the tenant pays them, and everybody moves on.

Then the tenant changes ownership, hires a new CFO, brings in a lease auditor, or simply has someone take a close look at the lease.

Now the tenant isn't questioning only this year's reconciliation. It may challenge several years of charges and demand a refund of expenses it claims were never permitted by the lease.

“Operating expenses” and “CAM” may be convenient shorthand, but shorthand isn't a substitute for a definition. If an expense is intended to be passed through to the tenant, the lease should make that clear.

It should also identify exclusions and establish procedures—and reasonable time limits—for reviewing and challenging reconciliations.

2. Pet Rules the Landlord Isn't Prepared to Enforce

Residential landlords have good reasons for regulating pets. Requiring residents to leash dogs, prevent them from running loose, or otherwise keep animals under control sounds like prudent risk management.

But there can be a downside to creating detailed safety requirements and then not enforcing them.

Suppose a lease requires dogs to be leashed whenever they're outside an apartment. Management repeatedly sees a resident allowing a dog to run loose and does nothing. Eventually, the dog bites another resident or visitor.

The injured person's lawyer now has more than an uncontrolled dog to talk about. The landlord's own lease established a rule intended to prevent exactly that situation. The argument may be that management knew the rule was being violated, had contractual authority to do something about it, and failed to act.

That doesn't mean landlords shouldn't have reasonable pet rules. It means they should think carefully before putting obligations into a lease that management isn't realistically prepared to enforce.

Sometimes more restrictive language doesn't provide more protection. It creates another question about what the landlord did after discovering its own rules weren't being followed.

3. Automatic Renewals That Survive a Sale

Automatic renewal provisions can be convenient. Unless one party gives notice by a specified date, the lease simply renews for another term.

That works nicely—until the property is being sold.

Suppose a lease automatically renews for another five years unless the landlord gives notice nine months before expiration. The property goes under contract around that time. During negotiations, inspections, financing and due diligence, nobody focuses on the approaching notice deadline.

The deadline passes.

The buyer may now be acquiring a property subject to another five-year lease term it didn't intend to accept. Perhaps the buyer planned to occupy the space, redevelop the property, change the tenant mix or renegotiate the lease when the existing term expired.

The seller may not have wanted the renewal either. But once the deadline has passed, the lease may have made the decision for both of them.

Automatic renewals aren't necessarily bad provisions. But when a lease can extend for a substantial additional term, consider what happens if the property changes hands near the notice deadline. A landlord may want a provision addressing a pending sale or transfer rather than relying entirely on someone remembering a date years in the future.

4. Retail Exclusives That Turn Out to Be Too Exclusive

A retail tenant asks for an exclusive use provision, and sometimes granting one makes sense.

The problem is predicting what competing businesses will look like five, ten or fifteen years from now.

Suppose a sandwich shop negotiates an exclusive prohibiting the landlord from leasing space in the center to another business selling sandwiches. What happens when a coffee shop wants to lease next door—and happens to sell breakfast sandwiches? Or a grocery tenant has an exclusive covering the sale of certain foods, and years later the landlord wants to lease to a pharmacy, convenience concept or specialty retailer that sells some of the same products?

Retail concepts change. Merchandise mixes expand. Businesses that once occupied entirely different categories increasingly overlap.

An exclusive drafted broadly enough to make today's tenant comfortable can eventually prevent the landlord from signing tomorrow's desirable tenant.

It can also become more than a leasing inconvenience. Restrictions on future tenants can affect the property's income, tenant mix, marketability and ultimately its value.

If an exclusive is necessary to make a deal, define it as narrowly and objectively as possible. Consider exceptions for incidental sales, existing tenants, changes in merchandise mix and uses that nobody contemplated when the lease was signed.

The question isn't simply whether an exclusive seems reasonable today. It's what those words might prohibit years from now.

5. Lease Buyout Provisions That Set the Price Today

A lease buyout provision can seem like a good idea for both parties. The tenant gets a clearly defined way out of a long-term obligation, and the landlord knows exactly what it will receive if the tenant leaves early.

The provision might require payment of six months' rent, a percentage of the remaining rent, or some other amount specified when the lease is signed.

The trouble is that nobody knows what the property or leasing market will look like when the tenant decides to exercise that right.

Five years later, the space may be much harder to lease. Tenant improvement costs and leasing commissions may have increased dramatically. Market rents may have fallen. The tenant's departure might create problems with financing, co-tenancy requirements or the property's planned sale.

The landlord may simply not want the tenant to leave.

A predetermined buyout can turn what the landlord thought was an option to negotiate an early termination into a contractual right belonging to the tenant. If the provision isn't tied to a particular event or limited in some other way, the tenant may be able to exercise it for reasons nobody contemplated when the lease was negotiated.

Even the economics can become badly outdated. A buyout amount that seemed substantial when the lease was signed may be nowhere near enough to compensate the landlord for the cost of replacing the tenant years later.

Sometimes it makes more sense for a lease to establish the circumstances under which an early termination can be considered—or a method for determining the payment at that time—rather than fixing both the right and the price years in advance.

There's a common thread running through all of these examples. None necessarily begins as a bad idea.

Operating-expense reimbursement is normal. Pet rules are sensible. Automatic renewals can benefit both parties. Retail exclusives can be necessary to land a tenant. And giving a tenant a defined exit may be part of getting a lease signed.

The downstream trouble comes from drafting a provision around today's circumstances without considering tomorrow's.

Before adding another “protective” provision to a lease, try asking a different question:

If the property, tenant, owner or market looks completely different ten years from now, what could these words make somebody do—or prevent them from doing?

Sometimes that's the question that catches the problem before the lease does.