Offering Suggestions to Better Represent Tenants

By Clint Wilson & Kent Burton for California Real Property Journal
January 29, 2016

I.    INTRODUCTION

The use of commercial lease forms provided by the American Industrial Real Estate Association (“AIR”) is widespread in California’s commercial leasing industry.  Founded in 1960 by brokers for brokers, AIR advances the interests of its membership by providing, in part, standardized lease forms that serve as useful tools which can be tailored to the specific needs of landlords and tenants with minimum cost and time. The cost and time efficiency are appealing to both landlords, who are in the business of leasing space, and tenants, who are generally focused on a much different business. Nevertheless, tenants and landlords often engage real estate attorneys to further tailor the AIR form lease and negotiate certain revisions that address their specific needs and concerns.

This article is written from the tenant’s perspective and discusses certain revisions to the AIR form lease that a real estate attorney, who is representing the tenant, can make to protect the client’s interest. More specifically, this article suggests tenant-oriented revisions to the current 2015 AIR Standard Industrial/Commercial Multi-tenant Lease — NET (referred to herein as the “AIR Form Lease” or “Lease”). This particular AIR Form Lease is used for multi-tenant buildings and shopping centers where the tenant pays triple net expenses (i.e., maintenance expenses, insurance, and taxes). While some of the same concepts apply to single-tenant leases, issues specific to single-tenant leases are not reviewed in this article.

From the tenant’s perspective, the AIR Form Lease is landlord-oriented, and therefore many of the revisions suggested in this article strive to re-allocate some of the risk to the landlord while others attempt to limit the tenant’s long-term monetary exposure. Before proceeding, it is necessary to note that certain provisions suggested in this article are better integrated into an addendum to the AIR Form Lease rather than attempting to insert them into the body of the Lease itself. Incorporating an addendum to an AIR Form Lease that consists of additional provisions is common practice and may be preferred by landlords and their lease administrators. Importantly, the addendum should state that if there is a conflict between the provisions in the addendum and the provisions in the AIR Form Lease, the provisions in the addendum will control. Finally, the provisions addressed in this article are in the same order as they appear in the AIR Form Lease.

II.    GENERAL NEGOTIATION ISSUES

A.    Square Footage of the Premises

The square footage of the premises is often used to calculate the base rent, and in the case of a triple net lease, the tenant’s share of common area maintenance and operating (“CAM”) expenses.  The landlord will use the square footage of the premises to dictate the base rent (i.e., some amount per square foot), as well as the tenant’s share of CAM expenses (i.e., some percentage based on the square footage of the premises compared to the total square footage of all buildings in the shopping center or multi-tenant buildings, both of which are referred to in this article as the “Project”).  Since the square footage is critical in determining the economic terms of the lease, the tenant’s counsel should consider including a “right to measure” provision giving the tenant the right to measure the premises after entering into the lease, thereby lessening the risk that the tenant will overpay for rent during its term.

1.    How the AIR Form Lease Addresses Erroneous Square Footage

Paragraph 2.1 of the AIR Form Lease states: “the Base Rent stated herein is NOT tied to square footage and is not subject to adjustment should the actual size be determined to be different.” Paragraph 2.4(e) further provides: “the square footage of the Premises was not material to Lessee’s decision to lease the Premises and pay the Rent stated herein.” Accordingly, the AIR Form Lease disclaims the issue of erroneous square footage (e.g., misstated or misrepresented square footage) in favor of the landlord. Given how the issue is addressed in the Lease, the landlord may have little incentive to ensure the accuracy of the square footage, which if over-represented will have long-term monetary implication for the tenant.  To complicate matters, there is no standard method of measuring the square footage of a leased space, and as a result, the square footage as represented may not accurately represent the premises’ floor area.  As such, if the square footage of the premises is not accurately represented or the tenant does not perform its due diligence in verifying the actual square footage of the premises before signing the lease (which is not always practical), then the tenant risks overpaying for square footage that does not actually exist.

2.    Right to Measure

To protect the tenant from overpaying in rent during the term of the lease, a right to measure provision authorizes the tenant to measure the square footage of the premises after entering into the lease and obtaining possession of the premises (when measuring the premises is more practical for the tenant). Both rent and the tenant’s share of CAM expenses should be subject to any adjustment in the square footage of the premises once the tenant has measured the same. In other words, if the tenant measures the premises and the actual size is determined to be smaller, then rent and CAM expenses should be reduced accordingly. To accomplish this objective, the tenant’s counsel should: (i) strike the provisions in paragraphs 2.1 and 2.4 that disclaim the tenant’s reliance on the square footage represented in the Lease; (ii) place an asterisk near paragraphs 1.5 and 1.6, and note that the base rent and the tenant’s share of CAM expenses are subject to change based on the tenant’s right to measure; and (iii) insert the right to measure provision in the addendum to the Lease.

3.    Drafting the Right to Measure Provision

The right to measure provision should include such terms as: (i) the time period the tenant has to measure the premises (e.g., within thirty to sixty days following the commencement date); (ii) who will measure the premises on the tenant’s behalf (e.g., a licensed architect); (iii) the points of measurement to be used (e.g., from the exterior of outside walls to the midpoint of common demising walls); (iv) a mechanism to resolve any dispute between the landlord and the tenant as to the tenant’s measurement (e.g., appointment of the landlord’s architect, and if still disputed, then a neutral third party architect); (iv) some amount of discrepancy in the stated square footage from the actual square footage that is both acceptable to the tenant and will not change the rental amounts (e.g., one percent); and, (v) a cap on how much the actual square footage can increase the rental amounts (e.g., two percent).

4.    Negotiating for the Right to Measure
In negotiating with the landlord’s counsel whether to include a right to measure provision, the tenant’s position benefits from case law that allows a tenant to sue its landlord for misrepresentation in the event the premises is discovered, after the lease is signed, to be smaller than represented in the lease.  In McClain v. Octagon Plaza, LLC, the tenant signed an AIR Standard Industrial/Commercial Multi-tenant Lease — Net, which also included AIR Form Lease paragraphs 2.1 and 2.4 disclaiming the tenant’s reliance on the square footage represented in the lease.  However, after receiving the landlord’s assurance that the stated square footage was accurate and signing the lease, the tenant discovered that the actual premises was smaller than represented such that the tenant was obligated to pay over $90,000 in excess rent and CAM expenses over the term of the lease.  McClain held that the tenant’s allegations were sufficient to establish the elements for intentional or negligent misrepresentation, and that the disclaimer language in paragraphs 2.1 and 2.4 did not preclude such claims.  In light of McClain, the tenant’s counsel can accurately assert that a right to measure provision will limit the landlord’s exposure to the tenant making a claim over square footage after the lease is signed. As such, the landlord should be agreeable to this provision.

B.    CAM Expenses

Pursuant to the AIR Form Lease, the tenant is obligated to pay base rent as well as items of additional rent, including its share of CAM expenses. One of the more favorable provisions for the landlord in the AIR Form Lease is paragraph 4.2. It defines CAM expenses as those expenses incurred by the landlord in the ownership and operation of the project’s common use areas and passed through to the tenant. Generally, the tenant is obligated to pay its proportionate share of CAM expenses based on the ratio of leasable square footage in the premises to the total leasable square footage in the Project. While CAM expenses are a staple of multi-tenant triple net leases, a careful review of this paragraph is necessary to ensure that the tenant is paying only its fair share of Project expenses, and that the landlord has not disguised CAM expenses as an additional source of profit. To this end, several changes can be made to paragraph 4.2 to limit the tenant’s exposure to excessive CAM expenses and unchecked year over year increases.

1.    AIR’s Definition of CAM Expenses

Paragraph 4.2(a) of the AIR Form Lease defines CAM expenses as “all costs relating to the ownership and operation of the Project,” which is then followed with a non-exclusive list of possible expenses. From the landlord’s perspective, this provision affords the landlord the freedom to decide what expenses can be charged as CAM expenses while capturing new expenses that may arise over the course of a long-term lease. From the tenant’s perspective, this open-ended definition of CAM expenses creates budget uncertainty and the possibility of paying more than its fair share of Project expenses. To address the tenant’s concern, counsel can insert a provision in the addendum to the Lease that expressly excludes certain expenses from the definition of CAM expenses. A provision excluding certain expenses will provide the tenant a degree of certainty regarding CAM expenses, and differentiates those expenses that should be the landlord’s responsibility.

For example, paragraph 4.2(a)(ix) of the AIR Form Lease obligates the tenant to pay its share of capital improvements to the Project. Generally, capital improvements are structural improvements or renovations that enhance the Project’s overall value. While the landlord may argue that capital improvements are good for the tenant’s business and therefore should be considered a CAM expense, capital improvements are investments into the Project, and despite their benefit to the tenant, are not an expense for accounting purposes,  and should not be included under CAM expenses. Alternatively, if tenants were responsible for reimbursing landlords for capital improvements, tenants, who have little to no control over how the landlord chooses to improve the Project, will nonetheless foot the bill.

2.    Excluding Certain Costs from CAM Expenses

The paragraph excluding certain expenses from the definition of CAM expenses can be included in the addendum to the Lease, and may include such items as: (i)  costs of financing the Project and interest payments; (ii)  costs for which the landlord has already been reimbursed; (iii) the landlord’s income or franchise taxes; (iv) reserves for future costs; (v) depreciation; (vi) the costs of capital replacements or improvements; (vii) brokerage commissions; (viii) attorney’s fees; (ix) wages or salaries paid to employees above the level of property manager; and (x) expenses related to a specific tenant or group of tenants. This is not an exhaustive list, but an example of some expenses that can be excluded from the definition of CAM expenses. Note that some of these expenses are currently included in the definition of CAM expenses, and therefore the tenant’s counsel will need to start the paragraph with “Notwithstanding any other provision herein to the contrary,” and strike the same or similar expenses from 4.2(a) paragraph of the AIR Form Lease.

3.    Capping CAM Expenses

In addition to excluding certain expenses from CAM expenses, including a cap on CAM expenses (as well as a cap on certain expenses within CAM expenses such as management and administrative charges) gives the tenant more certainty as to how much rent will be in the future, and prevents the landlord from establishing certain charges as profit-centers. These caps are beneficial to any business endeavoring to control its expenses (i.e., every business).

(a)    Cap on Controllable CAM Expenses

A cap on the amount of CAM expenses permitted to increase year over year works best with controllable CAM expenses. Controllable CAM expenses exclude those expenses that the landlord cannot control, such as real property taxes and insurance (the landlord may also negotiate to include other similar uncontrollable charges, such as common area utilities). Hence, capping controllable CAM expenses—as opposed to all CAM expenses—will be more agreeable to the landlord. The cap will be negotiated as some percentage increase over the prior year’s CAM expenses (e.g., not to exceed five percent over prior year’s CAM expenses). For example, the tenant’s counsel could include the following cap on controllable CAM expenses: “Lessee’s share of CAM expenses shall not exceed $____ per square foot of Premises floor area per month for the first year following the Commencement Date, and thereafter Lessee’s share of CAM expenses, excluding premiums for Lessor’s insurance, real property taxes, and common area utilities (for which there shall be no cap) shall not increase by more than five percent (5%) over such expenses for the prior year.”

(b)    Cap on Certain CAM Expenses

CAM expenses generally include expenses relating to the property management and administration of the Project. To limit the landlord’s ability to turn management and administrative charges into sources of profit, these charges should be capped as a percentage of total CAM expenses (e.g., five to fifteen percent). For example, counsel can include the following cap on the cost of management and administration of the Project: “a management and administration fee (whether paid to Lessor or to a third party management company, or an combination thereof) not to exceed five percent (5%) of CAM expenses, excluding real property taxes and landlord’s insurance.” By negotiating this revision to the Lease, as well as a cap on controllable CAM expenses, the tenant will have more control over how much it will pay in CAM expenses and a clearer picture of its rent obligations in the future.

4.    Audit Rights

The AIR Form Lease does not include the tenant’s right to audit the landlord’s books and records relating to CAM expenses, such as underlying invoices and billing statements. The purpose of such a provision is to ensure the accuracy in the accounting of CAM expenses and that the tenant is not overpaying for the same. Therefore, the tenant’s counsel should negotiate to insert a right to audit provision into the addendum of the AIR Form Lease.

In drafting this provision, counsel should include such terms as: (i) a notice period to the landlord prior to the audit (e.g., thirty days); (ii) some standard of accounting (e.g., accounting practices consistently maintained on a year to year basis sufficient to allow the tenant to verify the actual CAM expenses); and (iii) some mechanism to resolve any disputes in accounting resulting from the audit (e.g., appointment of a mutually agreed upon CPA). If the audit evidences that the landlord overbilled the tenant for CAM expenses, then the landlord should promptly reimburse the tenant the amount of the overbilling, and vice versa. Most landlords request that the accounting firm performing the audit not be hired on a contingency basis, which is a fair request. However, the tenant’s counsel should negotiate to have the landlord pay the reasonable costs of the audit if the tenant is overbilled by some percent (e.g., more than five percent).

5.    Standard of Care

Lastly, the tenant’s counsel can also include a standard of care as to how the landlord will incur and charge the tenant for CAM expenses. In the event the landlord breaches this standard, the tenant can make a claim under the lease. An example of such a provision is as follows: “Lessor shall use reasonable efforts to minimize CAM expenses in a manner consistent with good and generally accepted shopping center management practices. Lessor shall use commercially reasonable efforts to effect an equitable proration of bills for services rendered to the Project or to any other property owned by Lessor.”

C.    Maintenance Obligations

Paragraph 7 of the AIR Form Lease sets forth the respective maintenance and repair obligations of the landlord and the tenant. There are several changes that can be made to paragraph 7 to protect the tenant from exposure to huge cash outlays and potential disruption to its business.

Paragraph 7.1 of the AIR Form Lease provides a nonexclusive list of items that are the responsibility of the tenant, including items that may not be “readily accessible” (e.g., plumbing under the slab), and items needing repair due to age (e.g., an old HVAC system that needs replacement). In addition to the tenant’s maintenance and repair obligations, paragraph 7.1(c) provides the landlord with a right to cure the tenant’s default under paragraph 7.1. The AIR Form Lease, however, does not provide a reciprocal right to cure provision for the tenant despite the tenant’s critical interest in having repairs made in order to maintain uninterrupted business operations.
Nonetheless, the tenant’s counsel can make several revisions to paragraphs 7.1 and 7.2 to re-allocate some of the risk to the landlord and limit the tenant’s exposure from unreasonable repair and replacement expenses. How much risk should be re-allocated to the landlord and what repair and replacement expenses are reasonable will often depend on the size of the tenant’s leasehold and the condition of the premises.

1.    Unexposed Utility Lines

To protect the tenant from the cost and liability of replacing old plumbing or sewer lines under the slab or improperly installed electrical systems within the walls, the tenant’s counsel can distinguish between exposed (i.e., easily accessible to the tenant) and unexposed utility lines within the premises. Paragraph 7.1 of the AIR Form Lease currently allocates the risk of replacing both the exposed and unexposed utilities lines to the tenant, which, depending on the circumstances (i.e., the condition of the premises) and the tenant’s wherewithal, may be too much risk for the tenant. Therefore, in order to re-allocate some risk to the landlord, the tenant’s counsel can insert the term “exposed” before the plumbing and electrical references in paragraph 7.1, and include in paragraph 7.2, under the landlord’s obligations, “unexposed utilities within the Premises, except as installed by Lessee, including the electrical system and plumbing and/or sewer lines under the slab and within the walls.” This revision protects the tenant from the expense of replacing unexposed utilities, which can be overwhelmingly expensive and disruptive to its business.

2.    HVAC System

There are multiple ways of dealing with the repair and maintenance of the HVAC system, depending upon the condition of the current HVAC system and the tenant’s negotiating power. For instance, the tenant may be in a position to require that the landlord deliver the premises with a new HVAC system with not less than one (1) ton of HVAC service per some number of square feet of the premises floor area (e.g., 300 to 350 square feet) evenly distributed. Alternatively, if the tenant is not in a position to require a new HVAC system, the tenant’s counsel can negotiate one or both of the following: (i) extend the landlord’s warranty period as to the HVAC system set forth in paragraph 2.2 for a period longer than six months; or (ii) have the landlord assign to the tenant any manufacturer’s warranties remaining on the HVAC system.

3.    Right to Cure

Paragraph 7.1(c) of the AIR Form Lease provides that if the tenant fails to perform its repair obligations under paragraph 7.1, then after ten days’ prior written notice, the landlord has the right to perform such obligations on the tenant’s behalf and charge the tenant 115% of the cost thereof. The tenant’s counsel should insert a reciprocal provision in the addendum to the Lease providing that if the landlord fails to perform under paragraph 7.2, the tenant (after notice and expiration of cure period) can make the repairs and offset the cost thereof against the rent. The offset should also include a similar administrative charge of fifteen percent of the cost thereof. Moreover, the tenant should also have a right to cure without notice to the landlord in the event of an emergency affecting safety or access to the premises.
In negotiating with the landlord for a right to cure provision (aside from reciprocity), the tenant’s counsel can emphasize that without such a provision there can be major disruptions to the tenant’s business, potential injury to the tenant’s customers, and expensive litigation costs for both parties as a result of the landlord’s nonperformance of its maintenance and repair obligations. Therefore, a provision giving the tenant a right to cure the landlord’s nonperformance of its maintenance and repair obligations reduces the landlord’s liability under the Lease.

4.    Without Reimbursement or Contribution by the Tenant

Paragraph 7.2, of the AIR Form Lease should be revised to make it clear that the costs of maintenance and repair of the premises for which the landlord is responsible should not be passed through to the tenant as CAM expenses. Otherwise, the cost associated with the landlord’s maintenance and repair obligations with respect to the premises may still be borne by the tenant, albeit indirectly. Accordingly, the tenant’s counsel can revise paragraph 7.2 to separate the landlord’s responsibilities relating to the premises from its responsibilities relating to the common areas, and include a provision under the landlord’s responsibilities relating to the premises that states, “the costs of the maintenance and repair of the Premises shall be without reimbursement or contribution from Lessee.”

D.    Indemnity
An indemnity clause allocates risk between the parties.  In negotiating how risk is to be divided between the parties, the tenant’s counsel should strive to allocate risk first to the insurance companies, and second to the responsible party. The AIR Form Lease deviates from this principle by apportioning risk to the tenant that should be assigned to the insurance companies or to the landlord, as the responsible party. To properly redistribute the risk between the parties, tenant’s counsel will need to revise paragraph 8.7 of the AIR Form Lease on indemnification as well as include a separate indemnification paragraph in the addendum to the Lease in favor of the tenant as the indemnitee.

First, it is worth reviewing the concept of indemnity as it is used in paragraph 8.7 of the AIR Form Lease, which states that the tenant will “indemnify, protect, defend and hold harmless the Premises, Lessor and its agents . . . .” Here, the tenant is liable to the landlord for any direct damages caused by the tenant, and any third party claims against the landlord arising from the events indemnified for in this paragraph (e.g., events arising from the tenant’s use of the premises). Moreover, the tenant must engage counsel to defend the landlord against third party claims, as well as pay any judgment awarded to the third party as a result of such claims.  As such, the expense associated with indemnifying the landlord can be overwhelming, and naturally the tenant should be hesitant to assume this responsibility, especially for claims arising out of the landlord’s own negligence or breach of the Lease.

Paragraph 8.7 of the AIR Form Lease starts with the carve-out that: “[e]xcept for the Lessor’s gross negligence or willful misconduct, Lessee shall indemnify . . . .” Since the term “gross negligence” is used rather than “negligence,” the tenant must indemnify the landlord for the landlord’s own negligence. To avoid a situation where the tenant is liable rather than the responsible party (i.e., the landlord), the term “gross negligence” should be revised to “negligence.” Furthermore, the landlord should be required to pursue a claim against its insurance company before demanding that the tenant indemnify the landlord for damages. This should especially be the case since paragraph 4.2(a)(vi) of the AIR Form Lease requires that the tenant reimburse the landlord for the landlord’s insurance premiums for policies required to be maintained pursuant to the Lease as CAM expenses.

1.    Risks Covered by Insurance

In order to require that the landlord first look to its insurance company before the tenant’s indemnification, paragraph 8.7 should be subject to paragraph 8.6 on waiver of subrogation. Paragraph 8.6 of the AIR Form Lease provides that the landlord and the tenant waive their rights to recover damages from the other party for property damage arising out of the perils required to be insured against under the Lease. In this regard, if the tenant negligently damages the landlord’s property (e.g., causes a fire that destroys the premises), which is a peril required to be insured against by the landlord under the Lease, then the landlord should first file a claim with its insurance company before pursuing a claim against the tenant. As such, if the landlord’s insurance covers the damage caused by the tenant, then the tenant should not be required to indemnify the landlord. Therefore, to ensure that the landlord first looks to its insurance company and not to the tenant’s indemnification, the first sentence of paragraph 8.7, on indemnification, should start with the clause, “Subject to paragraph 8.6.”

Moreover, it is important to note that paragraph 8.6 of the AIR Form Lease continues to state that: “[t]he Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby” (emphasis added). According to the italicized clause, if the landlord’s specific policy would be invalidated by having the carrier waive its right to subrogation, and the carrier maintains its right to subrogate, then the carrier can step in the shoes of the landlord after the carrier pays a claim, and sue the tenant for damages. In other words, the tenant who has been paying the landlord’s insurance premiums as CAM expenses may nonetheless be liable to the insurance company for damages, which defeats the purpose of making paragraph 8.7 subject to paragraph 8.6. Since the italicized clause can play out against both the tenant and the landlord, both parties have an interest in striking this clause so that the insurance carrier must waive their right to subrogation, and if the carrier refuses, the insured party must find a carrier that will provide the waiver.

2.    Allocating Risk to the Responsible Party

A reciprocal indemnification paragraph for the tenant, as the indemnitee, should be included in the addendum to the Lease to properly allocate risk between the parties. Generally, both indemnification paragraphs should be similar, but with the landlord indemnifying the tenant for its negligence, its breach of the Lease, and any claims arising from the common area. The first sentence for both indemnification paragraphs should include the same carve-outs. For example, the indemnification paragraph for the tenant should start with, “Subject to paragraph 8.6, and except to the extent of Lessee’s negligence or willful misconduct . . . .” And the indemnification paragraph for the landlord should start with, “Subject to paragraph 8.6, and except to the extent of Lessor’s negligence or willful misconduct . . . .” That way, the parties will first look to their insurance companies and not indemnify each other for the other’s negligence. Also, by excluding indemnification obligations to the extent of a party’s negligence, the provision is consistent with comparative negligence standards.

E.     Waiver of Liability

Doubling down on the lack of a landlord indemnification, paragraph 8.8 of the AIR Form Lease provides, in part, that notwithstanding the landlord’s negligence or breach of the Lease, the landlord will not be liable under any circumstances for, among other things, injury to persons in or about the premises or to the tenant’s business, including any loss of income or profit. Accordingly, the landlord will not be liable for damages to the tenant resulting from the landlord’s negligence or breach of the Lease.

1.    Landlord’s Negligence

With respect to the landlord’s negligence, the goal here, as it was with paragraph 8.7, is first to allocate risk to the insurance company and second to the responsible party. Since paragraph 8.6 of the AIR Form Lease requires each party to release the other from damages to property arising out of incidents required to be insured against, and paragraph 8.7 has been revised to carve-out landlord’s “negligence” rather than “gross negligence” (as discussed in section D), this paragraph 8.8 will also need to be revised so that the landlord remains liable for its own negligence, especially for an uninsured incident. Therefore, the tenant’s counsel will need to, at a minimum, strike “negligence” from the first sentence of paragraph 8.8 so that the landlord will not be released from liability for its own negligence.

2.    Breach of the Lease

The exculpatory language of paragraph 8.8 of the AIR Form Lease with respect to “breach of this Lease” effectively bars the tenant from making a claim for injury to the tenant’s business, including loss income or profits, resulting from the landlord’s breach of the Lease.  As such, in the event the landlord breaches the Lease, and the breach causes the tenant to lose its business, the tenant will be barred from asserting a claim for consequential damages, including lost profits, against the landlord.

This clause was enforced in Frittelli, Inc. v. 350 N. Canon Drive, LP (“Frittelli”), where a shopping center tenant, who signed an AIR Standard Industrial/Commercial Multi-tenant Lease — Net, failed in its claim against the landlord for breach of the covenant of quiet enjoyment in the lease.  In Frittelli, the tenant alleged that the landlord’s failure to exercise reasonable care in remodeling the shopping center breached the covenant of quiet enjoyment.  In view of the clause in paragraph 8.8, Frittelli held that “the parties’ intent, as expressed in the agreement, was to exempt the lessor from liability for breach of the lease and ordinary negligence.”

Deleting this paragraph 8.8 is strongly encouraged given how this clause strongly favors the landlord, to the detriment of the tenant who is liable to the landlord for breach of the lease. However, if the landlord is unwilling to strike paragraph 8.8 in its entirety, tenant’s counsel should negotiate to at least limit the exculpatory language to property damage since property damage should be covered by insurance and subject to the waiver of subrogation.

F.    Utilities and Services

Paragraph 11 of the AIR Form Lease on utilities and services gives the landlord the unilateral right to increase the tenant’s rent due to an increase in utility use. It also allocates all risk associated with an interruption of utilities to the tenant.

1.    Unilateral Right to Increase Tenant’s Rent

Paragraph 11 states that “at any time in Lessor’s sole judgment, Lessor determines that Lessee is using a disproportionate amount of metered utilities or trash services, then Lessor may increase Lessee’s Base Rent by an amount equal to increased costs.” The landlord’s freedom to unilaterally increase the tenant’s base rent is problematic as the Lease already provides the landlord with the ability to collect utility expenses from the tenant.

Pursuant to paragraph 11 of the AIR Form Lease, the tenant will pay for utilities supplied to the premises, and its proportionate share of utilities not separately metered and charged as CAM expenses. Moreover, paragraph 4.2(b) allows the landlord to charge the tenant for CAM expenses specifically attributable to the tenant (e.g., disproportionate usage of utility services). Because the landlord already has the ability to recover utility charges from the tenant, a unilateral right to raise the base rent without notice or evidence given to the tenant unnecessarily favors the landlord. At a minimum, any increase in rent imposed unilaterally by the landlord should require notice to the tenant and the ability to dispute the same. Allowing the landlord the freedom to increase base rent by some fixed amount based on some variable expense, such as utility costs, appears too landlord-oriented. Tenant’s counsel can negotiate either to strike the landlord’s unilateral right to increase base rent, or provide for a process to ensure that any increase will be reasonable. For example, the negotiated revision can include: (i) a notice period to the tenant, (ii) a requirement that any increase in base rent be substantiated by actual costs and supporting documentation, and (iii) that the increase will be considered an expense item rather than an increase in base rent so that it can be reduced accordingly if utility usage is reduced.

2.    Allocation of Risk to the Tenant for Loss of Utilities

Paragraph 11 of the AIR Form Lease also provides that there will be no abatement of the tenant’s rent for interruption in utility services for causes beyond the landlord’s reasonable control. However, neither this provision nor any other provision in the AIR Form Lease provides that the landlord will abate tenant’s rent in the event that the landlord or the landlord’s agents negligently caused the disruption in utility services. In fact, paragraph 8.8 expressly states that, notwithstanding the landlord’s negligence, the landlord is not liable for injury to the tenant’s business or any loss of its income.

For that reason, the tenant’s counsel may consider inserting a provision such as: “[n]otwithstanding any provision herein to the contrary, in the event Lessor or Lessor’s agent causes the disruption in utility services and Lessee is unable to operate its business for more than [twenty-four] hours, then there shall be an abatement of rent until Lessee is able to reopen for business.” Such a provision properly re-allocates some or all of the risk to the responsible party rather than forcing the tenant to assume the entire risk.

G.    Inducement Recapture

Frequently, before entering into a lease, the tenant and the landlord will negotiate to include a period of abated rent while the tenant improves the premises, or for the landlord to provide a tenant improvement allowance. These benefits are always taken into consideration by the landlord in establishing the rent amount and often result in higher rent. The AIR Form Lease refers to these arrangements as “Inducement Provisions.” The tenant’s counsel should be aware that while including Inducement Provisions in the Lease can benefit or compensate the tenant, Inducement Provisions also expose the tenant to greater liability.
Paragraph 13.3 of the AIR Form Lease provides that “[u]pon Breach of this Lease by Lessee, any such Inducement Provisions shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor.” Accordingly, if the tenant breaches the Lease, any abated rent or tenant improvement allowance becomes immediately due and payable despite the landlord benefiting from the tenant improvements and the higher rent that it received prior to the breach. Therefore, tenant’s counsel, after considering the Inducement Provisions, should either delete paragraph 13.3 or provide that the tenant will only be responsible for the unamortized portion of any inducement (e.g., if the tenant breached the Lease at the end of the twenty fifth month of a fifty month lease term, the unamortized portion would be equal to fifty percent of the inducement).

H.    Limitation on Liability

Paragraph 20 of the AIR Form Lease provides another express limit on the landlord’s liability, stating: “Lessee shall look to the Premises, and to no other asset of Lessor.” While the primary purpose of this provision is to limit the landlord’s personal liability and is very common in commercial leases, any additional limit on liability, such as to the landlord’s interest in the premises, should be revised. Tenant’s counsel should limit the landlord’s liability to the Project (not just the premises), and any rents, issues, and profits therefrom. A sample provision to this effect may state: “Lessee shall look to the Project and its rents, issues, and profits, proceeds of sale, and condemnation or insurance recoveries, and to no other assets of Landlord, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against the individual directors, officers, shareholders, members, or managers of Lessor.”

I.    Quiet Possession

Often the covenant of quiet possession may be one of the few rights (and perhaps the most important) a commercial tenant has in a dispute with its landlord. Every lease includes an implied covenant that the tenant has the right to quiet possession of the premises during the term of the lease, but the parties in a commercial lease may waive or modify this covenant in the lease.  Therefore, the tenant’s counsel should carefully review paragraph 38 of the AIR Form Lease relating to quiet possession, to ensure that the tenant does not unknowingly waive its right of quiet possession during the term of the lease.

Paragraph 38 of the AIR Form Lease provides that the tenant shall have the right to quiet possession of the premises unless the tenant has not performed its obligations under the Lease. Because there is no notice provision or applicable cure period included with this clause, the tenant may be denied its right to quiet possession without receiving notice of such nonperformance, or knowing such nonperformance even existed. This raises an important distinction between the tenant’s nonperformance of an obligation, and a breach under the lease.

Paragraph 13 of the AIR Form Lease defines “Breach” as a default by the tenant and the tenant’s failure to cure the default within the applicable cure period. As such, the distinction between nonperformance of an obligation and Breach is that Breach requires notice of the nonperformance and the expiration of the applicable cure period. Without notice or an applicable cure period, the tenant may unknowingly be in default and held to forfeit its right to quiet possession. As a result, in the event there is a dispute or problem with the landlord, the landlord may refute any claim that the landlord has infringed upon the tenant’s right of quiet possession.

The tenant’s counsel should carefully review the provisions whereby the tenant forfeits some right under the lease for nonperformance of its obligation, and either replace the nonperformance clause with the term “Breach,” or include in parentheses following such clause “(following applicable written notice and expiration of any applicable cure period).” This will ensure that the tenant actually receives notice of its nonperformance and has the opportunity to cure the same before losing a fundamental right.

J.    Options

Options, including the right to extend the term of the lease, are important rights to the tenant in establishing its business, and ensuring the continued success of its business operations. For that reason, the tenant’s counsel should revise paragraph 39.4 of the AIR Form Lease to ensure that the tenant’s options are appropriately reserved. Paragraph 39.4, which favors the landlord, describes various circumstances in which the tenant may lose its right to exercise its option, or the tenant’s option is terminated altogether. Rather than permitting those various circumstances to dictate whether the tenant can exercise its option or if the option will be terminated, paragraph 39.4 should be revised to give the tenant the right to exercise any option it may have so long as the tenant is not in “Breach” (as the term is defined in the AIR Form Lease) at the time the tenant is required to exercise the option. No other circumstances should affect the tenant’s options and should be deleted.

III.    CONCLUSION

While the AIR Form Lease presents an efficient and cost effective tool for closing commercial lease transactions, multiple revisions should be considered when representing a tenant to the transaction. The concepts and suggested revisions to the AIR Form Lease discussed in this article, while not intended to be exhaustive, are common examples of acceptable negotiated revisions where the tenant has some degree of bargaining power. The purpose of these revisions is to redistribute some of the risk to the landlord and reduce the tenant’s long-term monetary exposure. In the end, tenant’s counsel should strive to make these revisions so that the AIR Form Lease fairly represents the interests of both the landlord and the tenant.

California Bar Real Property Law Section

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