Exit Strategy in Commercial Lease Agreements

March 31st, 2014

Firemen have an unwritten but clear code of conduct: Do not enter a building on fire, unless you know where the exits are. One of the first things that flight attendants do before take-off is familiarizing passengers on exits in the aircraft. Needless to say, knowing when and how to exit from a sticky situation is the first prerogative of a responsible individual.

Precisely the approach that one must adopt while entering into a Commercial Lease Agreement! With both landowners and tenants looking at ways to maximize returns on commercial property, Commercial Lease Agreements have only become more complex and less transparent over time, particularly in California.

Martire Law has been helping commercial lessees create an exit strategy in their Commercial Lease Agreements. Changes that can happen in the company, industry, or local market cannot always be predicted at the beginning of a lease term. Nevertheless, they must be planned for and negotiated effectively in the agreement.

CC&Rs (caveats, conditions & restrictions) imposed by landowners can be classified into two categories depending on how serious is their long-term impact on the tenant.

Key areas of concern

Some of the areas where tenants have blundered by not properly evaluating lease language pertain to:

  • ‘Use’ of Property: Land owners are known to restrict the lessee’s usage of the property by
    having a narrow use clause
    This can limit assignment of the lease, sale of the business,
    and diversification prospects over time. A good legal advisor can
    help keep the usage options as open as possible
    , even if the lessee is only seeking “general office use.”
  • Parking: As companies look at various staffing models such as the use of temps, double
    shifts, consultants (vis-a-vis employees)
    who do not work full-time, etc, estimating
    parking needs in the long run can be difficult. A good legal advisor can help you secure as
    much parking as possible, even if it’s not needed, especially if there is no additional fee involved.
  • Assignment and subletting:  A lessee must be able to get out of a lease if the space
    is no longer needed; however, a termination
    clause may not always be available or may be
    expensive. In such a case, subleasing or subletting the property is a good alternative.
    Again, subleasing space may not be easy and not knowing how to negotiate it can
    turn out to be a costly affair to the lessee

Other clauses requiring clarity

  • Guaranties: Factoring guaranties pertaining to termination after certain duration,
    limiting amount of rent, unamortized
    landlord costs, etc.
  • Relocation and Transition: Negotiating the timeline and costs in order to
    avoid delay damages in case the release of the
    premise or relocation cannot
    happen immediately.
  • Rights of Recapture and Leaseback: Knowing about exceptions when
    the landlords’ right of recapture and leaseback
    of a Tenant’s Space must be waived.
  • Defining ‘Default’: Tenants are expected not to be in default during
    the entire lease term. It’s important to define what is
    called default and
    what the exceptions to the same are.
  • Profit sharing from subletting/assignment: Negotiation involves limiting
    the owner’s profit participation and factoring
    various costs borne by the
    tenant against the profits accrued.
  • Liability of Tenant/Assignor & Guarantor: Negotiation involves

    understanding the extent of liability, and exceptions that can secure
    release from liability after the Lease Assignment.
  • Renewal & Expansion Options of Tenant
  • Non-Disturbance Agreements and Signage clauses

With evolution of the business, real estate requirements of companies can change. A good exit strategy can factor this shift, making it a top priority for tenants entering into a commercial lease agreement. Not having such a strategy can be risky to the business, and in worst case cause partial or total closure of its operations.

Recent Amendments to the Disclosure Regime Governing California Lease Agreements (Part 2)

December 15th, 2013

This article is the second in a two-part series dealing with the various disclosure obligations that have been recently included in the legal framework governing commercial lease agreements and real estate in California. In Part I, we discussed the disclosures to be made under the amended ADA accessibility regime; in Part II, we will focus on the energy use disclosures required under the Non-Residential Building Energy Use Disclosure Program.

The Non-Residential Building Energy Use Disclosure Program (AB 1103 and AB 531) mandates the disclosure of energy use data (for the prior 12 months), operating characteristics, and ENERGY STAR Energy Performance Score of commercial buildings of over 5,000 square feet, to be made to a prospective buyer or tenant no later than 24 hours prior to the execution of the purchase/lease agreement, and no later than the submission of the loan application in the case of a prospective lender. Since July 1, 2013, the program has been in force with respect to buildings of over 50,000 square feet, however the same is slated to come into effect on a staggered basis and will cover buildings over 10,000 square feet by January 1, 2014, and those over 5,000 square feet by July 1, 2014.

Indeed, this mechanism is not unknown to realtors and the administration – since January 1, 2009, gas and electric utilities have maintained energy consumption data for all commercial (non-residential) buildings, which have been uploaded to the United States Environmental Protection Agency’s ENERGY STAR Portfolio Manager portal on a consent basis. However, the program now mandates the usage of the free online portal, which requires utility account-holders to furnish data within 30 days of each request. Additionally, the user is also required to fill out a compliance report and download and make available certain “Energy Use Materials” (Disclosure Summary Sheet, Statement of Energy Performance, Data Checklist, Facility Summary) to prospective tenants and buyers.

The software tool compares buildings located in regions experiencing similar climate and operational conditions, and scores them relatively on a 1-100 scale – a rating of 75 qualifies for ENERGY STAR certification – allowing prospective tenants and buyers to estimate future operating costs, rather than mere utility bills, when comparing buildings. At the same time, maintenance of the ENERGY STAR profile and rating is an additional burden on the real estate developer, given the degree of influence it can have over potential customers.

This system is an improvement on the benchmarking system to aid tenants, buyers, and lenders to compare energy consumption data of similar commercial buildings that was created in 2007 pursuant to Section 25402.10 of the California Public Resources Code. Moreover, it must be borne in mind that these disclosure obligations apply specifically to sales, purchases, or financing agreements in respect of an entire building, and not portions of buildings, or to multi-family buildings.

Though no sanctions have been specified for the failure to comply with the above mandated disclosures, it is certainly in the interest of real estate developers to take these regulations seriously, when dealing with clients, who will almost certainly require evidence of compliance as a prerequisite to the closing of a real estate transaction, thus creating a self-regulating market, that significantly reduces the burden of enforcement on the state.



October 24th, 2013

If recent trends of the California Supreme Court are anything to go by, commercial real estate agents may have to be more careful about what they say when entering into lease agreements. In January 2013, the California Supreme Court in Riverisland Cold Storage Inc. v. Fresno-Madera Production Credit Association (2013 WL 141731 (2013)) reversed an 80-year old rule limiting the admission of extrinsic evidence (including oral evidence) to show that a contract was tainted by fraud, essentially opening the floodgates of litigation to a bare claim that would have otherwise found little favour with the court – “I never read the contract before signing it; they told me it said something else and so I did.”

The parol evidence rule, as codified in Section 1856 of the Code of Civil Procedure, and Section 1625 of the Civil Code, precludes challenges to the validity of an “integrated contract,” or one which the parties expressly intend (by the inclusion of an integration clause) to be the final expression of their agreement, on the basis of prior written or oral agreements and contemporaneous oral agreements; this rule, however, is subject to a number of codified exceptions, one of which is fraud.

The prevailing law in California prior to Riverisland was laid down in 1935 in Bank of America v. Pendergrass (4 Cal.2d 258, 263 (1935)), where the Court rejected the claim advanced by borrowers who had restructured their debt after defaulting on payments, that the lending bank had made oral representations contrary to the terms of the written agreement, to the effect that the renegotiated agreement would extend the period of the loan, in order to fraudulently induce them to put up additional collateral. In doing so, the Court refined the fraud exception, expressly excluding facts evidencing “a promise directly at variance with the promise of the writing,” and upholding its application solely in instances where the evidence sought to be admitted was an independent fact or representation evidencing either a fraud in the procurement of the instrument or a breach of confidence with respect to its use.

Since then, California creditors and mortgagees have enjoyed the protection of this peculiar rule that has prevented debtors from relying on oral statements made prior to or at the time of their entering into the contract, placing the onus of due diligence squarely on the shoulders of the contracting parties. In Riverisland, which presented facts virtually identical to those of Pendergrass, the California Supreme Court seized opportunity to correct what was widely considered an 80-year old mistake, terming its decision in Pendergrass an “aberration” that ran contrary to the statutes, restatements, and prior case law, in addition to constituting bad policy.

In its attempt to bring California law in conformity with the laws of the majority of the other states, however, the language of the court’s decision creates no safe harbours that would preclude fraud claims even in cases where both parties have carefully read the clauses of the contract, in contrast to the case in Riverisland, where the parties relying on the oral representations were uneducated. This will undoubtedly have significant ramifications on the climate for contract formation in California, even if the various other elements of fraud (knowledge of falsity, intent to deceive, reasonable reliance, and resulting damage) are difficult to prove. Indeed, leasing agreements have become some of the first victims of newly-expanded fraud exception to the parol evidence rule, with the Court ruling in favour of tenants who alleged fraud despite having read and renegotiated lease agreements in both Julius Castle Restaurant v. Payne (157 Cal. Rptr. 3d 839, Cal. App. 1st Dist. (2013)), and Thrifty Payless, Inc. v. The Americana at Brand, LLC (2013 WL 3786374 (2013)), as recently as July 2013.

While the inclusion of more robust and conspicuous integration clauses that evidence clear intention on that part of the parties to supersede any oral promises, in addition to clauses that express that the agreement has been jointly drafted with recourse to legal representation, may afford some protection, it remains to be seen whether such contracts will survive judicial scrutiny, given that the court has gone so far as to distinguish such cases from precedent that precludes challenges to validity where the party alleging fraud was negligent in acquainting himself with the terms of the written agreement despite having had reasonable opportunity to do so, as applicable only to the execution of the contract rather than its formation (Rosenthal v. Great Western Financial Securities Corp. (14 Cal.4th 394, 419 (1996)).

Indeed, the decision in Riverisland appears to have heralded the return to a position of law which had been historically evolved in the 1800s to protect the interests of mortgagors at a time when mortgage agreements were drafted so as to convey title to the mortgagee immediately, subject to the timely payment of a consideration (Pierce v. Robinson (1859) 13 C 116). However, in light of changing circumstances and norms in contract formation, a legislative clarification of the law in a manner that reflects a balancing of the freedom of contract and its policy interests in protecting small parties, is essential to preserving California’s environment as conducive to contractual relations.