Conduct due diligence, negotiate before signing commercial lease

Toronto business lawyer Anton Katz says there are multiple clauses and conditions that can be negotiated in a commercial lease agreement and, as such, it’s key for prospective tenants to seek legal advice before signing an offer.

In the first part of this series, Katz discussed the basics of commercial leases including term, rent and the right to assign a lease. This second installment will explore use, exclusivity and demolition clauses as well as leasehold improvements.

Use and exclusivity clauses

Katz says it may be important for a commercial lease to contain a use clause and an exclusivity clause, particularly in the context of a retail lease.

“If you’re leasing space in a shopping centre where there is a mixture of tenants, you want to have a use clause which will allow for as many different uses as possible,” he says. “For example, in the case of a coffee shop, is the use limited to selling coffee? Or is it coffee and baked goods? If there’s already a bakery three doors down, your use may be limited.”

As a result, the language in the lease is critical, Katz says. A tenant wants the use clause to be as broad as possible while the landlord would likely prefer it to be much narrower.

Using the same retail example, an exclusivity clause would allow for the tenant’s coffee shop to be the only one in the shopping centre.

“If you can negotiate it, that’s great,” says Katz, principal of Anton M. Katz, Barrister and Solicitor. “Depending on the size of the shopping centre, the landlord may be resistant because they plan to have an additional coffee shop at the other end of the mall.

“Once again, it comes down to negotiating power,” he adds.

Demolition clause

There may be a demolition clause in the lease which states the landlord can demolish or redevelop the building and terminate the lease on six months’ notice, for example.

“That’s very important information for a tenant to be aware of because that will affect the length of the term,” he tells AdvocateDaily.com. “While you may have agreed to a five-year lease, it could end up being as little as six months if the landlord decides to demolish the building.

Leasehold improvements

In situations where a landlord is very keen to have tenants come on board, they will sometimes offer sweeteners or inducements including leasehold improvements at their own expense.

Sometimes the tenant is given a period during which time it can renovate the premises.

“If it’s a restaurant going into the space, it could take three months to renovate and update before opening to the public,” he says. “Some tenants will ask for a rent-free or base-rent-free period for those three months.”

Landlords who are eager to enter into a long-term relationship may be amenable to waiving rent during the fixturing period, says Katz.

Professional advice

A commercial lease is a very important part of one’s business and as the above examples illustrate, there is room for negotiation. Prospective tenants are well advised to meet with an experienced lawyer and spend time reviewing both the offer and the lease, Katz says.

“These documents can be 40 pages long or more,” Katz says. “A layperson may not necessarily appreciate the absence or presence of some of these terms and clauses. You need a lawyer to guide you and to highlight these key points for you.”

He appreciates that clients may be fee conscious but says it’s crucial to keep in mind the importance of seeking advice and conducting due diligence before signing a commercial lease agreement.

“Keep in mind that if you’re paying $5,000 a month in rent, for example, that is $60,000 a year. Over a five-year lease, you’re paying $300,000 in rent,” Katz says. “To spend a few thousand on legal advice is a wise investment.”