§ 1.01

• Jurisdiction: United States

§ 1.01 Evolution of the Modern Commercial Lease—Emergence of the "Killer Lease"¹

[1]—The Past and Today

Prior to the early 1980s, the commercial office lease was typically a modest document of twenty pages or so, replete with standard clauses that rarely changed from one document to the next. Since that time, however, the approach to negotiating and drafting commercial office leases has undergone a rapid and drastic transformation. Huge, sophisticated commercial leasing documents, some of which exceed 200 pages in length including exhibits and work letter agreements, have become commonplace. These "killer leases,"² as they have come to be known, contain little of the familiar terminology of the older leases, and they make often subtle changes to many of the traditional clauses.³ They are typically extremely onerous, carefully drafted, one-sided agreements, which seek to shift the landlord's costs and risks to the tenant⁴ while at the same time carefully and quietly exacting hidden profits for the landlord.

The complexity of these "killer lease" documents poses unique challenges to the parties to the lease transaction as well as to those who represent them. It is not unusual for tenants to fail to grasp the complete ramifications of these complex documents. By analyzing key issues and provisions within these "killer leases," this treatise seeks to "level the leasing playing field" for all participants.

What is a modern commercial lease? The approach taken in this treatise is to consider a commercial lease to be a living, multi-faceted, many dimensional, multi-disciplined document. A commercial lease may grant a conditional interest in real property or it may confer occupancy rights to only a fractional interest. Under certain circumstances, such a lease may also be a pure contract. Alternatively, it may be a hybrid contract, a license, an operating agreement, a conditional grant or a limited demise for a period of time. Each of these possible scenarios may impact the transaction in slightly different ways.

A commercial lease can sometimes be a tool affecting the operations, cash flow and financing of real property. It is often a directive of, and a limitation on, the operations and ultimate business success and profitability of a tenant. Particularly in the case of the "killer lease," the commercial lease is frequently utilized as an offensive negotiation instrument in order to exact additional revenue for the landlord over the life of the relationship, usually unanticipated by the tenant.⁵

The commercial lease may be an asset of a tenant as well as a liability on its balance sheet. The lease may also be an asset to a landowner and an enhancement or an impediment to a mortgage transaction. It may be a roadblock to the sale of a tenant's business, or it may trigger environmental responsibilities or pose an operational risk to an owner of the underlying property interest. Under certain circumstances, such as percentage rent arrangements or participation in the operations of a tenant, the commercial lease may have the potential to affect minute details of the tenant's use and enjoyment of the property, such as the hours of operation, the character of use of the property or the inventory. Moreover, if a commercial lease is deemed to grant excessive management and control over a tenant, it may confer unwanted operator, partnership or lender liability on a landlord or mortgagee.

In general, a lease is one of the few legal documents that may span a relatively long period of time. With the underlying term of a lease document ranging in length from months to nearly a century,⁶ it rarely becomes dusty on the shelf! A typical commercial lease will be reviewed again and again by both landlord and tenant, as well as by investors and financiers of the real property or purchasers of the tenant's business. It will be interpreted frequently, many times inconsistently, even by participants of the same entity.

It is fair to say that issues arising under commercial leases have and will continue to provoke major legal battles, involving many millions of dollars a year. When drafting or reviewing a commercial office lease document prior to entering into a transaction, or when analyzing such a document after the fact, no provision should escape careful scrutiny. This treatise provides the framework to assist in this difficult process.

[2]—Looking to the Future—Trends Impacting Commercial Leasing⁷

A significant challenge for the commercial leasing profession will be determining and addressing the effects that globalization and technological advances will have both on the industry generally and the way professionals will approach their profession. Technological change will necessitate new models for developing, sizing and configuring and using office space and, similarly, new ways of dealing with the leasing process, lease terms⁸ and conditions and the attorney's role in negotiating the lease.⁹ Technology has become vital and integral to business operations often necessitating extensive modification of old buildings to include technological amenities in order to attract and retain the most desirable tenants. New structures are being built that reflect the desire for such amenities as well as reflect the desire for environmentally progressive space with shared amenities such as conference space, social space, restaurants, gyms and a host of other amenities.

Being technologically advanced will require office and retail buildings to be "techno-ready"—that is, capable of accommodating new and even yet-to-be created technologies, since today's technology can easily become obsolete very rapidly.¹⁰ However, even the "smartest" buildings of today quickly become outdated as technologies advance at breakneck speed. In a rapidly changing, tech-driven world, highspeed connectivity is a necessity in business operations.¹¹

Designers need to create flexible building and work place designs that enable updating to reflect those advances, and forward thinking developers must focus on keeping their buildings technologically flexible. Otherwise, these buildings will require costly changes to keep current, or risk losing tenants to more up-to-date buildings. At the same time, building operators, especially those operating retail buildings, need to be aware of the competition that vendors who do their business over the internet will have on traditional "brick and mortar" operations or at least account for those "online" sales in any percentage of gross rent they are charging their tenants.

[a]—A Traditional Lease vs. Alternative Occupancy Arrangements—Issues to Consider

There are a number of issues to consider when deciding what type of office or retail space will best suit a particular business's needs. For newly established companies, a traditional lease may be too costly or, if the business expects to grow quickly, a traditional lease may be too restrictive. For such businesses, nontraditional alternatives for space such as coworking/shared space arrangement or "pop up" operation may work better than a traditional office or retail lease.

[i]—The Traditional Commercial Lease

In the office situation, a traditional lease provides the tenant with more rights and a greater level of security than coworking arrangements, which are generally license agreements. Evicting a tenant from a lease is far more difficult than revoking a licensed right of access to a particular premises.¹² Before entering into either arrangement, however, it is important to ask the right questions. For a traditional commercial lease, consider the following:

• What, if any, use restrictions apply? Are there applicable zoning restrictions to consider?

• What rights does the tenant have to sublet, assign or license the premises? What restrictions apply? Are there options to lease additional space, if needed?

• What is the total rental cost? Be sure to factor in additional charges for services and escalations.

• Will the lease term and the actual premises meet the prospective tenant's business needs?

• Is there an option to renew? How about expansion rights?

• What guarantees are required? Are personal guarantees required?

• How large is the security deposit?

[ii]—Alternative Occupancy Arrangements

[A]—A Disruptive Force¹³

Coworking and other shared space arrangements have "disrupted traditional occupational office markets and changed the underwriting analysis performed by lenders, operators and capital partners in office and mixed-use assets. Instead of being treated as tenants, users of coworking/shared spaces are treated more as 'members'—similar to models more typically found in hotels or gyms. They have a more limited set of rights to use and access the space, but are also entitled to have easy and immediate access to a range of services, including space booking tools, printing and document processing resources, and phone and internet capabilities, among many others."¹⁴ Coworking and other shared space arrangements are proving to be major market disrupters significantly impacting the real estate industry. The extraordinary growth of "coworking office ventures is dramatically changing the way real estate investors and lenders value assets and how companies think about space for their employees."¹⁵ In fact, some important and far-reaching trends are impacting the entire commercial real estate industry.

Coworking options are providing corporate tenants with shorter-term and flexible office arrangements.¹⁶ The coworking model is also disrupting "traditional methods of real estate valuation."¹⁷ In response to the increasing popularity of coworking arrangements, many traditional office landlords are adopting service innovations, offering broader service options and enhanced amenities.

"Coworking has disrupted traditional occupational office markets and changed the underwriting analysis performed by lenders, operators and capital partners in office and mixed-use assets. Instead...