C. Leases

• Jurisdiction: New York

C. Leases

1. Nature of a Lease

Leases can be viewed in two ways: (1) as a possessory interest in real estate, giving one party, the tenant, the right to occupy the property of another party, the landlord, for a specified time, upon compliance with certain conditions, chief among which is the payment of rent; and (2) as a contract that may be extensively negotiated. As in any other transaction, market conditions can greatly affect the willingness of both parties to be flexible in the negotiations.

The attorney's first task is to anticipate his client's needs by understanding the transaction from the client's perspective.

2. Representing the Tenant

All businesses require some space in order to function. A small business may be able to start in the home or the garage of the proprietor, but at some point most businesses need outside space in which to function and meet clients. This is a big step for a business. To help clients with this step, at least in New York City, the NYC Department of Small Business Services has created a Comprehensive Guide to Commercial Leasing that might be helpful to clients, available at: https://www1.nyc.gov/assets/sbs/downloads/pdf/about/reports/commercial-lease-guide-accessible.pdf.

As counsel for the potential tenant, it is crucial to understand how your client intends to use the space. Some tenants will know a great deal about their intended use. For example, a chiropractor wishing to install an x-ray machine in an office might be aware that he needs to construct a lead shield around the room in which the machine is located, in order to protect surrounding tenants. He also may know the building code requirements, or he may be savvy enough to know that he needs to hire a contractor familiar with those requirements. A successful restaurateur opening a second restaurant may know the size and configuration of the kitchen he needs, the renovations needed to comply with the local building codes, where to obtain the appropriate equipment, what type of permits are required and how long the renovations will take.

Other clients will be less sophisticated. A person about to open a dry-cleaning establishment for the first time may not be familiar with the requirements for storing and disposing of toxic chemicals, and may not understand how those requirements will affect the configuration of the leased space. An accountant or doctor setting up an office for the first time may have thousands of details to consider, and may not focus as carefully as necessary upon the potential pitfalls in a lease. Thus, it is essential to question the client carefully about his needs. Might the client need to lease more space adjacent to the premises if the business is successful? Or might the client want to rent more space than he needs initially, and sublet space at first until the business grows, rather than carry the full expense of the entire space from the beginning of a business venture? In the era of pandemic, might a doctor need less space than he used to because he's doing more telehealth visits? Is the client's business dependent upon broadband Internet access, and does this building provide such access? What kind of lease provision can you obtain to protect the tenant if the Internet access fails? Asking such questions up front can mean saving the client thousands of dollars over the term of the lease. Failing to ask could mean that the client eventually goes out of business, because he must pay for space that he cannot use as intended and cannot dispose of by subletting or assigning his interest.¹⁵¹

3. Representing the Landlord

From the landlord's perspective, the proposed tenant must use the space in such a way as to minimize disturbance to other tenants, and so as not to create unanticipated expenses for the landlord—for example, by violating any laws to which the property is subject and incurring fines. The tenant must also use the premises in a manner consistent with the building's own standards, which may be different from, and more stringent than, the applicable building codes in a Class A facility.

A tenant in a downtown office building who rents the space for a take-out deli and closes down at 5:00 P.M. will have different requirements for building services than a tenant who runs a first-class restaurant that stays open until midnight. The landlord must be confident that the rent he receives covers the costs of running the property and providing the different types of tenants with necessary services.

Landlords of multiple dwellings are often bound by special laws intended to protect residential tenants. Familiarity with those laws is critical for landlords and their counsel.

4. Representing the Prospective Buyer

The buyer must review the leases and obtain the lender's approval of the leases. If the leases contain objectionable provisions, the buyer may decide not to purchase the property or may seek to negotiate with a tenant to change the objectionable provisions, which may require paying an incentive to the tenant or making other concessions in lease terms. Not all tenants are current in their payment of rent, and some may be in violation of the lease in other ways. A buyer may decide to initiate eviction or other proceedings; these might have to be started by the seller before the closing and require more active cooperation than the seller may have intended. Not all tenants will cooperate with a prospective buyer. Sometimes they see an impending sale as an opportunity to wring concessions out of the existing owner, and will deny access to the leased property necessary for the buyer to make inspections; or, they may refuse to provide estoppel letters required by the lender or the buyer. If there is a property manager, or a provider of other services, the buyer must assess the quality of their services and decide whether they need to be replaced, and if so, whether to ask the seller to initiate the change or wait until after the closing. Some buyers prefer their own service providers, and want the right to terminate existing service contracts, or to renegotiate their terms.

Where your client is buying a building which contains tenants, inquiry into the history of the building can also be essential. In the case of South Eleventh St. Tenants Ass'n v. Dov Land, LLC¹⁵² the court, citing Caldwell v. American Package Co., Inc.,¹⁵³ held that the current owner was limited by the actions of his predecessor, where the tenants were applying for protection under the Emergency Tenant Protection Act of 1974 (EPTA)¹⁵⁴ because the prior owner "acquiesced in the unlawful conversion" (to loft apartments).

5. Major Lease Provisions

A sample form of office lease and of store lease promulgated by the Real Estate Board of New York, Inc. are included in the Forms section at the end of this book.¹⁵⁵ The latest major amendment to the U.S. Bankruptcy Code became effective on October 1, 2005.¹⁵⁶

a. Premises

As in a contract of sale, it is essential to define the "leased premises."¹⁵⁷

b. Rent

Rent is an obligation that continues into the future after the lease is signed; it is subject to adjustments over time, unlike a sales price, which is generally paid once.

Depending on the nature of the leasehold, a lease may be "gross," calling for the tenant to pay rent in exchange for which the landlord provides all services, such as utilities, security, and cleaning, or "net," calling for the tenant to pay rent and the operating expenses of the space. A "triple net" lease is one in which the tenant pays absolutely all the operating expenses associated with its own space, including real estate taxes and insurance, and the costs of maintaining a percentage of the expenses associated with the common areas, such as the parking area and the lobby. Triple net leases are customary where there is a single tenant that occupies the entire leased premises, such as a 7-Eleven convenience store. (The term is bandied about somewhat casually, and counsel is advised to confirm that the tenant really expects to pay all operating expenses.)

Rent may be calculated in a variety of ways, depending upon the market for the type of space being leased. Most rent is fixed in advance and is due at the beginning of the year, although the tenant is allowed to pay in monthly installments, to match the payments due with respect to the underlying mortgage. In a lease for the anchor tenant in a regional mall, such as a Macy's, for example, you might see rent expressed partially as a fixed payment each month and partially as a percentage of sales due once a year.

PRACTICE GUIDE

Leases that call for additional rent payments based upon a percentage of sales are generally disfavored. It is difficult to assess what sales have been, and negotiating which sales are included is a complex process. Only the sales from this particular site? A percentage of catalog sales? How are returns handled, particularly if the original purchase was made on the Internet? Tenants often resist these clauses because of their preference for privacy if the store is not owned by a publicly held entity, and because enforcement is obtrusive, since the landlord usually seeks the option to audit the tenant's books and financial records to confirm the correct amount of rent has been paid. If the tenant owns several stores, breaking out the sales from one store can be an accounting nightmare. If the landlord finds that the tenant underestimates sales, the lease clause may also require the tenant to reimburse the landlord for the costs of the audit.

Rent escalations are usually included in the lease as well. In New York City office buildings the rent may be increased based upon a percentage of the increase in the so-called porter's wage, or in the Consumer Price Index (CPI), after the first year of the lease. Of course, in New York City office buildings, the rent may not be negotiable, except by the largest tenants. Rent may be based on the landlord's calculation of "rentable" square...