Tips and traps in commercial property leases in Alberta, Canada

1. Negotiating the
Commercial Lease
Peter Collins, Kevin Schouten,
Katherine Kowalchuk

2. Seminar Focus
• Review of major areas of offer to lease and
lease with a view to identifying common
issues and typical solutions
• Viewed from both Landlord and Tenant
perspectives

3. Know Your Limitations
• Your ability to get the lease deal you want
depends mostly on factors out of your
control:
– Leasing market conditions
– Importance of tenant to the development
– Strength of tenant’s covenant

4. The Offer and the Lease
• Two main steps in most lease negotiations:
– Offer to lease/Agreement to lease
– Lease
– (a.k.a. Beauty and the Beast)

5. Offer to Lease
• An “outline” document of essential terms
• Can act as an interim lease if it has the five
essentials:
– Parties
– Place
– Term
– Commencement Date
– Rent

6. Bridge to Lease
• The offer might compel tenant to sign
landlord’s standard lease
• Landlord will want to preclude Tenant from
negotiating changes to Lease
• Tenant will want ability to negotiate change

7. Bridge – Common Stepdowns
– “Sign standard lease, amended to include
terms of Offer”
– Stepdowns “ And amended to include”
– Changes agreed to by both parties
– Changes of a non-financial nature requested
by tenant, acting reasonably
– Changes of a non-financial nature requested
by tenant
– Changes requested by tenant

8. Offer to Lease, cont’d.
• Might permit landlord to terminate if tenant
doesn’t sign lease
• Might deem landlord’s presented form to
govern:
– Until lease actually signed, or
– If tenant goes into possession

9. The Tenant Covenant
• Goal of landlord: have maximum ability to
recover against Tenant and its principal(s)
• Financial statements of corporation
• Security agreement
• Personal guarantees from principals
• Security against assets of principals
• Letters of credit
• Security deposit
• Prepaid rent

10. The Tenant Covenant, cont’d
• Goal of Tenant:
• Avoid personal liability, if possible
• Use a corporation (preferably single
purpose)
• Avoid guarantees/indemnities, if possible
– Or limit by time
– Or limit by amount
• Letter of credit as alternate security

11. Lease
• Lengthy formal comprehensive agreement
• Usually heavily weighted in landlord’s favour
• May carry over construction and lease
startup provisions from Offer/Agreement
• There is no government or CSA approved
“standard” lease
– REALPAC has an approved form of office
lease – favours landlords

12. Developing the Space
• Tenant should:
• Review landlord’s development criteria
– Theme/design restrictions
• Review insurance requirements for
construction/fixturing period
• Review contractor requirements
– Who chooses contractor?
• If landlord, must the contractor’s prices be competitive?
(Beware “Cousin Bob’s Construction Co.”)
– Union affiliation

13. Developing the Space, cont’d.
• Landlord’s work v. Tenant’s work
– Landlord’s work – base building (what is
included?)
– Tenant’s work – plans approval process
• Fixturing period
– Fixed v. open for business
– Pay for utilities only

14. Term, Extensions and Renewals
• Initial term usually 5 years for retail, office
and commercial
• Longer initial term on full building build-to-
suit
• Monetary risk of longer term lease – tenant
is “locked in”
• Shorter term lease - tenant can reduce
relocation risk through extension/renewal
options

15. Rent
• Three basic types:
– Gross rent
– “Net” rents + additional costs
– Percentage rents

16. Gross Rent
• Read the definitions carefully
• Should be all inclusive
• Landlord should pay all operating and repair
costs and taxes
• Tenant should pay only rent and GST

17. Net Rent
• “Net”/ “triple net” etc.
• Landlord shifts some portion of ownership
and operating costs into tenant
• Most leases require Tenant to pay
– Landlord’s operation costs
– Landlord’s insurance
– Property taxes

18. Net Rent, cont’d
• If multiple tenants – pay only proportionate
share
– Floating proportionate share is more
accurate than a fixed/stated percentage
• Landlord might exclude some tenants
– Anchor tenants
– Separate pad tenants

19. Percentage Rent
• Often found in retail premises leases
• Landlord charges a percentage of tenant’s
gross revenues
• Definition of gross revenue is flexible
• Tenants should beware cash flow inclusions
– Lotteries
– Vending machines

20. Percentage Rent, cont’d
• Usually subject to a (high) floor amount of
base rent
• Tenant should seek to make it adjustable for
revenue fluctuations

21. Operating Expenses
• Three main categories
• Operating/administrative cost recovery
• Property taxes
• Insurance

22. Operating/Admin. Cost Recovery
• Typically is limited to recovery/
reimbursement of actual costs – tenant
should avoid surcharges
• Typically limited to operating, not ownership,
items
• Typically excludes capital costs recovery
• Difficult to negotiate changes to Op Costs
clauses with larger landlords

23. Operating/Admin. Cost Recovery
• Management fee – tenant should ensure
value for fee, or negotiate reduced fee
– Retail - typically 15% of operating costs (or 4
or 5% of Rent)
– Industrial/commercial properties - 0 to 5%
• Tenant should seek to exclude admin
charges if management fee charged
– Or, only payable when tenant is defaulting

24. Audit Provisions
• Tenant should seek to include right to audit
the landlord’s Statement of Operating Costs
• If Landlord grants audit right, Landlord
should limit the exercise period
• Tenant should seek right to audit at least
one year back

25. Audit Provisions – cont’d.
• Procedure:
– Selection of auditor
– Compensation of auditor
– Confidentiality
– Audit cost – who pays

26. Financial Inducements
• Three common major types
– Free rent - base or all rent?
– Straight inducement - cash payment on
opening
– Tenant improvement allowance - linked to
construction costs
• “Excluding GST”

27. Financial Inducements - cont’d.
• Notion of Net Effective Rent
• Is landlord’s financing rate better than bank’s
lending rate?
• Might ease cash flow - especially on startup
• Potential ability to expense capital items
• Landlord usually wants security to recover
cost of inducements

28. Use of Premises/Conduct of
Business
• Landlords define “permitted use” narrowly
• Change of use might require consent – can
affect tenant’s ability to sell business
• Controls on “classiness” of use
• Landlord will usually set hours of use, for
retail leases
• Landlord may require “continuous use” -
esp. in retail

29. Exclusivity
• Landlords are reluctant to grant exclusivity
• Exclusivity might be critical to tenant’s
success
• Exclusivity is usually narrowly defined
• Major tenants are often excepted
• Tenant should ensure it applies to
renewals/extensions

30. Insurance
• Landlord and tenant each insure. Typically:
– Landlord insures building
– Tenant insures own (interior) premises and
contents
• Landlord will require extensive insurance by
tenant
– Fire/damage
– Liability
– Rental payment/business interruption

31. Insurance, cont’d.
• Tenant should protect itself by obtaining
– Waiver of subrogation
– Waiver of cross claim
• Tenant should always review insurance
requirements with tenant’s insurance broker
• Change in insurability can permit landlord to
cancel lease

32. Maintenance and Repairs -
Landlord
• Landlord only liable as expressly set out in
lease
• Landlord usually responsible for structural
repairs
– Should not be recoverable as an operating
cost
• Landlord usually responsible for general
non-premises repairs/maintenance
– Recoverable as operating cost

33. Maintenance and Repairs -
Tenant
• Usually limited to the (interior) premises
• Tenant should ensure no obligation to repair
structure
• Restoration obligation on lease
expiry/termination
– Improvements – tenant should avoid
defixturing obligation
– Trade fixtures usually removable if tenant not
in default
– Permanent fixtures usually not removable

34. Transfer
• Assignment v. sublease
• If lease silent, no restrictions
• Most leases tightly control lease transfers
• Can affect ability to transfer lease as part of
sale of business

35. Transfer - cont’d.
• Typical transfer control provisions include
• Landlord’s consent
• Approval of financial strength and character
of assignee
• Review and approval fee
• Original tenant remains liable after transfer
• Change of corporate ownership triggering
transfer clause

36. Transfer - cont’d.
• Tenants should beware:
• “Unreasonable and arbitrary withholding” of
consent
• Long list of tests to meet
• Take-back right by landlord
• No change of use on transfer

37. Default and Termination
• Landlords have extensive common law
rights
• Most leases expand on common law rights
• There is no commercial tenancy legislation
in Alberta
• Tenants should ensure written notice of
default and right to cure default
• Match default events to lease rights (ex.,
continuous use/abandonment)

38. Default and Termination, cont’d.
• Right of entry on default
• Default will not necessarily result in
termination
• Landlord has no obligation to re-lease
• Landlord can claim rent for balance of lease
• Distress rights (unless/until lease
terminated)

39. Subordination and Non-
Disturbance
• Mortgage lender wants top priority
• Tenant wants security of tenure
• Lease usually requires tenant to subordinate
to lenders
• Quid Pro Quo – get a Non-Disturbance
Agreement
– Lenders agree to not evict, so long as tenant
not in default
– Landlord – covenant to obtain NDA

40. Estoppel Certificates
• Tenant certifies facts to the
landlord/lender/potential buyer
• Can result in tenant waiving claims against
landlord
• Tenant should limit scope of certificate
during lease negotiations
• Tenant should compare requested certificate
to lease obligation
• Nothing in it for tenant – tenant shouldn’t
give more than tenant contracted to give

41. Lease Renewal
• Limits on right to exercise/timing of exercise
• Ensure rent is set or there is a rent-setting
mechanism
• Definition of “fair market value”
– Improved space?
– What comparables?
• Tenant should avoid “floor” on renewal rent
– Variance from market
– Net effective rent issue

42. Bells and Whistles
• Option - expansion space
• Right of first refusal - expansion space
• Co-tenancy and right to terminate
• Arbitration/Mediation

43. After Lease is signed…
• Tenant should register a caveat
– Not required if lease term < 3 years
• Landlord should ensure all initial deliveries:
– Lease commencement certificate
– Proof of insurance
– Measurement

44. Summary
• Leases are usually heavily weighted against
most tenants
• Your ability to negotiate improvements to
your position is limited by many factors out
of your control
• Keep your perspective
– Small tenant = small changes
– Small landlord + big tenant = big changes
• Good luck! You’ll need it……

45. Questions??