The best time for a tenant to negotiate key lease terms is before the tenant negotiates the lease. After a tenant requests the landlord to prepare a draft lease (on its landlord favorable form), the tenant has signaled to the landlord that it has committed to the building and consequently loses market leverage. As office leases and the entire leasing process is decidedly tilted toward landlords, to level the playing field, tenants should negotiate a detailed Letter of Intent (“LOI”) memorializing all business terms and key legal terms to serve as the “blue print” for the lease draft. A well negotiated LOI will maximize lease concessions for the tenant as well as save time and money in the lease drafting process. Additionally, the inherent process of negotiating an LOI, will tell you a lot about the landlord and their “hot button” issues, etc… Discussed below are strategies that tenants should employ to effectively negotiate an LOI.
What should be in the Tenant’s LOI?
As most pre-lease negotiations are documented through an RFP process with proposals, counterproposals leading to revised proposals, etc.., the LOI should memorialize all of that documentation as well as any additional documentation and conversations into one document. It should also address and further detail key lease terms. The complexity of the deal and market conditions will drive the depth of the LOI.
The LOI should also include those gray issues that are business and legal in nature, but if not fully negotiated upfront, could cost the tenant. Besides the basic lease terms, the LOI should address the following issues.
- Premises and Building measurement standards
- Waiver of pre-emptive rights – lender consent, another tenant’s rights to the space, etc…
- Early Access Period
Commencement Date definition and triggering events (i.e., substantial completion of construction) and Penalties to the landlord for untimely completion of the construction, see our posts on Tenant Improvement Strategies
- Operating Expense & Tax treatment – define list of exclusions, audit right, cap
- Scope of Services and Interruption Remedy
Renewal Options – defining notice requirements, market terms, procedure
- Expansion Options – defining by Right of First Refusal or Offer, notice periods, market terms, see our posts on lease flexibility tips
- Assignment & Subletting – including the right to sublet or assign to an affiliate or subsidiary without landlord consent
Cancellation & Contraction Options – defining notice requirements, procedure, fee calculation, see our posts on lease flexibility tips
- Landlord’s Relocation Rights – eliminate or limit
Security Deposit or Letter of Credit – waive, limit and/or “burn-down” provision
- Compliance with Laws – both Premises and Building
- Non-disturbance Agreement – see our post on Plugging the Lender Loophole
How much detail should be in the LOI?
While the level of detail of the LOI will be influenced by the complexity of the deal and the tenant’s bargaining power, the basic business terms should be carefully specified. For other important lease issues, the LOI should outline the key concepts, but “stay out of the weeds” and avoid negotiating exact lease language. Landlords will push for a bare bones LOI, arguing that it is more efficient to negotiate lease issues in the lease. On the surface that sounds logical, but it is to the landlord’s advantage as they are negotiating from their landlord-favorable lease document.
To gain the upper hand in lease documentation, there are some business-legal issues that should be approached with more detailed language which will have a major financial impact to the tenant:
(1) Tenant Improvement Provision (“Work Letter”) – see my posts on Tenant Improvement Strategies
(2) Operating Expense and Tax Provision – include a list of exclusions to what can be charged as an “Operating Expense” or “Tax” as well as audit rights.
(3) Security Deposit – define the amount, timing of deposit or Letter of Credit, address transfer liability and a reduction provision (“burn-down”) of the amount assuming no defaults.
Lastly, depending upon the tenant and/or property, there may be certain “deal killer” provisions that you should introduce upfront, i.e., self insurance right, environmental, etc…
This all being said, tenants may be best served not raising certain issues at the LOI stage. Savvy tenants know the value of “strategic silence” on certain issues. It may be in the best interest of a tenant not to raise issues that would sour the deal.
Who should be involved in LOI negotiations?
- Decision Makers. Fundamentally, the prospective tenant and landlord parties are involved as the decision makers.
- Brokers. Since most tenants are not experts in office leasing, they will engage a broker. Typically, the landlord will also have a broker representing its interests in the transaction. While the brokers will be knowledgeable about the market and leasing process, they typically do not have a legal background and should not be involved in providing detailed leasing language. Tenants must also bear in mind that the broker’s compensation may create a conflict of interest as well if the broker’s firm has a business or prospective business relationship with the landlord.
- Lawyers. Depending upon the complexity of the deal, the landlord and the tenant may engage their attorney. While the attorneys will provide the necessary legal horsepower, there’s the risk that the deal could go off the tracks and get mired in details. There’s also the potential of a sunk cost with legal fees being expended, if a lease is not finalized.
- Construction Manager/Architect. Depending upon the construction involved, the tenant’s construction manager and/or architect should review the relevant LOI terms and offer necessary guidance.
Probably the best course is for the tenant to have a trusted tenant representative who is well-versed on leasing issues to be the lead on the LOI. The tenant rep should be knowledgeable enough to know when to consult with other members of the tenant’s team on the LOI documentation process.
Are they binding?
Most LOIs will contain a signature block for the Tenant. Without the appropriate disclaimers, an LOI signed by the tenant can create legal obligations. While it probably wouldn’t create an enforceable lease obligation, the tenant could be exposed to liabilities the landlord incurs in reliance upon the tenant signing the LOI. Even where the LOI has the appropriate disclaimers that would not create any legal liabilities for the tenant, there is the pain and reputation damage that is associated with the tenant backing out of the negotiations after the LOI is signed. That is not the case, of course, if the landlord does something in the negotiations that would change the deal terms thereby allowing the tenant to walk away.
A well crafted LOI will ensure that the tenant gets maximum deal concessions and lays the ground for a balanced lease document. It will also save the tenant time and money. Tenants should remember that the LOI is not the same as negotiating the lease and should stay out of the weeds, other than for certain key provisions.
Blackacre Advisors LLC
DISCLAIMER. Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).