Owners of residential and commercial property must be careful in preparing and signing leases with tenants...
Owners of residential and commercial property must be careful in preparing and signing leases with tenants. Beyond the financial considerations of the agreement and the income or financial statement analyses, an owner must consider how to protect themselves before, during and after the term of the lease. This article highlights several common mistakes made by property owners when leasing to a tenant. This overview addresses these issues directly, but is not an all-inclusive summary with respect to important issues facing a residential or commercial landlord. Leasing and contract preparation requires expertise—from the owner, from outside consultants and preferably from an experienced real estate attorney. While the author has substantial legal experience in real estate and leasing matters, this article should not be construed as formal specific legal advice to the reader, nor should the reader consider the author to be his/her attorney solely on the grounds of having read this article. (See also Renting Commercial Space without a Lease).
Every owner, every tenant and every lease is unique and advice for particular circumstance really does require individual review and consideration.
Legal disclaimers aside, an owner who wants to protect themselves from potential liability and attorney's fees (not to mention administrative headaches), should consider the issues detailed below with respect to the following 5 lease provisions, which commonly lead to substantial landlord mistakes:
While the intended use of the property has undoubtedly been considered well in advance of the signing of the lease agreement, it is essential that an owner include detailed limitations on the tenant's rights to use the premises. Due to assumptions, prior informal conversations and failure to consider potential ramifications, an owner may overlook this important portion.
When renting commercial property you should accomplish 4 things with respect to use commercial property:
While residential use specifications and limitations do not need to be as detailed as those applicable to commercial leases, there are still significant considerations that must be made. A properly-drafted residential lease should consider the following use limitations and specifications
A well-drafted real or sample commercial lease should spell out the insurance requirements of both the owner and the tenant. A property owner must be diligent in being sure that its property (and pocketbook) are protected upon the occurrence of events ranging from a fire or a slip-and-fall accident to a disgruntled tenant or negligent (or malicious) acts of a tenant or other party.
A commercial lease should explicitly require the tenant to obtain multiple types of insurance. In order to be sure these protections are in place, the owner will want to insert a contract provision specifically requiring tenant to provide proof of insurance. Furthermore, the landlord should retain the right to purchase the insurance policies on tenant's behalf (and charge tenant the cost) if tenant fails to provide this proof within a designated timeframe. It is important that the relevant insurance policies become effective immediately upon tenants occupancy/use of the property. An owner of a commercial property will typically want to consider requiring the lessee to obtain the following types of coverage*:
Insurance requirements in a residential setting are typically lighter than a commercial setting for obvious reasons, mostly having to do with the intended use of the property. However, an owner must consider requiring a residential tenant to obtain certain basic types of insurance policies. If these policies are required, the landlord should require that proof of insurance be provided to the landlord. The following basic coverage* should be considered in a residential setting:
*Insurance limit amounts should be determined in consultation with a qualified professional.
No matter how well-drafted a lease is or how well-situated a tenant might be, there will unfortunately be instances where a tenant defaults on its obligations under the lease. Whether due to cash flow shortfalls, misunderstandings regarding lease terms or simply a negligent (or malicious) tenant, every owner faces the very real risk of a tenant not living up to their contractual obligations. It should be noted that defaulting on a lease encompasses much more than late (or unpaid) rent—it also includes such events as misuse of the property, failure to obtain required insurance or violating other specific terms of the lease agreement.
A commercial lease should broadly define what constitutes default, including the following events/actions: (i) failure to make timely rental payments, (ii) failure to perform any covenants under the lease after a period of written notice from landlord, (iii) failure to perform any covenants under the lease which creates a hazardous condition which tenant fails to immediately cure upon notice from landlord, (iv) an event indicating tenant bankruptcy or other financial insecurity, including a writ of execution against the premises, and (v) tenant vacating the property for more than a designated period of days (usually 10 days). A properly-drafted lease should also detail the rights that the owner has against the property and the tenant, including the following:
While provisions in a residential lease will be quite similar to those in a commercial lease, there are some subtle differences, usually amounting to slightly simpler terms. A residential lease should broadly define what constitutes default, including the following: (i) failure to make timely rent payments, (ii) failure to perform any covenants under the lease after a period of written notice from landlord, (iii) an event indicating tenant bankruptcy, and (iv) the existence of a writ of execution against the premises or the tenant's leasehold interest. A properly-drafted lease should also detail the rights that the owner has against the property and the tenant, including the following:
It is not typically necessary to include specific provisions regarding landlord default. In the event that tenant insists on such provisions, they should be narrowly defined with limited potential remedies granted to tenant. An attorney should be consulted in case of any disputes.
An owner must seriously consider a personal guaranty for both commercial and residential leases. A guaranty provides an owner with added security regarding payment of rent and other expenses (and liability) while also committing the tenant to further responsibility and investment in the use of the property. There are no practical downsides of a guaranty for an owner.
A commercial lease should be guaranteed by an individual with adequate financial security. This will often be the owner of the company, a major investor in the business or a person with a close personal relationship to the operator of the business. The traditional theory is that the closer the guarantor is to the operation of the business the better, as they will have a vested interest in the success of the business, which always benefits the landlord. An owner may consider waiving the necessity of a personal guaranty in the event the tenant company has sufficient cash flow and credit history, or in the event of a renewal with a trustworthy long-time tenant. The contents of a personal guaranty requires the advice of an experienced attorney.
If a residential tenant does not have adequate income and/or personal credit history, an owner should seriously consider requiring a personal guaranty from a separate individual with more a more secure financial position. The content of a personal guaranty requires the advice of an experienced attorney.
Any owner of property knows that the day will come when they will want to sell their residential or commercial property investment. With respect to the lease, the owner needs to be sure to protect its right to transfer (i.e. sell, give away, or transfer to a related business entity) the property title while not terminating the lease. The following provisions will prove necessary to protect the owner's right to a transfer and his/her ability to do so.
Four predominate issues arise in the event a landlord wishes to sell leased property:
To these ends, the following provisions should be included in both residential and commercial real estate leases:
"In the event of any sale or exchange of the premises by landlord and assignment by landlord of this lease, landlord shall be and is hereby entirely freed and relieved of all liability under any and all of its covenants and obligations contained in or derived from this lease arising out of any act, occurrence or omission relating to the premises of this lease occurring after the consummation of such sale or exchange and assignment."
"Upon written request of landlord, or any mortgagee or beneficiary of landlord, tenant shall in writing subordinate its right hereunder to the interest of any ground upon which the premises is situated and to the lien of any mortgage or deed of trust, now or hereafter in force, against the land and/or building on the premises and to all advances made or hereafter to be made upon the security thereof."
"Tenant hereby irrevocably appoints landlord as attorney-in-fact for tenant with full power and authority to execute and deliver in the name of tenant any instruments or certificates to carry out the intent of [the previous article]. If fifteen (15) days after the date of a written request by landlord to execute such instruments, tenant shall not have executed the same, landlord may, at its option, cancel this lease without incurring any liability on account thereof, and the term hereby granted is expressly limited accordingly.
"Within ten (10) days after request therefor by landlord, tenant agrees to deliver to any proposed mortgagee or purchaser, or to landlord, a certificate in recordable form, certifying, if such be the case, that this Lease is in full force and effect and that there are no defenses or offsets thereto, or stating specifically those that are then claimed by tenant, and any other reasonable information requested for the proposed mortgagee, purchaser, or to landlord."
"Landlord shall deliver the funds deposited hereunder by tenant to the purchaser of landlord's interest in the premises, in the event that such interest be sold, and thereupon landlord shall be discharged from any further liability with respect to such deposit."
This article is for informational purposes only and should not be construed as legal advice with respect to any particular lease, circumstance or owner. For additional information, please contact Jim Schleiffarth, Schleiffarth Law Firm LLC, (314) 315-4117, [email protected].
Schleiffarth Law Firm • Jim Schleiffarth, Esq. • St. Louis, MO