The Ability (Or Lack Thereof) To Negotiate the “Small Tenant Lease”

We are often approached by small local commercial real estate tenants that would like to engage us to review and negotiate the lease form sent to them by the landlord. The reality is that small tenant leases can be difficult to negotiate because the small tenant does not have the clout that is necessary to negotiate major revisions to the landlord’s lease form.

The term “small tenant lease” refers not only to the mom-and-pop tenant which has only one or two stores, but also to any tenants that are not national “credit” tenants that add value to the center. It also refers to any tenant that occupies very small square footage. For these tenants, the most critical aspect of the lease is that they understand the implications of what they are signing and how the lease document will actually impact their day to day operations. They also need to understand the effects that the lease will have on their company or their personal lives, should the store fail and be forced to close. Therefore, our review focuses on their day-to-day business, the key issues that might be negotiable, and the prospects for what could happen if the business fails.

small shop.jpgA main topic for review in these leases is the Use Clause. It is important that everything that the tenant intends to do in the space is covered by the allowable use, or that there is enough wiggle room in the language as drafted to allow the tenant the ability to expand or modify its uses to accommodate market needs.

Another area which is always of concern is the construction section, which addresses the tenant’s construction obligations in the premises to make it operable for the intended use. This section also details how the construction will interrelate with the opening date requirement and the operating covenants which are usually included in the lease form. One of the major trouble areas for a tenant is the construction of the premises. With their lack of construction experience, they might miscalculate their timing needs and payment obligations to the contractor. If the work is not completed on schedule, the tenant will be required to begin paying rent to the landlord, whether they are open for business or not. This could cause a severe cash crunch for the inexperienced tenant, and it could also trigger payment problems with the contractor that result in liens being filed which would create further defaults under the lease. Careful consideration must be made in reviewing and agreeing to realistic time frames and payment schedules.

Insurance is also an important area of concern. The tenant’s insurance agent should always review the insurance paragraphs of the lease to confirm that the tenant’s policies comply with the lease requirements. Many times the small tenant may not be able to afford the amount of liability insurance coverage required by the lease, therefore the negotiation of appropriate amounts is required.

Sublease and assignment restrictions are typical in most lease forms, and they will require careful review and oftentimes be in need of modification. Many small shops are family-owned businesses that would pass on to family members in the event of the death of one of the shareholders. Also, the family patriarch may need to plan for a smooth transition and create trust and estate plans that cover such eventualities. The assignment provision should be reviewed keeping this in mind to allow for transfers without the landlord’s consent for estate planning purposes, as well as intra-family transfers for the tenant entity to give the small shop owner such flexibility.

Last but not least is the issue of which entity or individual is guaranteeing the lease. Most small shop landlords will require a guaranty of the lease from the principals of the tenant. This is because they want the owner to have some proverbial “skin in the game.” While these forms are rarely negotiable for the small shop tenant, a careful explanation of what it all means and what financial consequences a claim against the guaranty can have on the principals’ credit standing and future abilities to do business is essential.

The attorneys at our firm who focus on real estate matters have been negotiating small shop leases and license agreements for retail properties for more than 30 years, and we encourage the owners of these businesses and the landlords that cater to them to contact us with any questions about these agreements or other important legal and business matters.