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Office Tenants: Do Due Diligence on Your Landlord

Office markets from coast-to-coast are struggling mightily, especially in major urban downtowns. Chicago’s downtown business district (i.e. the Loop) is no exception. Right now, Chicago’s Loop office vacancy rates are the highest since such rates have been recorded.

In April of this year, Crain’s Chicago Business reported that downtown office vacancy broke 25% for the first time on record, landing at 25.1%. This number reflects seven consecutive quarters of increasing vacancy.

What does this mean for tenants? Well…a lot.

It means opportunity as landlords feel pressure to fill vacant office space. Lease concessions that never would have been considered three years ago, might be available now. These days, on most office deals, tenants enjoy considerable leverage. While this market brings tenant’s many benefits, it also brings significant risks. Here are a few risks for tenants to consider before signing a lease:

1. Is your landlord in financial distress? Landlords will always vet an incoming tenant’s financial condition. The same often does not happen in reverse. Many office landlords face financial pressure now. If the landlord is at risk of foreclosure, or otherwise in financial peril, the tenant should have a number of concerns ranging from how well the building will be maintained to whether or not they will be staying in a bank-owned building soon. Tenants should fully inquire into landlord’s financial condition, especially if meaningful tenant allowances have been agreed to.

2. Subordination and Non-Disturbance Agreements are more important now than ever. “SNDAs” can go a long way towards protecting tenant’s lease rights in the event of a foreclosure.

3. Will “creative” uses come to the building? Never underestimate the ingenuity of the commercial real estate industry. All kinds of ideas have sprouted up as to what could be done to fill empty downtown office space. Indoor dog parks, pickle ball courts and the often tossed about notion of converting vacant office space into residential apartments are good examples. Tenants should find out before signing if the landlord has any designs on filling vacant space with uses that the tenant might find objectionable.

4. Co-tenancy provisions and the careful review of how operating costs will be allocated are critical. Who bears the risk of vacancy as to operating expenses? Tenants needs to know if fewer tenants means they will have a higher share of operating costs. Tenants also need to know if they have any way out of the lease if the building really struggles. No one wants to be alone in an empty tower.

What You Need To Know: Boston and Cambridge Energy Use Disclosure Ordinances

On July 28, 2014, Cambridge, Massachusetts enacted an energy use disclosure ordinance, joining Boston and several other cities. The Cambridge ordinance is similar to its Boston counterpart, but contains several differences. Property owners in each municipality should be familiar with these ordinances.

1. Properties Covered By Each Ordinance

Cambridge:

Municipal buildings of 10,000 square feet or larger;
Non-residential buildings of 25,000 square feet or larger; and
Multi-family residential buildings with 50 or more units.

Boston:

City buildings (those the City owns or for which the City regularly pays energy bills);
Non-residential buildings (those located on a parcel of land with one or more buildings of at least 35,000 square feet and of which 50% or more is used for non-residential purposes, and which are not City buildings); and
Residential buildings (i) (a parcel with one or more buildings with 35 or more dwelling units that comprise more than 50% of the building, excluding parking, or (ii) any parcel with one or more buildings of at least 35,000 square feet and that is not a City building or a non-residential building, or (iii) any grouping of residential buildings designated by the Commission as an appropriate reporting unit).

2. Obligations of Owners and Tenants of Covered Properties

Both ordinances broadly defined “Owner” to include owners of record or a designated agent, and net lessees for a term of at least forty-nine years.

Cambridge:

No later than May 1st of each year, all covered properties must disclose energy consumed by such property during the prior year, together with other information required by an EPA Benchmarking Tool: (i) address; (ii) primary use type; (iii) gross floor area; (iv) energy use intensity; (v) weather normalized source energy use intensity; (vi) annual greenhouse gas emissions; (vii) water use; (viii) energy performance score; and (ix) compliance or noncompliance with ordinance.

Tenants (those who lease, occupy, or hold possession) of a covered property must comply with an owner’s request for information within thirty days or risk a fine.

Boston:

No later than May 15th of each year, owner of each covered non-city building shall accurately report previous calendar year’s energy, water use, and any other building characteristics necessary to evaluate absolute and relative energy use intensity of each building through Energy Star Portfolio Manager.

Owners must request information from tenants separately metered by utility companies in January for the previous year, and tenant must report information to owner no later than end of February, though a tenant’s failure to respond does not relieve an owner’s duty to report.

Enforcement and Penalties

Cambridge:

Failure to comply with the ordinance or misrepresentation of any material fact may result in a written warning on the first violation, and a fine of up to $300 per day for any subsequent violation.

Boston:

The Air Pollution Control Commission may issue written notice of violation, including specific delinquencies, to those failing to comply, giving thirty days within which an owner may cure the violation or request a hearing. The Commission also may seek injunctive relief requiring an owner or non-residential tenant to comply with the ordinance.

Boston provides a sliding scale fine schedule for failure to comply with a notice of violation, depending on the type of property, which ranges from $35 per violation up to $200 per violation. Each day of noncompliance is a separate violation, but owners or non-residential tenants may not be liable for a fine of more than $3,000 per calendar year per building or tenancy.

Both cities are actively developing programs to address climate change and adaptation. Property owners should monitor these efforts as well as similar initiatives by federal and state agencies.

ARTICLE BY

Jennifer L. Ioli

Sherin and Lodgen LLP

Attention Tenants! Grow-NJ Tax Credits Without Prevailing Wage

A little known regulation makes a big difference for tenants taking less than 55% of a leased facility. Namely, these tenants may be eligible to receive millions of dollars of monetizable corporate income tax credits under New Jersey’s Grow-NJ Program, without having to comply with that program’s prevailing wage mandate. For many, especially suburban tenants, that equates to a great deal of free money.

Grow-NJ is economic incentive program born out of the New Jersey Economic Opportunity Act of 2013 (L. 2013, c. 161) (“EOA”) and administered by the New Jersey Economic Development Agency (“NJEDA”). The goal of the program is to encourage businesses to either stay in or relocate to New Jersey. The program does this by offering tax credits for each job created or retained that range from $500 to $5000 per job, depending on the scope, location, and industry of the project.

However, the EOA specifies that each Grow-NJ recipient must agree to pay the “prevailing wage” to its contractors. The “prevailing wage” is that wage and fringe benefit rate based on collective bargaining agreements established for a particular craft or trade in the locality where the project is taking place. In New Jersey, prevailing wage rates vary by county and statewide and by the type of work performed.

Paying the “prevailing wage” can increase the cost of tenant work by 20% to 30% over non-prevailing wage. Though less of a concern in urban areas where tenants are likely to use union workers, in suburban areas, paying the “prevailing wage” may add substantial costs to the project. Depending on size of the award, this added cost may negate the value of the tenant’s Grow-NJ tax credits.

However, the NJEDA’s regulations provide an important exception to Grow-NJ’s prevailing wage requirements. Under the N.J.A.C. 19:30-4.2, the prevailing wage need not be paid on any project where:

(1) It is performed on a facility owned by a landlord of the entity receiving the assistance;

(2) The landlord is a party to the construction contract; and

(3) Less than 55 percent of the facility is leased by the entity at the time of the contract and under any agreement to subsequently lease the facility.

Because of this regulation, tenants taking less than 55% of a leased facility may be able to benefit from Grow-NJ’s tax credits, without paying “prevailing wage” for their fit-out.

Article By:

Michael A. Bruno

Steven P. Gouin

Of:

Giordano, Halleran & Ciesla, P.C.

Chicken Restaurant Case Serves Up A Bucket of Sound Contract Principles for Commercial Leases

In Tufail v. Midwest Hospitality LLC, 2013 WI 62, the Wisconsin Supreme Courthighlighted the importance of including precise language in commercial leases, especially if the lease includes an integration clause. The court confirmed that when dealing with a fully integrated lease, it is guided by the terms of the lease as written rather than by extrinsic evidence or unwritten understandings between the parties. While this may seem obvious, this case serves as a good reminder for those who negotiate commercial leases to always include all specific business and legal terms.

Tufail (“Landlord”) and Midwest Hospitality LLC (“Tenant”) entered into a lease for commercial property that was then being used by Landlord as a “New York Chicken” restaurant. Tenant leased this property with the intent of operating a “Church’s Chicken” restaurant. However, during build-out, Tenant discovered that a special use permit would be required to operate its fast food restaurant with a drive-through. While Tenant was able to obtain the permit it needed, the permit was conditioned upon the restaurant being closed by 9 p.m. (as opposed to the 4 a.m. close time allowed for the prior restaurant).

Tenant terminated the Lease and notified Landlord that it would stop paying rent due to the adverse effect the earlier closing time would have on its profitability. Tenant argued that the permit requirement was contrary to Landlord’s representation that Tenant would not be prevented from using the premises for the permitted uses set forth in the lease. The lease contained the following use clause: “[t]enant may use and occupy the Premises for any lawful purposes, including, but not limited to, the retail sales, consumption, and delivery of food and beverages which shall include, but not be limited to, Chicken products, Fish products, bread products, salads, sandwiches, dessert items, promotional items, and any other items sold by any Church’s Chicken store.”

After reviewing the lease’s integration clause and finding it to be complete, the court rejected Tenant’s argument that the general reference to “Church’s Chicken” in the use clause required that a fast food restaurant with a drive-through be allowed because the understanding between the parties was that Church’s Chicken restaurants were in fact drive-through fast food restaurants. The court concluded that the lease did not include a false representation and also limited its review to the specific language used in the use and representation clauses of the lease due to its conclusion that the lease was fully integrated.

The court also concluded that the terms of the representation clause as written required simply that Tenant not be prevented from using the property for the purposes set forth in the use clause. The court stated that there was nothing that prevented Tenant from specifically addressing hours of operation, the requirement that a drive-through be allowed, or other specific requirements it considered to be vital to the successful operation of its restaurant in the lease. However, the court was bound to interpret only the contract to which the parties actually agreed, and these requirements were not included therein.

While this is a misrepresentation case on its face, the case ultimately turned on basic contract principles and is an important reminder of the effects of integration clauses. Not only can these “boilerplate” clauses intensify the scrutiny of the specific language chosen by the parties, but, as shown in this case, they can be used to support the theory that even the smallest of deal points should have been included in the agreement if they were important to the parties. This case demonstrates that it is extremely important to include precise, unambiguous language in leases and to double check that even the seemingly minor deal points are included in the lease if they are necessary to make the deal viable.

Article By:

Chris A. Jenny

William R. West

Megan L.W. Jerabek

Of:

von Briesen & Roper, S.C.

Landlords, Make Sure Your Eviction is URLTA-Compliant – Uniform Residential Landlord Tenant Act

As tempting as it may be to immediately attempt to throw an unruly and non-abiding tenant out of the house or apartment, doing so can have serious legal consequences. Kentucky has codified the Uniform Residential Landlord Tenant Act in KRS 383.500 – 383.715 (“URLTA”). Pursuant to KRS 383.500, in order for the URLTA to be applicable in a given locale, that particular city, county, or urban county government must adopt the URLTA in its entirety. In areas where the URLTA has been adopted, tenants are often afforded greater protection at the landlord’s expense.

It is imperative that if your property is in an URLTA jurisdiction, you follow the specific, detailed requirements to effectuate a legal, proper eviction. Adequate notice must be provided and contain precise elements, such as the tenant’s name and property address, the nature of the breach and the time period within which said breach must be remedied. Depending on the type of breach, URLTA also requires that the tenant be given a certain period of time to remedy the breach (i.e., 7 days for nonpayment of rent; 14 days for material noncompliance with the lease agreement). It is only after the URLTA notice requirements have been satisfied and the period for remedying the breach elapsed that a landlord may initiate eviction proceedings by filing a petition with the court.

In Kentucky, the eviction procedure is known as a “forcible detainer” action under the law and is outlined in KRS Chapter 383. The biggest misconception in forcible detainer actions is that the end result will be the landlord receiving the money owed to him for past due rent and/or damages. However, this is not the purpose of a forcible detainer action. The purpose is solely to determine who has the right to possession of property. If a forcible detainer judgment is entered against the tenant, the tenant has seven (7) days to vacate the premises. If the tenant does not vacate within the allotted seven (7) day period, the landlord may seek a writ of possession and have the tenant’s property removed from the premises. A separate civil action must be filed against the tenant in order to recover the past due rent, late fees, damages, etc.

The Effect of On-line Shopping on Retail Leases and Percentage Rent

“Percentage Rent” is a familiar concept to retailers and landlords and has long formed a significant aspect of the business arrangement between commercial landlords and their retail tenants. In a lease arrangement that includes percentage rent, a landlord may negotiate a relatively reduced base rent for the chance to have some “skin in the game” by agreeing to participate in a percentage of tenant’s revenue, through gross sales, when that revenue exceeds a certain threshold amount. Tenants appreciate this arrangement because they pay percentage rent if they are doing well and their sales exceed that negotiated threshold level. Landlords appreciate this model because it compensates them for the costs they incur in creating and maintaining successful shopping centers with amenities, such as food courts and open spaces. If a successful shopping center drives foot traffic to individual tenants that increases their sales, tenants are often willing to compensate landlords for their part in driving that foot traffic. The concept really is a “rising tide lifts all boats” model, in which landlords and tenants work as partners.

The explosion of on-line shopping throws a wrench into this scheme. With more people purchasing from retailers on-line, and more retailers encouraging customers to place orders on-line, how will retail leases with percentage rent provisions be affected? Many percentage rent leases are carefully crafted to limit the types of sales that count toward the revenue in which landlord shares, often by including as only those sales “made from the store.” The question to consider: if a large percentage of a store’s sales are made on-line, can or should those sales be treated as made from, or initiated in that store, such that the landlord will be entitled to a percentage of such sales?

It is clear that out of stock items unavailable during a customer’s visit to a store, but ordered at the store and delivered directly to the customer’s home should be counted toward gross sales at that store and counted toward the percentage rent calculation. Similarly, on-line sales made at a computer terminal in the store, or on-line sales made at the customer’s home and picked up at the store should also be counted. It becomes much less clear when a customer never sets foot in the store itself in either placing an order or receiving goods. It may be difficult for a landlord to assert their right to a percentage of an on-line sale made by a customer in their home where the merchandise is then delivered directly to that customer’s home where the transaction occurs without any contact with the store premises.

As traditional retail stores work to accurately account for on-line sales with their landlords, another issue has recently emerged. Traditional on-line only merchants such as Amazon have seen a potential benefit of having a brick and mortar presence to market their business and may soon open physical locations. The question of percentage rent may become even more difficult to account for when the store front is really merely a marketing device to drive customers to company websites.

A thoughtful balance should be found to properly compensate Landlords for the sales they are driving to retailers. At the same time, from tenant’s perspective retail leases must be carefully drafted to exclude sales that are not derived from a particular store. If this balance is struck properly, landlord/tenant partnerships will be well positioned for success in the retail and commercial real estate markets.

Article By:

Geoffrey H. Smith

Of:

Sherin and Lodgen LLP

Tag: landlord

Office Tenants: Do Due Diligence on Your Landlord

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