What To Expect During A Commercial Lease Process?
So you’re ready to open your business. You’re ready to grow your business, and you found the perfect location to lease office space, lease a restaurant, lease warehouse, lease a school and you’re ready to talk terms. And we do several dozen commercial leases a year.
Ranging from you know, a thousand square feet for an office to a building of 70,000 – 80,000 square feet for an educational institution or multiple uses. And we like to get involved at the term sheet stage. Typically clients who are looking for space have a real estate broker who have showed them a variety of different spaces which may suit their needs .
And the landlord will draft or the tenant’s broker will draft the term sheet and the term sheet will set forth basic things like location of the property, what rent is going to be paid, the length of the term of the lease. Is it two years. Is it five years? Is it 10 years? Are there renewal options? What is the landlord permitting the tenant to do in that particular space? Will the space be delivered raw? Will it be delivered finished or something in between? Will the landlord be putting in money to build out the space? Will the landlord be giving the tenant allowance to build out the space?
We like to get involved with a term sheet stage, because we typically work with our clients on an ongoing basis. We know their needs, we know their likes and dislikes and we could work alongside of their real estate broker to really put together the best term sheet to advance to the landlord or to enhance and increase the opportunity to secure the space they are looking for.
So you found the space, you’ve negotiated a term sheet along with the our assistance and along with the assistance of a real estate broker and we’re now ready to go to a lease stage. 99 times out of a hundred it’s the landlord’s counsel or if it’s a sublet, it’s the sub landlord’s counsel who’s going to be drafting up a lease or a sublease.
And the lease can range anywhere from 20 pages to a 100 pages depending on its complexity. And as tenants council we’ll get a draft of the lease and we start to look through it for a variety of different things. Both, some of which we discussed at the term sheet stage, making sure that all the business terms that have been agreed upon are properly reflected into the lease.
But then also everything else that goes into a lease and there’s typically a lot of things that go into drafting a lease and a lot of things that as a tenant you should be concerned about and want your real estate lawyers to be walking you through.
What Is A Good Guy Guarantee?
An example of one of the things that you want to understand that the leasing stage is what is a good guy guarantee? It’s a term that that’s typically thrown around the lot and that people don’t really understand what it means or what the importance of it is.
Typically with a new business or a business that’s sort of not quite large with a lot of assets. The landlord wants some security, not only in the form of a security deposit, which is going to sit in the bank account, but also some security to have things don’t go well with this business that they’re not going to have to run to court, file a lawsuit to get the tenant evicted, which can take many, many months.
So a good guy guarantee is essentially saying to a landlord, look, I’m an owner of the business where I otherwise have control of the business. And if I’m not doing well as the business owner and the business isn’t doing well, I’m going to say to you, I’m going to be a good guy. Here are the keys. Take the space. You don’t have to kick me out of it. You don’t have to go to court to evict me. I’m going to give you this space back so you can go ahead and re-rent it. And in exchange for that, as a good guy guarantor, I’m not guaranteeing the entirety of the lease, I’m just guaranteeing the portion of when I turn you the keys over and vacate the space.
So if there was rent outstanding to that date, as a good guy guarantor, I’m responsible for paying it. But if there was, let’s say 3 years left on the lease and my business is going out of business, I’m not responsible personally for the remainder of that lease, the landlord has the space back, they could go and re-rent it. We’ll lease it to somebody else.
And if your business wasn’t doing any well anyway, it’s not like they could go after that business for the balance of the lease. But the important part is the good guy guarantor is off the hook as soon as they turn over the keys and otherwise comply with the terms of the lease prior to the date of surrendering it.
How Does Real Estate Escalation Work?
One of the items that comes up at both the term sheet stage and the lease negotiation stage is real estate taxes. Who’s going to pay them and how does real estate tax escalation work?
The typical procedure in most office leases and most commercial leases in New York is for the tenant to be responsible for a real estate tax escalation and being responsible for that. And they share that is proportionate to the amount of the building that they’re using.
So for example, if my office is 10% of a particular building and the year that I take occupancy of the building, taxes are $1 million. The landlord is paying that million dollars all across the board for the building. The following year and what we call that the base year. So in the first year when you take occupancy, you’re not paying any taxes.
But after the base year, to the extent that taxes go up and let’s say they go up from $1 million to 1 million, $100,000, I as a tenant of 10% of the building, I’m going to pay 10% of that escalation.
So that $100,000, $10,000 is now going to be my responsibility. Why is that important? It’s important not only to understand the concept but to budget for it. So while nobody could estimate what real estate taxes are going to go up because it’s the city of New York, you could look back at the history and sort of say, okay, over the last X amount of years, taxes has gone up Y percentage?
So that in your budgeting, before you take occupancy and sign a lease, you do understand that you’re going to be paying a portion of the taxes. If you’re on a five year lease, you’re going to be paying 4 years in escalations. So that’s something you should be budgeted for.
What Is An Assignment Versus A Sublet?
Another thing that we negotiate at the time of a lease transaction is the assignment and sublet clause. And what is the difference? What does it mean? Why should you be concerned as a tenant?
Assignment of a lease typically means that you’re no longer going to use the property for the balance of the term and it’s going to become somebody else’s. Whether that’s because you’re going out of business, you’re merging with another business, or you just no longer need the space and need to be relieved from the obligation. You’re transferring your interest in that lease to another party.
Typically that’s not done without any ongoing liability, although that can be negotiated. But a landlord will want to make sure that whoever you’re going to transfer to, they get a right to say no, and they also get a right to see what qualifications that new tenant will have.
And there’s a whole approval process that’s built into the lease itself. A sublet is something a little bit different than an assignment. It typically means that you either don’t need all of the property you’re currently occupying.
So I want to share it with somebody else or that you have a term left on the lease you’re not going to completely let go of the property for the balance of the term but just for a short period of time and you want another tenant to come in just like an assignment.
Same thing, a landlord can have the opportunity to approve whoever is going to come in as a sub-tenant and there is a bunch of documentation that they’ll require and a procedure by which you as the tenant looking to sublet, we’ll have to follow in order to have a landlord approve the sublet.
What Is A Desk Sharing Agreement Or A Space Sharing Agreement?
Something short of an assignment and a sublet, which we like to make sure that we work into certain leases is what’s called the desk sharing agreement or space sharing agreement, which essentially means you don’t need landlord’s approval but you can have one or more persons or a certain portion of the office or a certain number of desks and a true desk sharing arrangement that you could have people come in, share the office with you.
They need to abide by the terms of the lease. But the landlord doesn’t get a right to approve their existence in your space. They might not have the right to throw their name up on a directory, but they can legally be in your space typically without even notice to the landlord. But certainly not with the landlord’s approval. And those are things we work in at the lease negotiation stage.
Do I need Landlords Approval For Renovation Or A Remodel?
So you’re now in your space. You’re excited to build it out maybe or you’ve been in your space for a while and you’re excited to do a remodel or a renovation and you have plans drawn up and you’re ready to go. Before you commence any work with some exception you do need to get your landlord’s approval.
And there’s a process built into most typical leases as to how that’s done. What plans need to be drawn up? What notice needs to be provided to a landlord? How much time the landlord has to approve the request? And what happens if they say no? And if they say yes, what terms are still attached? What do you need to deliver to them as far as plans or final plans? What permits do you need to obtain? And what types of contractors could you use?
When we are looking at the renovations clause or a tenant improvement clause or landlords work or tenants work, the things that we look for is the restrictions the landlord tries to put on a tenant when they’re looking to undertake some work. So there could be a lease clause that says landlord has to approve any and all contractors.
We typically like to see some more flexibility where as long as a contractor has insurance, has experience, has a license that the tenant gets to select them, that it doesn’t have to first go through the landlord to obtain approval.
We also try to differentiate in a lease, the work that a tenant wants to do, what needs to be approved by landlord and what may be landlord doesn’t need to approve. So, for instance, we try to work in what’s called a decorative alteration. So you may want to paint, you may want to re-carpet, you may want to hang certain things on the wall and you don’t want to have to go to the landlord to obtain approval because they’re more cosmetic things in nature.
They’re not going to effect the structure. And we differentiate that from a structural alteration. So if you were going to break through a ceiling, add a staircase, do something major interior, knocking down walls, putting up walls where you may need to pull a permit where the landlord may want to approve the plans, exactly what you’re going to do in their space.
And we sometimes try to set a threshold for that as well. So maybe it’s not a decorative alteration, maybe it’s not a structural alteration, but it’s going to be $50,000 worth of renovations where the landlord doesn’t really care that strongly about approving the plans because they understand there’s only a limited amount of things you could do for $50,000 or 25,000 and anything above that, that’s where you need need to obtain their approval.
But in any event, we try to structure it in a way where it gives the tenant the maximum flexibility to operate their business, to make modifications to the space while also recognizing the landlords need to protect their asset and protect the interest in this space.
What Is The Insurance Requirement for Commercial Leases?
When reviewing a commercial lease another thing that we look closely at and advise a tenant on is the insurance requirements. And so typically a landlord is going to require a full compliment of insurance to come from a tenant, a general liability insurance property insurance, which is going to cover their tenant’s personal property for furniture, fixtures and equipment, which are going to be in the space.
Employers legal liability insurance, making sure that the tenant is going to have proper workers’ compensation insurance, disability insurance, etc. We review the insurance clause to make sure that it’s consistent, that it’s market, but at the same time we always recommend that the tenant needs to speak with their particular insurance brokers to ensure two things.
One, the coverage that is being requested they have or if not, they could obtain and understand what the cost would be. And two, the insurance professionals and insurance are the folks who understand if coverage requests are way out of line.
So while we see a whole bunch of commercial leases dozens a year, we also do look to our insurance colleagues to ensure that they’re also advising our client, our mutual client on what’s market, what’s reasonable and what, if anything, should be pushed back upon when negotiating the lease.
What Are Limits On Service Providers?
As a condition to a lease, landlords may want to also impose restrictions on what service providers that the tenant could use within the landlord’s building.
That can include exterminators, HVAC contractors, elevator service, but also things like water, office supplies. So where a tenant may want to order their office supplies from Staples or their water from a particular vendor, the landlord may have their preference.
And so when we’re reviewing the lease, we want to ensure that obviously we provide the tenant with the most flexibility. Often that’s pushing back on a landlord and saying, well, you know, we understand your needs for certain types of services, but otherwise our client wants the flexibility to buy certain items or services from where they want to.
And it’s a negotiation, depending on the particular building will depend on how much flexibility we can obtain. But ultimately, it’s something that the tenant needs to be aware of when they’re entering into a lease. If there’s going to be restrictions on the service, the services, or the products they could buy from particular vendors.
What Are The 4 Steps To Setting Up A Not For Profit Corporation?
Setting up a not for profit corporation is not dissimilar to setting up a regular for profit corporation or any other business entity. The difference between a not for profit corporation and a for profit corporation is in a non profit, profits generated actually don’t go to any particular individual, owner, director, officer, that type of thing. So folks who come to us to set up a not for profit corporation are typically looking to do something charitable, looking to do something in the education space. It’s a multistep process.
The first process to actually incorporate in New York state, you need a minimum of three directors, sometimes called trustees who are going to serve on the initial board of directors. So we get their information and then we need together to find a purpose. What is this not for profit corporation going to do? What charitable or educational or scientific or social mission are they going to serve?
So after we incorporate a not for profit corporation, the next thing we do is we host an initial meeting of the board of directors. At that meeting we approve bylaws which govern how the corporation is going to operate and also a conflict of interest policy, a whistleblower policy and other policies that are best practice and also required by the New York state law or the Internal Revenue Code.
And the third part, which actually gets the corporation exempt from taxation. So just forming a not for profit corporation does not grant it a tax exemption, you need to file an application with the Internal Revenue Service to obtain tax exemption. The application takes a bit to produce, it takes a lot of information, a budget, other operational information coming from the founders and we submit it to the Internal Revenue Service and it can take anywhere from two to approximately nine months to ultimately get the exemption from taxation.
And the fourth and final piece is once we get the Internal Revenue Service to grant the tax exemption for the organization. We also apply for New York state tax exemption, which gets a sales tax exemption and also a registration with the charities bureau of the New York Attorney General’s office.
Who Might Consider Starting A Not For Profit Corporation?
A variety of people come to us considering to start a not for profit corporation. Some have an idea for a charitable mission, whether in the US or outside of the US. Others are looking to set up a scholarship fund. Others are looking to start a not for profit school or other educational venture.
And it’s typically folks who have done this before, are in the not for profit space and have a new idea and they’re looking to create a new organization or folks for the first time are coming out of a for profit job and decide that they want to pursue something in the not fo profit arena.
Why Is It Important To Find A Qualified Business Attorney To Help Set Up A Not For Profit Corporation?
A not for profit corporation while having many of the same attributes as a for profit corporation. They sign contracts, they own real property, they can finance whatever they need to. It is very different and there are completely different set of laws that apply to a not for profit corporations than for profit corporations or limited liability companies.
And there’s also a different way of operating the business as well. And it’s important to work with an attorney who has experience working with not for profit corporations who will pick up on those nuances and properly advise so the corporation and its directors and its officers and employees are compliant.
What Are The Benefits To Creating A Not For Profit Organization?
Creating a not for profit organization has a variety of benefits, not only for the public or other institutions who are going to receive services from the non profit, but it also opens up the potential for getting funding and grants from organizations that only provide grants and funding for not for profit corporations.
What Is a B Corporation?
So one of the requests we receive from clients sometimes is could we form a B Corporation? And they also want to understand more about what is a B corporation? How is it different from a regular corporation? How is it different from a not-for-profit corporation? So a regular corporation under state law, you actually have to seek to maximize profits for your shareholders.
A not-for-profit corporation, there are no shareholders and there is no profit for the benefit of anybody, it just helps the organization continue its operations. B Corporation is a bit of a hybrid. It’s certainly not a not-or-profit corporation, but what it does is it says, okay, we’re still going to maximize profits for shareholders, but as we do that we can take into account a social benefit.
So there are a variety of corporations out there. Kickstarter is one of them. Warby Parker is one of them. Where they not only think, okay, we’re going see how much money we can make and maximize our shareholders profits but, we’re able to take in a social benefit of social good as another very important and of equal factor in determining how we’re going to operate our business.
What Type Of Company Would Want a B Corporation Status?
Founders of a corporation that are looking to sort of do a hybrid between a not-for-profit and a for profit are good candidates for people who are looking for a B Corporation or B status in a corporation. They realize and recognize that it’s important to make money for their shareholders and investors, but at the same time also want to be able to pursue a social mission, a social good. It’s a nice hybrid organization that works achieving both ends.
What Is The Biggest Difference Between a B Corporation And a Regular Corporation?
So we often get questions about what differentiates a B corporation from an actual corporation or a regular corporation that somebody would form. And the biggest difference is in a regular corporation your plan is to maximize profit for owners, for the investors.
In a B corporation, you still are going to pursue maximizing profit, but you could also take into account a particular social good that you enumerate in your founding documents or amending your founding documents to also benefit society in some certain way. So it’s not just an organization that’s out to make money, but it’s also looking to achieve a particular social good.
What Is The Difference Between an S Corporation And a C Corporation?
So one of the questions we get at initial consultation stage is I want to form a corporation and I don’t know if I should form an S Corporation or a C Corporation. The actual corporation itself, there is no differentiation. You incorporate a corporation and you have a corporate body.
The S or C status is actually a tax based status. C Corporation is traditional status which you get by default, which essentially means whatever profit is leftover at the end of the year for tax purposes is taxed and any distributions or dividends to shareholders is also taxed.
An S Corporation’s status, which allows a corporation to operate essentially like a partnership or a limited liability company where profit or loss is not taxed at the corporate level, rather it passes through to the individual owners or partners. There are some limitations with S Corporations. The shareholders need to be individuals. They need to be US persons. There are some trusts that can be shareholders, but it’s primarily just US people with a green card or a citizenship.
There’s a maximum of a hundred shareholders that are permitted under the S status of a corporation. And anytime when you actually have shareholders who have different financial interests, meaning rights to more money or less money, when we typically see with preferred stock, sort of an a venture capital deal, you can no longer be an S Corporation and you have to be a C Corporation.
Which Corporation Status Should I Choose? S or C?
So when choosing whether or not you’re going to be an S corporation or a C corporation, we always advise clients that they also need to speak with their CPAs or their tax accountants to figure out what’s best for their particular structure. Just because you read something online or you have a friend who has an S Corporation versus a C doesn’t necessarily mean that’s the appropriate structure for you. And we very much consider it a joint decision making process between us from a legal structure and liability perspective, aw well as a CPA or a tax advisor.
Making the decision as to if you’re going to be an S Corporation or a C Corporation is usually done at the formation stage. So you actually need to make the election within the first 75 days of formation of the corporation. There are late elections, but we always recommend that people make the timely election. And that decision will be made at the time we’re first having the conversation and it’s usually the individual founders. That’s one of the decision points as to when they choose the type of entity. They’ll ask you know, are we going to be an S Corporation or a C Corporation? At that point we will recommend they have a conversation with us, conversation with their accountants, circle back, and then make a decision.
Why Is It Important To Choose Your Corporation Status Right Away?
So making the S election or deciding you don’t need to make an S election and you’re going to be treated as a regular corporation. Why it’s important upfront is because that does sort of set the stage for how your tax going forward. You’re supposed to make the S selection within the first 75 days of formation. If you miss that deadline, there is a procedure under the internal revenue code to request a late election. That becomes much more complicated if you’ve filed tax returns already.
Converting from a C Corporation to an S Corporation once you’ve filed returns could certainly add layers of complication. It’s doable, but that also adds layers of expense. And not only are you working with your lawyers, but also your tax accountants. So we always recommend that it’s a thorough analysis up front. You make the election and then you work with it until it doesn’t work for you any longer.