May 5

Insurance Requirements in the Lease

Kenneth T. Calegari
Calegari Law Corporation
The insurance clause in a lease works to adjust risk between the lessor and lessee as the parties negotiate. The key is for the parties to understand the meaning of this clause, and hopefully avoid any gaps in coverage, which could increase costs or expose the parties to litigation.
General Information
The lease should spell out which party is responsible for obtaining insurance, what the minimum required types and levels of insurance are, what the maximum deductibles are, and hopefully who is required to be covered under the policies. This clause can also require specific language in the policies, state timelines for notifying the other party of pending claims/actions, and more. Regardless of who pays for or obtains insurance, property and liability insurance will be needed at a minimum. General property insurance will cover the property and building in the event of a loss. Liability insurance will cover the parties from third party claims, such as slip and fall accidents.
Special Situations
In addition to the basic property and liability policies, the parties will benefit from including language in the lease that addresses loss of rental income, lessee improvements, and waivers of subrogation. The lease should specifically state that the lessee is required to pay rent if the building is damaged or destroyed. The lessee can then choose to insure this specific situation in order to minimize their risk. Similarly, the lease should state which party is required to insure and replace lessee improvements. These can be covered by insurance, so the party bearing the risk of their loss should verify coverage with their broker. A mutual waiver of subrogation can benefit both parties in the lease. This prevents the lessee’s insurer from seeking reimbursement from the lessor if the lessor is responsible for some or all of a loss paid on the lessee’s policy, and vice versa.
Additional coverages that a lease may address are boiler and machinery coverage, which usually relates to the heating and air conditioning system and plate glass coverage. The lessor is often in the best position to insure these items, especially in the case of a standard commercial or industrial lease with multiple lessees in a single building. If the plate glass is to be covered by the lessee, it will need a special endorsement to ensure coverage.
A Few More Thoughts
While the lease may place all the burden of obtaining the insurance on one or the other party, both parties should seek a comprehensive review from their insurance broker in order to insure against items not outlined in the lease. A lessor should never assume they have transferred all of their risk to the lessee and therefore have no need for insurance of their own. For example, if the lessor is required to insure the building against loss from fire or other casualty, it also likely has the ability to cancel the lease if the building is lost. If that occurs, the lessee will want leasehold interest insurance to cover an increase in rent at a new location, and/or the costs associated with relocating.
Some leases require the lessee to obtain insurance and list the lessor as an additional insured. This is often not sufficient to protect the lessor from exposure. Instead, the lessor may wish instead to be a named insured. Similarly, a certificate of insurance, while a helpful way to determine if adequate limits are carried on an annual basis, is only a snapshot at a specific point in time. It doesn’t alter the insurance policy, require notice to the party obtaining the certificate of cancellation, or ensure continued coverage.

Kenneth Calegari is the founder and President of Calegari Law Corporation, a San Diego law firm providing comprehensive legal representation in the areas of construction, real estate, and litigation. Mr. Calegari provides a “full service” approach to clients, which stems from Mr. Calegari’s extensive experience in business, construction, real estate and the practice of law. Clients benefit from realistic legal AND business advice in order to make the most informed decisions as to how to proceed. Please contact Kenneth Calegari at 858-304-1988, or ken@calegari-law.com.
May 5, 2015 Article #8–Commercial and Industrial Leasing Series

April 3

Allocating Common Area Maintenance (and Repair) Expenses

Kenneth T. Calegari
Calegari Law Corporation
A large percentage of commercial and industrial leases are triple net leases, which means the lessee pays rent plus property taxes, property insurance, and maintenance/repair expenses. In leases on property with multiple lessees, the question then arises about how to allocate those maintenance/repair expenses, especially when there is a mix of lessees such as office and retail, or retail and industrial. I will discuss some ideas with regard to allocation of common area maintenance (CAM) and repair expenses in this article, but discuss taxes in a later article.
Common Allocation Options
CAMs can also be described in leases as “Additional Rent”, “Maintenance” and “Repair,” “Operating Costs” or similar language. Regardless of the language used, the effect is the same: the lessee is responsible for all or a portion of these expenses. When all lessees in a property are similar, such as retail lessees, industrial lessees, or office lessees, the allocation is usually determined by the percentage of the total leased square footage for each lessee. As a simple example, a property with 100,000 square feet of office space would charge the lessee with 5,000 square feet of office space, five percent of the CAMs, while the larger lessee, with 50,000 square feet of office space would be charged 50% of the CAMs. The lease may also allow this allocation to change in the event of vacant space, such that when the lessee with 50,000 square feet of office space leaves at the end of its lease, the denominator of the allocation fraction becomes 50,000 (instead of 100,000), and the lessee with 5,000 square feet now pays 10% of the CAMs until the 50,000 square feet or a portion of it is occupied again.
However, when a mix of types of lessees is present, they often impose differing burdens on the common areas. For example, a retail space would involve many more cars coming and going from the parking area, which would cause greater wear and tear on the parking lot, and likely landscaping, than an industrial lessee. Let’s assume your property has ten roughly equal industrial spaces. While you leased nine of those spaces to industrial lessees, the remaining one was leased to a business that has an indoor playplace for the age 2-10 crowd. That lessee, unlike the other lessees at the property, now has a steady stream of customers coming and going all day long. Your other nine lessees may be happier if, instead of paying 10% each of the CAMs, they now pay less. Perhaps you estimate the playplace will be responsible for two or three times as much of the CAMs as the other lessees, and the remaining nine will equally share the remaining CAMs.
Modifications to Standard Triple Net Lease
Yet another way individual leases may differ is that the lessee may not be responsible for all maintenance and repair obligations. Perhaps the lessee will be relieved of responsibility if the cost to perform the maintenance exceeds a particular dollar amount or percentage of the annual rent. The lessor may also accept responsibility and risk for repairing the foundations, roofs, and/or exterior walls.
In many cases, the lessor retains a management company that ensures maintenance and repairs are performed to the lessor’s standards, and the costs/fees are passed through to the lessees according to the allocation in their leases. Although some lessees may argue that they may be able to perform this work at less expense, this also avoids the hassle and potential conflicts that arise from one lessee managing other lessees.
Closing Note
The most important part to remember about CAMs is that no matter what decisions are made with regard to allocation and management, the lease should clearly spell out what was decided.

 

Kenneth Calegari is the founder and President of Calegari Law Corporation, a San Diego law firm providing comprehensive legal representation in the areas of construction, real estate, and litigation.  Mr. Calegari provides a “full service” approach to clients, which stems from Mr. Calegari’s extensive experience in business, construction, real estate and the practice of law.  Clients benefit from realistic legal AND business advice in order to make the most informed decisions as to how to proceed.  Please contact Kenneth Calegari at 858-304-1988, or ken@calegari-law.com.

April 3, 2015                                                               Article #6–Commercial and Industrial Leasing Series

March 13

Using Guarantees to Protect the Lessor

Kenneth T. Calegari

Calegari Law Corporation

Finally. The lease terms are agreed upon and the lease is being drafted. In no time, that income property will be producing income and the next several years should be relatively stress free. However, you aren’t aware of the fact that the new lessee’s accountant has been embezzling funds and your new lessee is about to go belly up as a result. How can you protect your income stream? Do your homework on the lessee before signing a lease with them and require a guarantee from the individual(s) who own the business, which requires them to pay the rent even if their company ceases to exist.

What Does a Guarantee Do?

A lease guarantee is a promise by one party to honor the terms of a lease entered into by another entity. For example, if the lease is entered into by a corporation or LLC, the guarantee may be a personal obligation signed by the individual or individuals who are the owners of the lessee company, or have another personal relationship to the lessee company. Once executed, the guarantee allows the lessor to require the guarantor(s) to cover past due rent, sums, costs and charges in the event the lessee defaults in its obligation to pay rent or other amounts under the lease.

When Is a Guarantee Recommended?

If the lessor has any questions about the solvency or continued existence of the lessee, the lessor will want a guarantee. This is often the case whenever a new lease relationship starts, but may not be if this is a renewal of a lease with a lessee who has been on site, paying rent on time, for the past ten or 20 years. The lessor may also require a guarantee mid-way through an ongoing lease if the current lessee is seeking to assign their lease to a new party. The new party may be starting a business or significantly expanding it, and need to provide a guarantee in order to assure the lessor this is a risk worth taking.

The guarantee should be requested from whichever party is likely able to step in and have the assets to cover the lease. The guarantor could be an individual, a parent corporation, a predecessor lessee, a business owner’s family member, or a combination of parties. The key is finding the party or parties who are willing to provide a guarantee that the lessor will accept. It will do no good to obtain a guarantee from an insolvent or poorly capitalized party. The guarantor must have the financial ability and means to assist if needed.

When is the Guarantee No Longer or Not Needed?

While the guarantee protects the lessor, it also places a burden on the guarantors. The guarantors will prefer to have the guarantee terminate as soon as possible, instead of having that burden hanging around forever. In negotiations, it may be desirable to agree to a limited term for the guarantee. Perhaps the lease is being assigned and the owner of the prior lessee company agrees to guarantee the lease for the first year after the assignment in order to get out of the lease. A guarantor for the new lessee may also be able to negotiate a termination date – perhaps five or ten years into the lease, or as soon as the new lessee’s company reaches a specific financial goal.

In some cases, a guarantee may no longer be required after assignment if the lease is assigned to a significantly lower risk lessee, such as a franchise for a successful multinational restaurant chain. In this example, the lessor may forego requiring any guarantee at all in exchange for a lessee who appears more solvent. There may also be a price point at which the lessor agrees to higher rent in exchange for no guarantee in any number of cases.

Kenneth Calegari is the founder and President of Calegari Law Corporation, a San Diego law firm providing comprehensive legal representation in the areas of construction, real estate, and litigation. Mr. Calegari provides a “full service” approach to clients, which stems from Mr. Calegari’s extensive experience in business, construction, real estate and the practice of law. Clients benefit from realistic legal AND business advice in order to make the most informed decisions as to how to proceed. Please contact Kenneth Calegari at 858-304-1988, or ken@calegari-law.com.

March 20, 2015 Article #6–Commercial & Industrial Leasing Series

March 13

What’s So Different About Industrial Leases?

Kenneth T. Calegari

Calegari Law Corporation

Industrial leases, or leases for property including places like warehouses, light manufacturing buildings, and factory-office multi-use buildings, are often managed and drafted similarly to other commercial leases. Industrial leases, like other commercial leases, don’t all look the same. However, they tend to be triple net leases more often than other types though due to their unknown capacity and utility requirements. In that way, the lessee, who is in charge of utility consumption, bears the risk of that expense and bears the incentive to conserve costs as well.
Industrial Leases Are Attractive to Investors
Making industrial leases attractive to investors is the fact that they tend to be easier to manage and have a longer life. With fewer lessees than a large office building, the common area expenses and tenant disputes tend to be less. Along with that are fewer headaches and a reduced management effort needed. Similarly attractive to investors is the fact that these properties often have a longer lifespan. Unlike a strip mall or office building, an industrial property is not in need of architectural updates and renovations as often. This also translates into a lower cost to the investor, and increased return. In areas with a large amount of regulation, such as California, this can result in an even longer useful life because the cost of new construction is so much higher, making older properties attractive for a longer period, and the expected lifespan of new properties longer.
Green Leasing
Green leasing is relevant to all types of leases – not just industrial – but industrial leases may tend to see a greater need for green leasing as energy efficiency is more relevant to a larger energy consumer. Green leasing will help reduce those energy costs for the lessee, while making the property more marketable for the lessor. A green lease, although not a separate form document, will likely help implement ratings systems such as Energy Star® and the U.S. Green Building Council’s LEED™ program. Complying with these rating systems can result in changes to the basic terms of the lease, starting with the term. For example, the LEEDTM program for Commercial Interiors awards a point of credit if the lease term is longer than ten years.
A lessor who obtains LEEDTM certification may want to pass along some or all of the costs of maintaining that certification. These items will need to be added to the expenses for which the lessee is responsible. Similarly, that lessor will need to ensure the lessee complies with sustainability and energy efficiency when conducting maintenance, repairs and tenant improvements. For example, LEEDTM for Commercial Interiors awards points for reductions in lighting power, so the lessee will need to maintain lighting that is at least as efficient as that which was installed at the start of the lease. This is a simple matter to insert in the lease, and can benefit both parties – the lessee in terms of lower costs and the lessor in terms of maintaining certification and the added marketability that involves. Likewise, the lease should outline that any professionals engaged for tenant improvements be LEEDTM qualified.
Managing Costs
Green leases can go a long way toward helping manage costs for the parties. However, the lessee in a triple net lease will also want to ensure the taxes and other expenses do not increase beyond the initial budgeted amounts in order to maintain a healthy bottom line. For example, requiring the parties to cooperate in seeking a reevaluation of the tax assessment, if needed, may help control tax expenses. There may also be tax incentives associated with the green lease that can be shared between the parties.

Kenneth Calegari is the founder and President of Calegari Law Corporation, a San Diego law firm providing comprehensive legal representation in the areas of construction, real estate, and litigation. Mr. Calegari provides a “full service” approach to clients, which stems from Mr. Calegari’s extensive experience in business, construction, real estate and the practice of law. Clients benefit from realistic legal AND business advice in order to make the most informed decisions as to how to proceed. Please contact Kenneth Calegari at 858-304-1988, or ken@calegari-law.com.
March 13, 2015 Article #4–Commercial & Industrial Leasing Series