The Pitfalls of Boilerplate Lease Agreements

SAN FRANCISCO—There are several provisions landlords should insist upon when renegotiating leases. But there are also several common pitfalls including failing to consider local ordinances and using form agreements to be wary of, says Quinn Arntsen, partner with Farella Braun + Martel LLP in San Francisco.

GlobeSt.com: How typical is it for long-term tenants, particularly in buildings not owned by large landlords, to use form leases (the California Association of Realtors or AIR CRE forms) where the contract language is boilerplate and the parties only negotiate a limited number of business terms, such as rent, security, deposit, term, etc.?

Arntsen: This depends on the property type. For industrial or warehouse leasing, it is common to see the parties use an industry-form lease, such as the AIR CRE Single Tenant Net Lease. Those are typically triple-net leases where most of the risk is allocated to the tenant. For office or retail leasing, larger landlords almost always have their own internal documents and smaller landlords are split. Office and retail leases are less suited for the industry-form documents because there are usually more property-specific deal terms that are inconsistent with the form.

GlobeSt.com: For these landlords, does the standard lease generally include clauses made relevant by the pandemic, such as force majeure or virus exclusions?

Arntsen: In general, the industry form documents did not include provisions that were intended to address situations like a global pandemic and the subsequent shutdowns. This was usually to the landlord’s benefit, because there was not a basis for the tenant to claim rent abatement or try to terminate its lease. The major exception to this was for landlord construction obligations. A few landlords got nailed on leases that included a landlord construction obligation with a firm deadline and no force majeure provision or a force majeure provision that did not cover COVID.

GlobeSt.com: Beyond the pandemic, what are some of the common gaps/pitfalls to using boilerplate lease agreements?

Arntsen: I have four main issues with using the industry form documents. First, they are blunt instruments and not well suited to properties that have quirks or deals with atypical business terms. Second, the final agreements do not always match the business deal/the parties do not actually know the lease terms. This is especially true with allocation of maintenance and repair obligations, and associated cost reimbursement. Third, there are some terms in each of the forms that are unreasonably one-sided and need to be struck or revised every time. Finally, the forms are clunky and inefficient to edit, which means that some of the cost savings from using a form is eaten up in document processing.

GlobeSt.com: What are some of the key areas that new lease language addresses due to COVID?

Arntsen: Landlords were fairly well-protected by existing leases, at least when it came to ensuring that tenants remained obligated to pay rent and could not terminate their leases. Most of the trouble for landlords has been because tenants are unable or unwilling to pay rent and the eviction moratoriums make it difficult for landlords to enforce the lease terms. The main exception I’ve come across is that landlords are focusing more on their construction obligations and what happens if they are delayed in completing construction. On the tenant side, many tenants are trying to insert provisions that would treat government shutdowns or stay at home orders in the same way as a utility outage or casualty: rent abatement initially and a termination right if the condition continues for a certain amount of time.

GlobeSt.com: Are temporary rent-adjustments/deferrals becoming common?

Arntsen: Rent adjustments and deferrals have been quite common, especially at the start of the pandemic. Landlords realized in many jurisdictions they could not evict tenants because of the eviction moratoriums and, even if they could, the market is so soft that they would have trouble finding a replacement tenant. Most landlords I work with decided they were better off finding an arrangement to keep tenants in their spaces and paying as much rent as possible. One caveat to this is for properties that are encumbered by securitized mortgages. In those cases, landlords were sometimes prevented from waiving tenant defaults or deferring rent because of the covenants in the loan documents.

GlobeSt.com: How have local COVID ordinances affected lease language and enforcement?

Arntsen: I have not yet seen local COVID ordinances impacting lease language, other than the changes previously discussed. The COVID ordinances, in particular the commercial eviction moratoriums and court closures, have had a profound impact on landlords’ ability to enforce the terms of their leases. Eviction is a landlord’s most powerful remedy against a defaulting tenant and without it, the negotiating leverage shifts dramatically to the tenant.

GlobeSt.com: Are landlords offering potential tenants shorter lease terms with greater concessions, lower rent, purely to boost occupancy and weather the pandemic?

Arntsen: The commercial and office leasing markets have softened, with corresponding reductions in rent and landlords offering other tenant-favorable terms. There has been less softening in warehouse/industrial because demand has remained steadier and retail because the market was already soft. In general, landlords have a lot of incentive to keep tenants in buildings in order to cover debt service on the property and because insurance rates for an empty building can be expensive. Interestingly, many landlords are seeking shorter terms on the rationale that rental rates are currently depressed and they do not want to lock in a below-market rates for several years. Instead, they will lease the property for a short term and bring it back to the market in two or three years.

GlobeSt.com: Are/could landlords be more apt to chase businesses without foot traffic, such as mini-logistics hubs and ghost kitchens for spaces that normally have high foot traffic, just to find tenants?

Arntsen: Landlords have become more focused on prospective tenants’ creditworthiness and lines of business. That has meant that certain industries have become more appealing. Think medical office, distribution facility or other essential business versus non-essential retail or restaurants. Landlords are also allowing tenants greater flexibility in permitted uses, which is important since many tenants are re-evaluating their business models. However, landlords need to be cognizant of restrictions that might limit the use of a space, particularly restrictions in loan documents or in CC&Rs/REAs for retail developments.

GlobeSt.com: Generally, are landlords focused on win-win scenarios where tenants can limp through the worst of the pandemic and then return to normal, or are landlords gearing up for significant evictions as the second wave accelerates?

Arntsen: This varies from landlord to landlord, but most are looking to find reasonable compromises with tenants. At the end of the day, eviction proceedings and litigation are expensive and there is no guarantee that a landlord would find a better replacement tenant. The main exceptions to this are: some landlords are using this as an opportunity to remove tenants that were troublesome before the pandemic and continue to struggle; if a tenant has deep pockets or the lease is guaranteed by a creditworthy guarantor, landlords are more likely to play hardball; and landlords are becoming increasingly frustrated and less willing to compromise with tenants who refuse pay rent and do not engage in problem-solving discussions, especially as other tenants continue to or have resumed paying rent.