I’ve had the opportunity to meet with numerous agents and lawyers who specialize in commercial leasing and they all say the same thing: it’s a tedious, difficult and boring job to read a full lease, but it’s necessary. There’s always a risk that something’s lurking behind the shadows of clause 34.12 (r) and that something will bite you when you least suspect it.
Your client, the CEO of a national pet store, calls upon you to represent its expansion into the downtown Toronto area. Your client needs 5,000 square feet of space, as they have a lot of inventory. They expect to gross about $75,000.00 per month in the first year sales.
Eager to move quickly, you show your client several spaces and, after a lot of demographic research and rent projections you decide on the third property with a reputable Landlord.
You’re able to negotiate a monthly break-even figure of $115,000 per month; well above your client’s monthly revenue projections for their first year. The Landlord is very appeasing regarding the term, tenant improvements and you’re confident that this Landlord-Tenant relationship is made to last. Without much more debate, your client signs the Offer to Lease and the Lease. You manage the entire move-in process and you don’t hear from them until….
You get a frantic call from your client. They received a notice from the Landlord claiming that your client failed to provide a Monthly Report and that the Tenant’s rent is deemed to be two and a half times the monthly break-even value. The Landlord is also auditing the Tenant and requesting the personal and banking information of all shareholders, principles and their spouses and children and related companies. To top it all off, the Tenant is responsible for the costs! Your client is livid and asks how you could have let this happened. They vow to never use you again.
You didn’t fully read the Gross Revenue Reports clause and the Landlord’s Audit clause. An oversight of a few key sentences exposed your client to huge financial risk and the unnecessary burden of having to deal with an intrusive, inconvenient and costly audits.
What Are These Clauses and Why Does the Landlord Want it?
The Gross Revenue Reports and Landlord Audit clauses help mitigate the Landlord’s concern that the Tenant is “cooking the books” so as to avoid paying percent rent as percent rent is based on the tenant’s gross revenue. In the context of a percent rent lease, this is neither unreasonable nor uncommon; what is unreasonable, however, is the frequency of which the Tenant must provide monthly statements and the extent and nature of the Landlord’s audit rights.
The Landlord’s right to audit, for example, may, allow the Landlord to access the books of any arm’s length party, including relatives of the Tenant or shareholders. Landlord audit rights may also include the right to access the premises for physical examination. What is more, the costs of such audits are typically borne by the Tenant and the request of the audit can occur whenever the Landlord wants, without notice or any sort of time limitation.
What Should You Do?
Put in a Cap
The first step is to delete any “up-charging” terminology that allows the rent to double, for example, if the Tenant fails to produce a report. Also, make sure your client is comfortable with the reporting period and ensure that it is extended as much as possible. Always insert wording that forces the Landlord to “act reasonably” when making its determinations about whether or not the monthly statements is of sufficient detail, form and scope”.
Add a Drop Dead Date
A Landlord asking to audit the tenant’s sales should be required to do so promptly. The audit should occur within a specific period of time after receiving the Tenant’s report, after which this right expires.
The Landlord’s access to the tenant’s books and records should be limited to the Tenant’s financial records that are kept on Premises and not the records of any relatives, arms length parties, directors or shareholders. It is also prudent to require that the “CFO” of the company, and not an auditor, prepare the records. Doing so will reduce costs for your clients.
Natalka Falcomer is a lawyer and Certified Leasing Officer who has a passion to make the law accessible and affordable. She founded, hosts and coproduced a popular legal call-in show on Rogers TV, Toronto Speaks Legal Advice. She founded Groundworks, a firm specializing in commercial real estate law, and is the EVP of corporate development at Chestnut Park.
DISCLAIMER: This article offers general comments on legal issues and developments of concern to business organizations and individuals and is not intended to provide legal opinions. Readers should seek professional legal advice on the particular issues that concern.