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Pitfalls Lurk in Using Lease Forms

David N. Morrell Jr.

Next to selling single-family homes, commercial leases are probably the most common
form of real estate transaction — involving up to hundreds of thousands of dollars — for
which one or both parties doesn’t have an attorney. As with residential transactions, one of the
parties, typically the landlord, fills in the blanks of a form document and presents it for the
other party’s signature. Then the (often unrepresented) tenant will check to make sure the
blanks are filled in correctly and may skim the rest of the document, sign and return it.

Though the State Bar of Texas and Texas Association of Realtors promulgate forms
for commercial leases, most leases are unique to a particular building or landlord. A lawyer
may have prepared these forms some time ago, but often they have been modified many times
since leaving the lawyer's desk. Other times, a party simply may use a form from another
transaction, without an attorney's advice or consultation.

Because commercial leasing transactions are so common and so many forms exist,
many businesspeople feel they can be completed without assistance from an attorney. The
documents are long, and it can be expensive for each side to hire an attorney to negotiate line-
by-line. Most of the time no issues arise, and the money spent on attorneys’ fees could have
safely stayed in the party's pocket.

When problems come up, however, poorly drafted lease documents can cost the parties
many times more than they would have spent on a simple review by qualified counsel. There
are a number of common mistakes in commercial leasing agreements.

Who am I? Even though it's the first blank on the form, it's amazing how many leases
fail to correctly identify the landlord and/or tenant, especially if either is an entity rather than a
natural person. Fortunately, the Internet makes it easy to confirm the correct names in most
instances. If a tenant is a Texas corporation or limited liability company, a free search can be
done at the State Comptroller's Web site: http://ecpa.cpa.state.tx.us/coa/Index.html.

Other types of Texas entities, such as limited partnerships or foreign entities registered
in Texas, can be verified for $1 per search using Texas Secretary of State's SOS Direct Access
service at: http://www.sos.state.tx.us/corp/sosda/index.shtml. Though not a substitute for a
search of the real property records, http://www.txcountydata.com provides access to county
appraisal districts throughout Texas. Appraisal district records can assist in identifying a
property’s ownership history, building size and location.

If it ain't broke, why fix it? Form leases vary widely in allocating responsibility for
maintaining the leased premises. Typically the landlord maintains the outer walls, roof and
foundation. Either party can be liable for repairs to the water, sewer, gas and electric lines
within the premises. Tenants in office parks, industrial parks and shopping centers can be
responsible for the operation of heating, ventilation and air conditioning (HVAC) systems.
These responsibilities may include paying for a service contract for the life of the lease and
replacing failed equipment. Depending on the size of the space, these expenses can range from
hundreds of dollars to tens of thousands of dollars. HVAC system replacement can be an
especially unpleasant surprise when it occurs near the end of a lease. While the allocation of
responsibility for replacing an aging system may be buried in the lease, it's best to figure out
whose responsibility it will be before signing the lease.

Where's my stuff? Most commercial lease forms include provisions giving the
landlord a contractual lien on the tenant's property. Only rarely, however, does the landlord
file a proper financing statement necessary to perfect its lien. The Texas Property Code gives
the landlord a statutory lien independent of the lease, but it will be subordinate to a prior
perfected security interest and can only be enforced by judicial process. Tenants often need to
grant first-lien security interests in all their assets to lenders that provide working capital for
their businesses.

Unless a lease either expressly waives the landlord's liens or requires the landlord to
subordinate such liens to that of a tenant's primary creditor, the tenant may find itself squarely
between its two largest creditors, after the government, of course. Landlords must be aware
that when a tenant's lender comes seeking to subordinate the landlord's lien, the lender
frequently tries to amend the lease to provide it with notices of default and allow the lender
rent-free access to the premises to maintain, store or remove equipment after a default from a
tenant. Casebooks are rife with examples of landlords charged with abetting conversion of
tenants’ assets by improperly allowing lenders access to tenants’ equipment.

Subro-what? Many form leases contain waiver-of-subrogation clauses that are


confusing or unenforceable. Simply put, a waiver of subrogation between two parties means
that the parties agree to look to their own insurance for recovery after a loss and not to make a
claim against the other party, even if the other party was at fault.

In most commercial leases, a portion of the tenant's rent payment goes to pay the
premiums for a property insurance policy on the building. Without a waiver of subrogation,
however, a tenant whose negligence caused damage to the building could end up getting sued
by the landlord's insurer for recovery after a loss — even though it was the tenant's own
money that paid the premium for the policy.

Waivers of subrogation can apply to liability policies as well. Two common mistakes
occur, however, in integrating a waiver-of-subrogation clause into a lease. First, it is often not
enough to require the waiver in the lease; it should also be set out in the parties' insurance
policies. Unless the waiver of subrogation is explicitly recognized in the policy, the insured
may risk voiding its coverage by agreeing to lease terms in violation of the insurance policy.
Second, since a waiver of subrogation attempts to release a party from claims caused by its
own negligence, it should be conspicuous by appearing in all capital letters, boldface type or
both.

Foreclosure? Now what? One of the most misunderstood, if not unread, sections of a
commercial lease form deals with subordination, attornment (a tenant’s recognition of his
obligation to a new landlord, i.e. to the mortgage holder who has foreclosed on the landlord’s
property) and nondisturbance. These provisions either automatically subordinate the tenant's
lease to a creditor holding a deed-of-trust lien on the property (even if recorded after the lease)
or require the tenant to sign a subordination agreement upon the landlord's request. The
subordination agreement often includes additional provisions whereby the tenant agrees to
attorn to the landlord's lender or other purchaser after foreclosure and the lender agrees it (or
the purchaser) won't disturb the tenant's possession as long as all of the tenant's obligations
under the lease are performed. Subordination agreements with these provisions are called
SNDAs.

A tenant such as a doctor or dentist who spends large sums on leasehold improvements
or otherwise has substantial value in her leasehold should attempt to negotiate an SNDA with
the landlord's lender at the same time she enters into the lease. In addition to favorable
nondisturbance provisions, a tenant may also want to address post-foreclosure responsibility
for construction allowances and other future benefits to be conferred under the lease.

Where do we begin? Though landlords most often have the upper hand in lease
negotiations, sometimes tenants are in a position to dictate the form of the lease, especially in
retail developments. One of the most confusing areas of a tenant-form lease is to determine
when the tenant starts paying rent. Typically the landlord is required to construct certain
improvements. Once complete, a regimen of inspections and reports will create checklists of
additional work for the landlord. The commencement date for rent may be tied to the
completion of the work to the tenant's satisfaction, to the date the tenant opens for business or
to the date the landlord notifies the tenant the work is done. The method is not that important,
so long as it is clear and the parties know their responsibilities. It also is important that if the
lease fails to set a specific date for rent commencement, the parties identify a drop-dead
deadline so that, if a condition outside the parties' control has failed, the parties will be
relieved of further responsibility, rather than extending their obligations on into perpetuity.

While form leases can help business people conduct leasing transactions in an efficient
manner, they must remember that, even though they think they're just filling in blanks, leases
are complicated documents that both parties need to understand. It's only by understanding
their obligations that the parties can ensure they are fulfilling their obligations. If an exec
cannot have an attorney review each lease, he at least should have a lawyer look at the forms
periodically to ensure that outdated language is removed and that "form creep" hasn't added
confusing language to the document.

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