Sole Reality: Everyday Footwear Is Worldwide Business. Executive Director s Message page 2. Reviewing Subordination and Nondisturbance Agreements

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1 Sole Reality: Executive Director s Message page 2 Everyday Footwear Is Worldwide Business Member Profile: page 8 For Retailers and Office Tenants Exploring Occupancy Cost Overcharges page 3 Reviewing Subordination and Nondisturbance Agreements from a Tenant s Perspective page 4 Developments in Real Estate Law page 8 Clarks is the world s largest casual and smart shoe company and the fourth largest footwear company on the planet.

2 Executive Message Measuring the Value of NRTA s Annual Conference Many retailers and other commercial tenants understand the direct bottom line results obtained when their real estate management specialists attend the NRTA conference. With 51 classroom discussions and 15 Discussion Groups on topics concerning occupancy cost, lease administration, real estate and legal issues, it becomes crystal-clear that you need to be a part of this education forum. There is no substitute for this opportunity. There is a clear direct return on investment gained through improved cost recovery skills and occupancy cost management performance. Let s stop here for a moment and ask: What does that mean when we say there is a clear Return On Investment from attending the NRTA conference? It is simple. Adoption of best practices in a complex business environment such as ours, has favorable financial payback extending several years or more. Additionally, the networking opportunities are endless. It s an investment that keeps on giving for years ahead. The value of professional training in some fields of business may be difficult to measure. However, not for our field of business. Every thing we do impacts the bottom line one way or another. We are talking about managing and protecting Tenants in-common Published by: National Retail Tenants Association, Inc. 60 Shaker Road, East Longmeadow, MA nrta@retailtenants.org Ted Pajda, Editor Copyright 1999 National Retail Tenants Association, Inc. No part of this publication may be used commercially or reproduced in any form without prior written permission of the publisher. your company s real estate portfolio: one of your major cost centers. Time and time again I hear stories of how conference attendees, new or veteran, are able to show management in credible terms that the conference experience and best practices studied at the conference, has proved to be a good return on investment. As business professionals, we know the pressures that are especially likely to arise when an organization feels the pinch during mergers and acquisitions, sales slumps, or simply when working capital is scarce. It is so easy in the short term to cut travel, training, or even staff. The cost side of training activities may be best addressed by producing hard evidence for returns, or demonstrated training value. The most compelling measures of training value are understood when you can point to actual savings results derived from improved lease management and review of lease related charges. Regular Members CIT Costco Wholesale Emerus Holdings Inc. Galardi Group, Inc. Goodman Manufacturing Lane Bryant Learning Care Group Nationwide On a personal note, after all these years I am still learning something new every time I attend an NRTA Conference. Attending these classes for the second and third time, and listening to others discuss the tools they use and the strategies they apply to manage their real estate portfolios...it s amazing just how much information you absorb. As the number of registrations continues to grow each day for the 19th Annual conference, my expectations for an incredible education adventure are very high. It is going to be another great conference. When you step back and see who attends an NRTA conference you get it. There is a reason the conference attendee list looks like a Who s Who of successful retail chains. They understand the necessity of having solid, recession-resistant lease administration skills pushing cost recovery results. Hope to see you in Reno. NEW NRTA MEMBERS Welcome New NRTA Companies Paul Kinney, NRTA Executive Director Noodles & Company Raymond James & Associates, Inc. Smashburger Tri Counties Wells Fargo Affiliate Members Huntley, Mullaney, Spargo & Sullivan, Inc. For membership information go to retailtenants.org or call the NRTA office

3 For Retailers and Office Tenants Exploring Occupancy Cost Overcharges by Rick Burke, Lease Administration Solutions, LLC Tenants must understand the lease before signing it. Much too often, a tenant looks back and realizes it has agreed to something that is now costing it thousands of dollars per month. This article opens the door and introduces the tenant to the many areas of possible overcharges. It looks at several basic areas of overcharges and explains why an overcharge exists and how to avoid them. These areas include pro-rata share allocation, administrative charges, non-cam Expenses, real estate taxes, and Caps. The article also looks at some specific overcharges related to office and industrial leases such as the Base Year and the Gross-up clause. Understanding all the ins and outs of a lease is very difficult to do, especially if you are not in the real estate business. As with most things, the more detailed it gets, the more complex it becomes. Imbedded in landlord statements may be layers of portfolio expense allocations which can become very complicated when trying to peel back to the actual expense. This is especially true for expenses associated with real estate taxes, insurance, labor and other common area maintenance and operating expense items. These items, if not fully understood, will be a sure reduction to your bottom line. The lease was negotiated and signed a year ago, the billings from the landlord are coming in and you realize that what was budgeted for rent and additional rent is much lower than the billed amount. It begs the question, why? Most likely the answer is in the additional rent components of the lease such as common area maintenance (CAM), real estate taxes, and insurance also known as CTI. If you are a tenant in an office building these items are called operating expenses. These expenses have been dubbed by many as the Hidden Rent. Over the years, billing additional rent to tenants has become much more aggressive. An obvious reason for this in the last several years has been the economy. Landlords that are looking for additional revenue to survive in a downturn economy often look at additional rents as a potential profit center. The creation of Real Estate Investment Trust (REITS) has also put pressure on the landlord to produce more revenue for its shareholders. Another reason is the lack of legal consequences or penalties in the lease for deliberately over-billing a tenant. Thus, it has become the tenant s responsibility to review these billings to avoid overpaying. The lease language dictates what a tenant is responsible for paying, and the leverage the tenant has when negotiating the lease dictates the lease language. However, no matter what shape the deal takes, every tenant should incorporate a thorough review of its CAM or Operating Expense reconciliations. In the commercial real estate industry, this is called the Desktop Review and can achieve significant savings for a tenant. The Desktop Review is designed to catch the overcharges before the tenant pays them. This is important, especially for a tenant with smaller square footage, because it is much harder to collect the overcharges once they are paid. Another form of reviewing the CAM or Operating Expense statements is the lease audit. The lease audit is mostly performed after the tenant has paid the overcharges, and is generally much deeper in scope. Lease audits are usually conducted by third parties that specialize in lease auditing. Again, like the Desktop Review, lease audits can provide significant dollar savings to the bottom line. Following is a review of areas of overcharges frequently identified by tenants during a Desktop Review: Pro-Rata Share: The first item to review is the basic calculation of the tenant s pro-rata share. The pro-rata share is the percentage of expenses shared by the tenant for expenses incurred for the shopping center or office building. In most leases, the pro-rata share is calculated as a fraction of the tenant s square footage divided by the total leasable square footage of the shopping center or the building. Beware that your lease may state leased square footage versus leasable square footage. If so, the reviewer must now verify all tenant vacancies and movein dates because only the leased tenants will contribute to the tenant s allocation of expenses. A tenant should never agree to leased and occupied square footage (GLOA) as its denominator when negotiating a lease. It should always be gross leased area (GLA). GLOA is much too difficult to verify and provides opportunity for mistakes or overcharges. The tenant s square footage (Numerator) is easy to verify in your lease. However, verifying the shopping center or building square footage (Denominator) may be more difficult. Asking your landlord for a tenant roster with square footages is common when verifying the pro-rata share. If you are a tenant in an office building and you have a base year, then you should only continued on page 9 3

4 Reviewing Subordination and Nondisturbance Agreements by Andrew N. Jacobson, Esq., Maslon, Edelman, Borman & Brand, LLP from the Tenant s Perspective When reviewing a nondisturbance agreement (NDA) or a subordination and nondisturbance agreement (SNDA) it is important to keep in mind that state laws vary significantly with respect to the impact of a foreclosure on interests (including leases) that are junior to the foreclosing interest (typically a mortgage). In some states, the foreclosure automatically extinguishes all junior interests, in the absence of an agreement between the foreclosing entity and any individual applicable junior interests. Many states use what is sometimes referred to as the pick and choose rule that allows the foreclosing entity to decide which, if any, of the junior interests will survive a foreclosure. Finally, other states provide tenants in possession with limited protections in the event of the foreclosure by a senior interest. In any situation, the best approach from a tenant s perspective is to assume that, in the absence of affirmative recognition and nondisturbance protection that, a foreclosure may result in the extinguishment of the lease or important rights under the lease, at the lender s option. Thus, in situations where the tenant might otherwise welcome the lease being extinguished by foreclosure (e.g., rent at above market rates), the lender can require the tenant to remain in place. Conversely, where the tenant has an advantageous lease, the lender might elect to extinguish the lease in the foreclosure or, use the threat of such extinguishment to extract A Summit For Learning A related conference course is Estoppels & SNDAs concessions from the tenant (e.g., higher rent). Below are basic steps to consider when reviewing an NDA or an SNDA from a tenant s perspective. NDA s are typically a document that is executed at the beginning of the lease, often as a tenant contingency, where the lease is naturally junior in priority to an existing mortgage or deed of trust. SNDA s typically arise in the context of an existing lease, where there will be a new or modified mortgage or deed of trust on the property that would otherwise be naturally junior in priority and subject to the lease. Most frequently, the initial form for an NDA or SNDA will be generated by the landlord s lender or potential lender. Some, but not many, leases will include an agreed upon form NDA and/or SNDA as an exhibit to the lease, although lenders and buyers often ignore the agreed upon form from the lease if it is not that lender s standard form, and instead will submit their preferred standard form to the tenant instead of the form attached to the lease. STEP ONE: Upon receipt of a proposed SNDA or NDA, it is good practice to first check the underlying lease to determine precisely what obligations, if any, the tenant has with respect to subordination. Leases typically specify a required 4 turnaround time for the tenant to respond to and execute the SNDA or NDA. Many leases also specify what the lender may include in the SNDA or NDA, including required waivers by the tenant of some of its rights under the lease if the lender or another party acquires the property through a foreclosure or deed in lieu of foreclosure. Occasionally, the lease will include an exemplar of the SNDA or NDA as a lease exhibit. In those circumstances the SNDA or NDA is typically the standard form for such document in then in use by the landlord s existing lender at the time of the lease. Note that many lenders often provide a form that is substantially favorable to the lender, going well beyond what the tenant is required to provide to the lender under the lease, in an attempt to shift as much of the underwriting risk as possible related to a landlord / borrower default from the lender to the tenant. STEP TWO: The SNDA or NDA will typically include a specific reference to the document(s) that constitute the lease. Someone familiar with the lease needs to confirm that the description of the lease used in the SNDA or NDA is correct and includes all addenda and amendments (including any relevant side letters or agreements). continued on page 5

5 Reviewing SNDAs & NDAs continued from page 4 STEP THREE: While most SNDA s and NDA s focus on the substance and mechanics of subordination, recognition and nondisturbance, some lenders will also include estoppel language for the tenant in the SNDA or NDA, rather than require a separate estoppel certificate in connection with the SNDA or NDA. To the extent that an SNDA or NDA includes estoppel provisions, those provisions should be reviewed and revised in the same manner as a stand-alone estoppel certificate, a subject covered in a prior Practical Real Estate Lawyer article. STEP FOUR: As long as the SNDA or NDA includes appropriate and adequate recognition and nondisturbance protections, the subordination component of the SNDA or NDA is typically noncontroversial. Expect that the document will include language requiring the tenant to subordinate its interest under its lease to the lender s mortgage or deed of trust, including any future advances or modifications of that mortgage or deed of trust. STEP FIVE: There are several important elements to the recognition and nondisturbance components of the SNDA or NDA. First, the tenant s obligation to subordinate its lease to the lender s mortgage or deed of trust needs to be expressly conditioned upon the lender s agreement to recognize the lease and not disturb the tenant s occupancy under the lease in the event of a foreclosure or deed in lieu of foreclosure. Second, most lender generated SNDA s or NDA s will condition the lender s obligations to recognize the lease and not disturb the tenancy upon the tenant being in full compliance with the lease. While the general concept of conditional recognition and nondisturbance is reasonable, the condition should be tenant not being in default under the lease beyond the applicable cure period. Third, where possible, the tenant should obtain an assurance from the lender that the tenant will not be joined as a party in any foreclosure action, except where the tenant is a necessary party. This will save the tenant unnecessary attorneys fees incurred in participating in any foreclosure action that ultimately will not affect its tenancy. STEP SIX: In addition to conditioning recognition and nondisturbance protection upon tenant s default status under the lease, almost every SNDA or NDA will include significant limitations on the obligations of the lender (or any purchaser at a foreclosure sale), in the event such party comes into possession of the property that includes the premises. Below is a list of common limitations requested by lenders, along with comments on each from a tenant s perspective. Lender Will Not Be Liable for Any Act or Omission of Any Prior Landlord Unless included as a provision expressly required under the lease, this item should be deleted. A tenant does not want to be in a position where the landlord fails to perform under the lease or otherwise harms continued on page 6 5

6 Reviewing SNDAs & NDAs continued from page 5 the tenant and then, following the foreclosure, the tenant has no recourse against the new landlord and the tenant is left only with its claim against the foreclosed out landlord, who is likely judgment proof. If the lender s primary concern is not having to pay additional funds to cure an existing landlord default, one potential compromise is for the tenant to agree to limit its remedies with respect to any default of a prior landlord to offset rights, often with a cap as a percentage of the base rent (e.g., tenant can offset up to fifty percent of the base rent per month to cover tenant s damages from a prior landlord s default). Lender Will Not Be Subject to Any Offsets or Defenses that Tenant Might Have Against any Prior Landlord Similar to the item immediately above, this provision should be deleted unless expressly required by the lease. Note that these first two types of waivers sought by lenders reflect the landlord s desire to shift some of its risk related to a borrower / landlord default onto the tenant. Lender Will Not Be Bound by Any Base Rent or Additional Rent that Tenant Might Have Paid for More than the Then-Current Month to Any Prior Landlord This provision is fair and commonly granted by tenants, but should be tied into the lease requirements (e.g., no rent has been paid more than one month in advance of the date required in the lease ). Such language will help avoid problems arising from situations where components of the rent may be paid on other than a monthly basis (e.g., semi-annual tax reimbursement). Lender Will Not Be Bound by Any Amendment or Modification of the Lease Made without Lender s Consent This provision is also commonly granted by tenants, but with three caveats. First, the provision should be limited to amendments that materially impact the landlord s rights or remedies under the lease. Second, the provision should not apply to any amendments that arise from the tenant s exercise of an express right under the lease (e.g., an amendment memorializing tenant s exercise of an expansion or extension option). Third, to the extent that tenant agrees the lender s consent is required, that consent should not be unreasonably withheld, delayed or conditioned. Lender Will Not Be Bound by Any Assignment or Subletting by Tenant Made without Lender s Consent Typically this provision should be deleted because it materially changes the terms of the lease. Where tenant must accept this provision, lender s consent should not be required for any assignment that the tenant has an express right to make under the lease (e.g., transfers to an affiliate or in connection with a merger). In addition, where the lender s consent is required, that consent should not be unreasonably withheld, delayed or conditioned. Lender Will Not Be Bound by Any Early Termination of the Lease Made without Lender s Consent Typically this provision should be deleted as it materially changes the terms of the lease. It would be rare that an early termination would benefit a lender. Regardless, this provision should never apply to an early termination that arises under the casualty damage or condemnation provision in the lease. To the extent that the tenant agrees the lender s consent is required, that consent should not be unreasonably withheld, delayed or conditioned. Lender Will Not Have Any Obligation with Respect to Any Security Deposit Made by Tenant under Its Lease, Unless Physically Deposited with Lender This provision should be deleted unless expressly required by the lease. If the lender is to get the benefit of the lease (e.g., future rental payments), the tenant should not forfeit its security deposit where the tenant has done nothing wrong. Lender Will Not Be Required To Pay Any Improvement Allowances, Make Any Improvements for the Tenant s Benefit, or Be Bound by Any Warranties of Construction Made by the Landlord This is often the thorniest issue in negotiations for an NDA or SNDA. Understandably, a lender does not want to end up in a situation where its borrower (the landlord) has defaulted, triggering a foreclosure, with the lender then required to come out of pocket to pay for unfinished landlord s work and/or a tenant improvement allowance. At the same time, the tenant relies on the initial landlord improvements and/or the tenant improvement allowance and the tenant s rent typically is higher to account for the return of those costs to landlord on an amortized basis over the initial term of the lease. Typically, a landlord will take its initial additional costs (e.g., landlord construction costs and/or tenant improvement allowance), amortize those costs of over the initial term of the lease (often at prime plus 4% or more), divide by the square footage of the premises and add those costs to the rental rate. From the tenant s perspective, it is much like a loan, except the tax treatment is more advantageous to the tenant as the payments on that loan (i.e., a portion of continued on page 14 6

7 Member Profile Sole Reality: Everyday Footwear Is Worldwide Business Ingrid Kushinsky Director of Lease Administration, Retail Division Clarks Americas C. & J. Clark International Ltd., is a British shoe manufacturer and retailer. Founded in 1825 in Street, Somerset, England by brothers Cyrus and James Clark, the company has over 1,000 branded stores and franchises around the world and also sells through third-party distribution. The company is best known for its Desert Boot a distinctive ankle height boot with crepe sole usually made out of calf suede leather. Officially launched in 1950, the Desert Boot design is based on an unlined suede boot worn by British officers. Clarks focuses on everyday footwear. The shoe maker and retailer is one of the largest manufacturers of non-sports shoes in the world, selling more than 50 million pairs of shoes a year in some 50 countries. Its lineup of boots, casual and sports shoes, slippers, and sandals are made for men, women, and children; and sold through department stores, online, as well as retail operations under its own banner. More than two-thirds of Clarks is owned by the 500 living descendants of co-founder James Clark. Worldwide growth and a global brand Company CEO Melissa Potter has overseen the re-organization of the business in four regions: Americas, Asia Pacific, Europe and United Kingdom & Republic of Ireland; as well as the re-launch in China, the move into India, the launch of the online business and the increased focus on building a global brand. Clarks is the world s largest casual and smart shoe company and the fourth largest footwear company on the planet. A new logistics center in Hanover, Pennsylvania opened in Spring The 451,000 sq. ft. distribution facility, which includes the latest in material-handling technology and designed with LEED gold certification as the goal, was built with the company s future needs in mind. Now online, it handles North and Central American distribution, which accounts for up to 50 million pairs of shoes each year. For more information about the new facility and its unique design features, check out this 2012 article in The Evening Sun. com/ci_ /clarks-new-logisticscenter-unique-inside-and-out Clarks Americas The history of Clarks representation in America dates back to Bronson Davis, a car salesman, who had seen the Desert Boot at the Chicago Shoe Fair in 1949, established a sales organization covering 150 accounts with outlets that stocked Clarks products, predominantly Desert Boots. Headquartered in a Boston, Massachusetts suburb, by the end of this year (2014) Clarks Americas will operate nearly 340 full price and outlet stores in 42 states from Maine to Hawaii, plus the Commonwealth of Puerto Rico. Clarks Americas retail stores average 2,500 square feet, while its outlets range between 3,000 and 4,000 square feet. Tenants In-Common was fortunate to spend some time with NRTA member Ingrid Kushinsky, Director of Lease Administration, Retail Division for Clarks Americas, to learn more about the company s lease administration and real estate management team. NRTA: When did you first learn of the NRTA? IK: I first learned of the NRTA through sheer luck! When I joined Clarks in continued on page 13 Lawyers who remove roadblocks instead of creating them. At Williams Mullen, we have a Retail industry team of attorneys with extensive experience and relationships to help our clients achieve cost-effective, timely results. We partner with our Retail clients in a variety of areas, including site acquisition, leasing, cost recovery and dispute resolution. We also offer alternative fee arrangements that meet clients unique needs. References visit williamsmullen.com or contact William F. Devine at or bdevine@williamsmullen.com. Imagine that. 7

8 Legal Corner Developments in Real Estate By Andrew N. Jacobson, Esq.; Maslon Edelman Borman & Brand, LLP and Rebekah Fisher, Esq.; Fisher Matthews, PLLC Editor s Note: Legal Corner contains case summaries and analysis of recent court decisions that impact retail leasing and lease administration. These summaries focus on the leasing issues covered in each case and do not include detailed discussions or analysis of the procedural and peripheral issues in the cases. Liquidated Damage Provisions Do Not Evaporate Commercial Real Estate Inv. v. Comcast of Utah II, Inc., 2012 UT 49 (2012). Landlord and Tenant (through a predecessor entity) entered into a build to suit lease for a large commercial building in Riverdale, Utah, where Tenant could operate its regional cable television business. The lease, drafted by Tenant s predecessor, included an operating covenant that required Tenant to operate in all of the building during the entire term. The operating covenant was tied to a liquidated damages provision that called for an additional element of rent, equal to the base rent, during any period when Tenant failed to operate in the building. The lease also contained a provision requiring Landlord to use its reasonable best efforts to mitigate its damages arising from a breach by Tenant of the operating covenant. Tenant ceased operations in the building in 2001 and the building sat empty until sometime in 2006, when an assignee moved into the space. During this period, Tenant continued to pay all rent due under the lease, but did not pay the required liquidated damages. Over the 5-year vacancy, Landlord referred inquiries on the space to Tenant, but otherwise took no action to address the vacancy. Landlord brought an action to collect approximately $1.7 million in liquidated damages, along with around $2 million in interest on the unpaid liquidated damages. Tenant defended on the basis that the liquidated damages provision in the lease was both unconscionable and unenforceable. On appeal, the Supreme Court examined the appropriate standard for evaluating liquidated damages provisions. The court acknowledged that the existing common law included cases that used a number of different and inconsistent standards. These competing standards included an unconscionability review (often on a post hoc basis) and application of the common two part standard (i.e., amount of the liquidated damages represented a reasonable estimate by the parties of damages at the time of contract and actual damages were impossible or very difficult to accurately estimate). The court observed that the competing standards had led to obscurity by contradictory decisions. Giving deference to freedom to contract, the court held that liquidated damages provisions should be evaluated in the same manner as other contract provisions and unless unconscionable, such provision are enforceable and it was not the court s prerogative to renegotiate an arms length contract to relieve a party from the effect of a bad bargain. In this instance, the court found that although more favorable to Landlord, the liquidated damages provision, which was drafted by the original tenant, was neither substantively or procedurally unconscionable, and thus was enforceable. With respect to Tenant s failure to mitigate claim, the court held that Tenant had failed to provide evidence as to how Landlord could have further mitigated its damages. As a result, Tenant failed to carry its burden of proof on the failure to mitigate claim. Technical Defense Does Not Deliver Top Quality Realty, LLC v. Cupo, DOCKET NO. A T4, 2012 N.J. Super. Unpub. LEXIS 348 (App. Div. Feb. 17, 2012). Tenants signed a 3-year lease, with an additional 2-year option, for commercial property in New Jersey. Under the lease, Tenants paid a security deposit equal to several months of rent. Upon expiration of the initial 3-year period, Tenants did not exercise the option, but remained in the premises and paid increased rent for an additional year. Tenants then vacated the premises, sometime prior to the start of the fifth year. After Tenants vacated the space, Landlord sent Tenants a notice that the Tenants had vacated the premises without proper notice and making claims against the security deposit and additional amounts, including attorney s fees. Tenants did not respond to the letter and about four months later brought an action continued on page 12 8

9 Overcharges continued from page 3 be paying your pro-rata share of costs over the base year amount in any year. If the base year is a result of the first year s actual costs, then it is important to review the base year to determine what items are included, because the base year will be used to determine the cost you pay every year going forward. Now assuming that your retail lease does not allow for anchor contributions, you should be done verifying the square footage that determines your pro-rata share. However, if your lease allows for anchor contributions, you will need to verify the anchor s square footage that is deducted, and determine if the anchor or major contributions being deducted from the billing is fair. This is done by comparing the cost per square foot of the anchor contribution deduction to the cost per square foot of what you are paying and deciding how big a variance you can live with. Understanding the definition of an Anchor or Major in the lease is also very important in verifying the calculation. Many leases will define the Anchor or Major by the amount of its square footage. Administrative Charge: Most commercial retail leases allow for a 5% to 15% administrative charge on expenses to cover the landlord s administrative cost for the common area. If administrative cost is included, in addition to the administrative fee, then the cost should be disallowed. During the Desktop Review, a general ledger or invoices are requested to identify these administrative costs and then disallowed. In addition, administrative fees are not always applied to all expenses. Accounts such as insurance, real estate taxes and utilities may not be subject to the administrative fee. In this case the reviewer would just disallow the applied fee on these accounts. Management Fees: A common overcharge to the office tenants is the management fee. Most management fees, unlike administrative cost, are calculated based on 2-5% of gross revenue of the building. The first step a tenant should do when reviewing it is refer to its lease to verify if it is required to pay a management fee. Not every lease requires the tenant to do so and the language regarding management fees maybe silent. In this case, the tenant is not responsible for such a fee. In addition, there are different methods on how to calculate a management fee. Some calculate it on a percentage of gross revenue; others are gross revenue less pass through cost. In some cases, we have seen landlords include investments income as part of the revenue from the building. Because a management fee is a pure profit to the landlord, the tenant should always request back-up documentation and as well as the method calculation before paying a management fee. 9 Non-CAM Expenses: Many expenses are dictated by your lease language that allows or excludes such expenses. The reviewer will need to read his or her lease carefully to understand which expenses can be billed to the tenant. Some of the more common excluded items are expenses relating to building, structure, roof, capital expenses, initial construction, specific tenants, and landlord professional fees. In addition, if your lease states expenses for operating, managing, and repairing the common area, instead of the shopping center, certain expenses related to areas other than the common area may be disallowed. Real Estate Tax: Real estate taxes have long been an area where a tenant can expect to find overcharges. But until recently the review process was long and cumbersome due to the lack of availability of information. However, in today s dynamic environment, reviewing real estate taxes has become much simpler. Today this information is much more available due to the increased access of online documents by county tax assessors, tax collectors and the deed of records. Quite often information such as Tax Maps, Property Record Cards and Assessment Values can be found by simply searching for the tax assessor s website for that city or county. The reviewer should check to see if the tenant is paying for the correct tax parcel. This is easy to do by going to the tax assessor s website or calling the tax assessor and getting a tax map (also called a tax plot plan). By comparing the parcel numbers on the tax bill with the tax map, the reviewer can determine if the taxes are being billed correctly. A pro-rata share review as described above for CAM should also be performed on the real estate taxes if the tax prorata share differs from the CAM pro-rata share. continued on page 10

10 Overcharges continued from page 9 Another area within the real estate taxes review is abatements (refunds) received by the landlord for the location resulting from a challenge of the assessed value. Sometimes these abatements do not get passed through to the tenant. This is verified by calling the tax assessor and asking them if there have been any abatement on a particular parcel for the shopping center or building. Lastly, depending on your lease, late fees or interest charges to the tax collector may not be an allowable expense. These can be detected by comparing the tax collector s amount on its website to the amount billed to the tenant. Caps: Tenants often feel that they do not have to worry about their CAM or Operating Expenses because they are capped per the lease. Think twice. There are many ways to be over-billed with a cap. The tenant s protection in some cases is less with a cap than without, because often a review is not performed. For example, if your lease states that in the first year of the term your cost is not to exceed $4.00 per square foot and will increase 5% annually thereafter, without realizing it, the landlord will often charge you the $4.00 per square foot in the first year, even if the actual cost is less. This ripples through the entire term of the lease, overcharging the tenant thousands of dollars. If the lease does not have a stated dollar amount, then the tenant should review the first year because the entire term of the lease is affected by it. Base Year: Many retail leases are triple net meaning tenant pays its share of CAM, Tax and Insurance in addition to base rent. However, in office leases, it is very common to have a base year lease. This is often called a modified net lease (sometimes referred to as Modified Gross lease). In a modified net lease, the tenant pays its pro-rata share of the amount over the base year amount. The base year is often the actual cost of the operating expenses relating to the first year of the term or renewal term. In other situations, it can be a stated or negotiated amount that is also called a Base Stop. A base year or stop is treated the same in the first year as it is assumed to be included as part of the negotiated base rent. However, in subsequent years after the first year of the term, the tenant only pays its pro-rata share of the operating cost over the base year amount or stop amount. Because the higher the base amount the less the tenant pays, it is in the landlord s best interest to have a low base year for a tenant, especially if it is a large tenant. Accordingly, it is very important for the tenant to review or audit the base year amount because it will be part of calculating the tenant s costs in subsequent years. There are several areas that a tenant is exposed to possible overcharges with a base year. The first and most obvious is that the base year is understated. This continued on page 11 10

11 Overcharges continued from page 10 can happen if the landlord does not report all the expenses in the base year. During audits, we often find that large expenses that should have been expensed off in November of the base year are held off till the following year. This creates a double overcharge to the tenant. Not only don t they get credit for it in the base year, but they end up paying their share of the expenses in the following year. Another area of overcharge happens in the subsequent years after the base year. In subsequent years, the operating expense billing statement sent by the landlord needs to have the same accounts as the base year. A common overcharge we see is the landlord adding new accounts such as management fees or management salaries that were not included in the original base year. The expense accounts from the base year should not change in subsequent years unless it is an extraordinary event that could not be anticipated. Comparing the base year to subsequent years should be apples to apples. If there are additional accounts in the subsequent years, these can often be disallowed and not paid by the tenant. Gross-up: The gross-up is a method of increasing the operating expense of the building in relation to the occupancy level of the building. For example, a lease may state the following: If the building occupancy rate drops below 95% in any one year, then the actual operating expenses as defined in the lease shall be extrapolated (grossed-up) as if the building were 95% occupied. Although this may appear a bit strange to the tenant, it does have a logical reasoning behind it. Originally, gross-up was designed to benefit both the landlord and the tenant depending on the timing and the level of occupancy of the building. For example, assuming the lease language above, if a tenant with a base year moves into a new building with a low occupancy level, then the tenants base year would need to be gross-up based if it was less than the 95% occupancy level. This would increase the base year for the tenant and it could benefit from it on a going forward in subsequent years if occupancy levels are not met. To landlord s advantage, the gross-up clause would also benefit the landlord in subsequent years if the level of occupancy fell below 95%. It is important to understand that only variable expenses that change with the level of occupancy of the building are grossedup. Variable expenses; may include tenant utilities, cleaning, management fees if based on revenues, and real estate taxes if based on the income method. Fixed expenses; such common area utilities, insurance, landscaping, and snowplow would not be grossed-up. Again, there are several ways a tenant may be overcharged with regards to a gross-up clause. One type of overcharge we often see is when the lease allows for a gross-up on subsequent years for the landlord, but does not provide a gross-up on the tenant s base year. This can become a substantial overcharge to the tenant. This is primarily a lease negotiation mistake. If there is a gross-up clause, it should always apply to both the base year and subsequent years. Another common gross-up mistake is the calculation of the variable and fixed expenses. We have seen where landlords gross-up both variable and fixed expenses in subsequent years when they should only be grossing up variable expenses. In addition, when the landlord calculates the occupancy level of the building, it may be incorrect. Occupancy level is calculated based on a weighted average of occupancy for the building for that year. Knowing when a tenant moved in and moved out becomes a major part of the calculation and determining the amount of the gross-up. It is vital for the tenant to request a tenant roster with move-in and out dates to verify the calculation. Final Word Understanding the lease is the key to an efficient and effective review. Knowledge of how to review for incorrect expenses is directly related to the amount of savings realized. Most tenants do not have the time to review these expenses in detail, A Summit For Learning Related conference courses are: Understanding CAM Lease Language Reconciling CAM Workshop: Big Box (>15,000 sq. ft.) The Desktop Audit (Parts 1 & 2) Reconciling CAM Workshop: Small Box (<15,000 sq. ft.) The Desktop Audit (Parts 1 & 2) Real Estate Taxes Advanced Real Estate Taxes Accounting for Property Managers & Lease Administrators Insurance Auditing Landlord Billings Understanding Office Lease Operating Expenses Auditing & Reviewing Office Operating Costs Base Rent: What Really Is in the Calculation? Base Year, Gross-Ups & the Loss Factor so they call companies that specialize in lease auditing to perform a review or lease audit. For those tenants who want to build a review process internally within their company, there is an excellent annual educational conference for further learning called the National Retail Tenants Association (NRTA). The NRTA has educational learning tracks for both office and retail tenants. I encourage anyone who wants to learn more about the subject to participate in its forums and network opportunities and attend the national conference. For more information go to Lease Administration Solutions, LLC specializes in lease auditing, lease administration, lease abstracting, lease administrative software and training. For questions about this subject, contact Rick Burke at x201 or RBurke@ LeaseAdminSolutions.com 11

12 Developments in Real Estate continued from page 8 to recover their security deposit. Landlord counterclaimed for outstanding rent, utilities and legal fees, property damage, and real estate taxes. Tenants introduced evidence they had hand-delivered and sent, via certified mail, notice of their intention to vacate the premises to Landlord s business address, as required in the lease. Tenants also introduced evidence of their attempts to surrender the keys to the premises via hand delivery, through their attorney, and via Federal Express. Landlord denied having received Tenants notice of their intention to vacate, asserted that the location of Landlord s business was not the address used by Tenants and insisted that Tenants never contacted him regarding the surrender of the keys. Landlord also asserted that Tenants attempts at notice were insufficient, as the lease required notices by both certified and registered mail. At trial, the court denied Landlord s claim for damages on the basis that Tenants had done everything in their power to effectuate notice of the intent to vacate the premises and effectuated the intent to vacate the premises, and that Tenants actions were generally consistent with the requirements for delivery and notice set forth in the lease. On appeal, the court dismissed Landlord s claim of deficient notice for failure to send by registered mail, noting that the purpose of the notice provision in the lease was to avoid disputes as to whether a notice was actually delivered or received. In this instance, the Tenants had shown they had done everything possible to provide notice and that the Landlord s technical defense was not supported by law. Bad Chi, Good Faith Denial Patel v. Am. Econ. Ins. Co., Case No. 12-cv WHO, 2014 U.S. Dist. LEXIS (N.D. Cal. May 8, 2014). In 2009 a fire damaged the office space Tenant was leasing for Tenant s dental practice. Tenant s insurance policy covered, among other things, direct physical damage, loss of business income for 12 consecutive months after date of direct physical loss, and necessary expenses. Tenant sued Insurer for costs to hire a feng shui consultant, breach of good faith, and lost business income because Tenant was forced to relocate when the building closed for repairs in 2014 (four years after the fire). In rendering its verdict the court noted that insurance policies are contracts to which the normal rules of contractual interpretation apply. The court denied Tenant s claim for feng shui costs because they did not fall under any category covered in the policy such as direct physical loss or necessary expense. The court also denied Tenant s claim for breach of good faith because, under California law, bad faith only occurs when denial of coverage is unreasonable. Here the court found that while Insurer may have breached their contractual duties under the policy, their initial denials were reasonable. Finally, the court denied Tenant s claim for loss of business income because adopting Tenant s interpretation of the policy would require it to ignore the explicit language limiting coverage to a consecutive 12 month period after direct physical loss. 12

13 Clark Americas continued from page , I was coming from a landlord background and was curious if there were any educational or networking resources available to lease administrators on the retail side. Developers, of course, have the International Council of Shopping Centers, BOMA and the like, but nothing specifically tailored to the lease management industry. A few Google searches later, I discovered the NRTA (only to find out later that Clarks had previously been a member but let that membership lapse)! NRTA: What education resources do you look to the NRTA for? IK: Having spent my entire career since college graduation (20+ years!) in a lease administration capacity within the retail industry, one would think I ve learned everything there is to know. This is furthest from the truth! As the industry continues to evolve and leases get more complex, I believe that we all benefit greatly from the knowledge that others just like us can share, from the member forum on the website to the free-for-members webinars to the annual conference with a whole host of diverse courses from which to choose. NRTA: Many companies tell us that they use the NRTA to help them develop their professional lease administration staff. Is that the case with your team? IK: Absolutely! It is so important to invest in your team, to ensure their professional as well as personal growth. The NRTA is an all-encompassing resource that devotes itself to its members and member companies. I know it sounds cliché, but knowledge really is power. Through the NRTA, we are able to learn better, newer, more efficient, cost-effective ways of managing our leases. NRTA: What are some of the key lease administration challenges your team faces? IK: While I take pride in the lease administration achievements Clarks and I have made over the past several years, like most companies, we also are confronted with difficulties to overcome. The ability to audit triple net expenses in a complete and meaningful way is crucial for us. Currently I do not have a designated analyst on my team to handle triple net, CPI increases and percentage rent. Because of this, Clarks is woefully behind in bill analysis and payment. I hope to remedy this in the near future, however. NRTA: How many staff people do you have as NRTA members? IK: We are lean and mean with a staff of two, including me. NRTA: Do you and your staff attend the conference? If so, what are the benefits of the experience? IK: Yes! I am proud to be a co-track leader for the Lease Administration track on the Curriculum Committee, a speaker (**shameless plug alert** I hope you can attend either or both of my workshops in Reno in September Collecting Construction Allowances and Understanding Percentage Rent) as well as a Board Member. Having several hundred of your closest colleagues at your disposal of whom to ask questions or with whom to share best practices is invaluable. NRTA: How is your real estate lease administration function organized? IK: As of this issue of Tenants In- Common, the organization is in a state of analysis and transition. Until recently, the lease administration function was housed in the real estate department. My manager, Clarks Vice President of Real Estate, retired at the end of January of this year, and HER manager, Clarks Senior Vice President of Retail, also retired at the same time. Since then, my team and I have been part of the Channel Management and Planning team, a group that is, in and of itself, a newly created department. Fortunately, our lease administration team is solid and no matter where we land, we will continue to manage our leases seamlessly. 13

14 Reviewing SNDAs & NDAs continued from page 6 the rent) can be often be expensed. There are several ways to negotiate landlord improvement work and tenant improvement allowance issues in the NDA or SNDA, including the following: Option 1: Include an express provision that obligates any party that succeeds to the role of the landlord through a foreclosure be obligated to pay the tenant improvement allowance in accordance with the requirements of the lease. While an optimal solution from a tenant s perspective, most lenders (at least any institutional lender) will not accept this approach; Option 2: Include a provision that gives the tenant an express right to offset against rent any portion of the unpaid tenant improvement allowance and/or costs incurred by the tenant to complete work that the landlord was to perform. This approach is often structured as a recognition by the lender of an express offset right tenant has under the lease, but on occasion offset rights may need to be added when the SNDA is negotiated, particularly if the underlying lease contains a prohibition on the tenant claiming any offset rights. Option 3: Include a provision for the rent following any foreclosure to be adjusted to account for any portion of the tenant improvement allowance not paid to tenant and to account for costs incurred by the tenant to complete the landlord s work. If the tenant cannot get lender cooperation on these issues or desires additional assurance with respect to landlord s required work or a tenant improvement allowance, consider one of the following approaches: Approach A: If the NDA is being negotiated concurrently with the lease or as a contingency to the effectiveness of the lease, the tenant could negotiate in the lease to require the landlord to pay the tenant improvement allowance to the tenant at the execution of the lease (or after any contingencies have been satisfied). Alternatively, the tenant improvement allowance could be placed in escrow for 14 the tenant s benefit, with the only requirement to distributions from escrow to be reasonable construction draw provisions (e.g., sworn construction statements, lien releases). With respect to landlord required improvements, consider requiring funds to construct those improvements to be deposited into an escrow account for the joint benefit of landlord and tenant to be dedicated towards such improvements, and include a mechanism for the tenant to access those funds should tenant be required to complete the landlord s work; Approach B: Require the landlord to provide credit enhancement to back up the tenant improvement and/or landlord construction obligations, either through an irrevocable stand by letter of credit or by a guaranty from a judgment worthy entity (e.g., landlord s parent entity or primary investor). While this may sound like an odd approach (e.g., landlord providing a guaranty from its parent entity), I have use this approach on several occasions to resolve this issue; Approach C: Include in the lease (or a lease amendment) a provision granting the tenant an express right to offset against rent if the tenant improvement allowance is not paid as required or if the tenant incurs costs to complete the landlord s initial construction obligations. Ideally, such an offset provision would include an interest factor equivalent to the interest factor the landlord used when incorporating its amortized costs into the rental rate. Any offset right should be structured as a right that is in addition to the right of tenant to declare the failure of landlord to pay a default, as the tenant may want invoke its offset rights without escalating matters by declaring a landlord default. STEP SEVEN: Almost every lender will seek to get copies of notices from the tenant to the landlord as well as the right (but not obligation) to cure a landlord default under the lease. There are typically a number of issues raised by such a provision. First, with respect to the notice component, the tenant will want to make sure that: (i) the lender is only entitled to a notice of default, not other general correspondence and notices under the lease; (ii) the tenant s obligation to provide the landlord with notices of default does not adversely impact the effectiveness of such notices against the landlord; and (iii) the tenant s obligation to provide notices is for prompt notice rather than simultaneous notice (the best practice is to send the lender a copy of any landlord default notice contemporaneously with the notice from the tenant to the landlord). Second, with respect to the cure periods, the lender should be limited in its cure period. Typically, a specific number of days following the expiration of landlord s cure period is appropriate (e.g., an additional 30 days). Many lenders will seek open-ended cure periods, which are typically crafted to allow the lender additional time to cure if in order to cure lender needs to take possession of the property. However, given that a foreclosure action will often take a considerable period of time, this is not an attractive approach for a tenant who would then be required to wait indefinitely for the foreclosure to be completed. Third, the only remedy that the tenant should be required to forebear during any additional lender cure period is the right to terminate the lease as a result of the default. The tenant should not be required to wait to assert any claim for damages or any offset rights during the period following the expiration of the landlord s cure period and the expiration of the lender s additional cure period. Similarly, the lender s notice should have no impact on the tenant s right to seek declaratory or other equitable relief. Fourth, many NDA s and SNDA s require any notice from the tenant to the lender to be given by registered mail, return receipt requested. Not only is this an outmoded form for notices, but it is also slow and these provisions are intended primarily to buy the lender additional time to cure. Tenant should make sure to add in the right to deliver copies of continued on page 15

15 Reviewing SNDAs & NDAs continued from page 14 any notices to the lender by a nationally recognized overnight courier service or, when possible, by FAX or /pdf. STEP EIGHT: Many commercial mortgages and deeds of trust provide the lender with the right to apply casualty insurance and/or condemnation proceeds against the then outstanding principal under the loan. This is problematic for a tenant because the tenant is likely paying for the casualty insurance carried by the landlord and anticipating that the landlord (or tenant) will be able to use any insurance or condemnation proceeds to reconstruct the premises or other affected improvements. As a result, any provision in the SNDA or NDA that states that the mortgage or deed of trust provisions regarding the disposition of insurance or condemnation proceeds will prevail over the requirements for reconstruction in the lease should be deleted. STEP NINE: Some lenders will include a provision in their NDA or SNDA that requires the tenant to covenant not to further subordinate its lease. In general, such provisions should be deleted as they will directly conflict with the tenant s typical affirmative obligation under the lease to subordinate the lease to any mortgage, deed of trust or ground lease entered into by the landlord and the tenant cannot control the actions of the landlord. To the extent that the lender wants assurance of no further mortgages / deeds of trust on the property, the lender should obtain that assurance from the landlord, not the tenant. STEP TEN: Unless expressly required in the lease, remove any requirement for the tenant to provide the lender with periodic financial statements. Such provisions are an overreach by the lender and, at least with respect to privately held companies, many companies view such provisions as an improper intrusion into proprietary information in addition to the administrative burden such a provision creates for the tenant. STEP ELEVEN: It is typically good practice to delete any attorneys fees provisions in an NDA or SNDA. As between the tenant and the lender, the lender is the more likely party to seek enforcement of the NDA or SNDA and thus, more often than not, any attorneys fees provision in an NDA or SNDA will disproportionately benefit the lender. As between the tenant and landlord, attorneys fees will be covered in the lease. STILL WAITING ON YOUR Lease Abstracting & Data Validation? We provide on-time results and savings. Visit us online for a special intro offer! (917) STEP TWELVE: Any NDA or SNDA should be a tri-party agreement, executed by the lender, landlord and tenant. Some lenders set up their forms only for the tenant s signature. Since the tenant is relying on the quid pro quo of recognition and nondisturbance protection from the lender in exchange for the tenant s subordination of its lease, the tenant has a vested interest in making sure that the lender also executes the NDA or SNDA. To the extent that the lender requests any covenant from tenant that may conflict with the tenant s obligations under the lease (e.g., tenant will send rent checks directly to lender following any notice from lender to tenant that the landlord has defaulted under its loan), it is important to the tenant that the landlord also signs the agreement so the tenant does not end up whipsawed between its obligations under the lease and its obligations under the NDA or SNDA. Caveat: Remember is that the tenant and landlord will have an ongoing relationship under the lease and that the landlord is likely anxious to get the loan and/or to keep its lender happy. As a result, there is little to gain from needlessly upsetting the landlord or lender. A bit more cooperation than required often benefits a good landlord/tenant relationship. The easiest component of cooperation is to be prompt and responsive. Landlords often are more concerned with the return of a proposed NDA or SNDA in a timely manner, than with tenant proposed modifications to that document. Also, it is often prudent to have some flexibility on minor issues (e.g., not paying rent more than one month in advance, providing lender with copies of any notices of default) that do not materially and adversely harm the tenant. Article reprint courtesy of The Practical Real Estate Lawyer (PREL). 15