Request Representations and Warranties for Items Crucial to Operation

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1 Request and Warranties for Items Crucial to Operation Even if a space seems to be perfect for your office or retail business, it could have flaws that won t pop up until after the lease is signed, and you have little or no recourse against the property s owner. That s why it s important to remember that your lease negotiations aren t limited to just the usual issues, such as determining the length of the lease term and renewals, hashing out a cotenancy clause, and agreeing on operating expenses. During negotiations, you should also ask the owner for representations and warranties about key items that you ll need in order to operate in the space. Keep in mind that the breadth and depth of the owner s representations and warranties will depend in part on your leverage as a tenant. Is your store or restaurant a key part of a shopping center s synergy? Are you renting office space that has been empty and the owner has been struggling to lease? Regardless of those factors, there are certain representations and warranties that most owners expect to be asked to make, and that you should insist on. Even if the owner tries to severely limit or not provide the representations and warranties that you ask for, you don t necessarily have to give up a seemingly perfect space. Performing due diligence can uncover flaws to either address with the owner up front, be prepared to pay for, or walk away from, if necessary. Get Three Key Assurances It s important for tenants to fully understand the importance of getting certain representations and warranties in lease deals. A representation is a statement made by one of two contracting parties to the other, before or at the time of making the contract, in regard to some fact, circumstances, or state of facts pertinent to the contract, which is influential in bringing about the agreement. Warranty is usually defined as an agreement to be responsible for all damages that arise from the falsity of a statement or assurance of facts, so this is applicable after the lease has been signed. Essentially, representations and warranties work together as assurances that the owner gives to the tenant, that the tenant can rely on as factual, explain Chicago commercial real estate attorneys Kenneth Klassman and Travis Jeffries. (continued on p. 2)

2 2 (continued from p. 1) When a tenant signs a lease, it s the beginning of a relationship with the landlord for the rest of the lease term. If the tenant ends up not being able to operate there because of factors it didn t get representations or warranties about ahead of time, and the owner doesn t agree to help the tenant, it can find itself in real trouble, Klassman warns. Jeffries emphasizes that small tenants are at higher risk without representations and warranties from the owner because the expense of making the space actually usable after the lease is signed can run very high. Ask your attorney about requesting these three assurances, which cover major issues that a tenant could encounter. 1. Owner s authority. At the outset, tenants should make sure that the owner has the authority in the first place to enter into the lease especially when you re dealing with a property manager. If it doesn t, the lease may not be valid. Including this language in your lease will hold the owner to the representation that its legal entity has been properly formed and run, and has all the necessary authority to legally enter the transaction. Corporate Authority. If Landlord is an entity, the individuals executing this Lease on behalf of Landlord each warrant and represent that Landlord is a duly constituted entity organized under and in good standing under the laws of the [insert name of state]; that the persons executing and delivering this Lease on behalf of Landlord are duly authorized by Landlord to execute and deliver this Lease on behalf of Landlord; and that all necessary actions have been taken which are necessary to authorize and approve this Lease and to authorize the signatory hereto to execute and deliver the same and bind Landlord to the terms and provisions hereof. If Landlord is more than one natural person, corporation, partnership, or other entity, then liability under this Lease among such parties shall be joint and several and each provision of this Lease shall bind each such party. 2. Condition of premises. Much of the conflict we see is the result of whether or not the premises is in compliance with applicable law, Klassman notes. This can drive up the price for a tenant that must bring it into compliance later, at its own cost, in order to be able to use the space for its business. For example, a tenant that s completing a buildout might find out from an inspector that it needs to add additional electrical equipment in order to comply with the law and get the power that it needs to its space. A tenant could end up paying thousands of dollars to have proper services, like electricity, that are necessary for its permitted use if it doesn t have a representation from the owner that the space is in compliance with the law and has the services the tenant needs in the space, warns Jeffries. He notes that in situations like the buildout example, if the owner had represented that the space was in compliance for the tenant s permitted use, the tenant could go back to the owner to ask it to pay for the electrical work. (continued on p. 3)

3 3 (continued from p. 2) To ensure that the owner will be responsible for making upgrades or repairs to bring the space into compliance for your use if it turns out that they are needed, include the following representation in your lease: Delivery of Possession and Condition of the Premises. Landlord shall, at its sole cost and expense, deliver the Premises to Tenant in broomclean condition. Landlord represents and warrants that the Premises is in compliance with all applicable building, safety, fire, and all other laws, statutes, codes, ordinances, rules, and regulations of federal, state, and local governmental agencies, including, without limitation, the Americans with Disabilities Act, as amended (collectively, Applicable Laws ). All of Landlord s Work shall be done in a good and workmanlike manner and in compliance with all Applicable Laws. Landlord hereby warrants and represents that at such time as it delivers possession of the Premises to Tenant, the structure, roof, roof membrane, freight elevator, heating, ventilating, air conditioning, lighting, electrical, plumbing, sewer, and other systems and fixtures serving the Premises will be in good condition and working order, and there will be sufficient utilities available to heat, illuminate, ventilate, air condition, and provide power to the Premises in the quantities or at the capacities required by Tenant for its Permitted Use. 3. Tenant s use. Proper zoning is also a key representation to get from the owner. After all, if you move into your space without that assurance from the owner, and later find out that the property isn t zoned for your use, you ll be on the hook for paying rent for a space you won t be able to legally use for your business. Klassman warns that this issue comes up in cases where there is a dramatic change in use for a space, such as a retailer that takes space that had been used as a daycare center. Restaurant tenants are classified as retail, but still should investigate whether moving into a previously non-restaurant use space will violate current zoning laws. Office building tenants don t need to be as concerned about zoning, but still should check to make sure that there aren t any issues that could limit or preclude their planned use. Tenant s Use/Zoning. The current zoning for the Building will allow Tenant to use the Premises for the permitted uses set forth in this Lease. The Tenant s use of the Premises permitted under this Lease will not violate any Applicable Laws. Landlord will take no actions that will unreasonably or materially affect Tenant s ability to conduct its normal business operations in the Premises and use the Premises for the purposes permitted herein. Don t Get Left on Hook for Expensive Systems Issues One of the chief reasons for getting representations and warranties from the owner is to avoid having to pay for upgrades, maintenance, or equipment that should be the owner s responsibility. You might think that the building or center is running efficiently, but if expensive systems break after you ve moved into your space and you don t have a representation from the owner that they are supposed to be in regular working order, you could have to pay (continued on p. 4)

4 4 (continued from p. 3) to get them running again. Jeffries points out that the expense of certain items, specifically heating, ventilation, and air conditioning (HVAC) equipment, which can easily reach into the thousands of dollars, can be devastating to small or struggling tenants. To commit the owner to providing the HVAC that you need, ask your attorney about using a variation of the following language in your lease. Don t be surprised at pushback from the owner regarding expensive systems, though. Jeffries notes that the following language requires the tenant to maintain an HVAC service contract. A tenant would not want to be the first person to suggest this term, but it s a great counteroffer to a landlord that requires that the tenant replace the HVAC, he recommends. If the landlord requires the tenant to replace the HVAC, the tenant can refuse but suggest that it maintains the HVAC with a service contract; this gives the landlord assurances that it will be well maintained and delay any need for replacement, he adds. The model language below also includes a representation by the landlord that all mechanicals and systems are properly functioning upon lease commencement. HVAC Maintenance and Repairs. Landlord shall maintain the Common Areas and the exterior walls, fire sprinkler system, roof, and foundation of the Property. Except as set forth herein, Tenant shall, at its expense, keep the Premises and every part thereof, in good condition and repair, and shall be responsible for the maintenance and repair as necessary of the Premises including, without limitation, electrical, plumbing, and sewer systems solely related thereto, the exterior and interior doors, door checks, door frames, and door hardware. Tenant shall be responsible for hiring a third-party maintenance company to maintain the existing HVAC system on a quarterly basis and shall provide Landlord with a copy of the contract for such service within ten (10) business days after the execution of this Lease. In the event that the heating, air conditioning, and ventilation system ( HVAC ) is beyond its useful life and, in the reasonable opinion of Tenant s HVAC contractor, is unable to be repaired to a condition that would allow for regular use, then Landlord shall replace the HVAC with a reasonable comparable system, unless due to the negligence or willful misconduct of Tenant. Notwithstanding anything else in this Section, Landlord represents that all mechanicals and systems serving the Premises are and will be on Commencement Date in good working order and repair. Level Playing Field with Owner If you encounter an owner that will make no or only limited representations and warranties, you won t be able to get relief from future issues if something goes wrong. But if some aspect of the space is crucial to your business, and you d like to go ahead with the deal anyway, you can perform due diligence to root out any foreseeable problems. Don t assume that the landlord has all the leverage and then sell yourself short, says Jeffries, who recommends that small tenants or those that want (continued on p. 5)

5 5 (continued from p. 4) to save on fees assure themselves that they ll actually get the property in the condition they think it seems to be in by consulting with professionals in the field and doing their own research. Tenants don t have to rely solely on the word of the owner and can make their own inspections, adds Klassman. A tenant can shift the balance of power by doing the following on its own: Zoning or use. If an owner won t represent that the tenant s use is permitted, the tenant can check itself, but should also request a title commitment and underlying documents from the owner to make sure there s not some limiting use in the documents governing the land, says Klassman. HVAC, roof, capital replacements. Get an inspection done to determine the lifespan of items like the roof, and to ensure that the HVAC is operating well especially if you ll be responsible for replacing them under the lease, says Jeffries. An inspection will be an out-of-pocket expense, but it s in the tenant s best interest to do that, rather than replace items later. Compliance. A walk-through with an architect can uncover what you need to do to be in compliance with zoning and other laws. And a general contractor can also give you an opinion about the condition of the premises, says Klassman. For example, depending upon the size of your prospective retail space, you might or might not need to install a public bathroom or provide other accommodations. A tenant considering a single tenant property may also want to do a Phase 1 environmental report, if the landlord won t represent and warrant that there are no hazardous materials as of the date of the lease, Klassman suggests. The reason for doing so is that the Phase 1 establishes the environmental conditions as of a certain date so that a tenant is responsible only for impacts to environmental conditions that it causes after that date. Remember that, as with all lease terms, there is room for negotiation when asking for representations and warranties. For instance, a franchisee tenant could use its franchisor as leverage to equalize itself with the owner by making it clear to the landlord that the requests being made are required by the franchisor. The owner might be willing to make accommodations for the franchisee in order to have a master agreement with a billion-dollar company, Jeffries says. Both Klassman and Jeffries stress that due diligence is crucial to feeling comfortable signing a lease, whether or not the owner will agree to make the requested representations and warranties. Just because the landlord won t give you an actual representation, that doesn t leave you powerless, Klassman notes. Insider Sources Travis C. Jeffries, Esq.: Associate, Horwood Marcus & Berk Chartered, 500 West Madison, Ste. 3700, Chicago, IL 60661; tjeffries@hmblaw.com; (312) Kenneth Klassman, Esq.: Partner and Head of Real Estate Group, Horwood Marcus & Berk Chartered, 500 West Madison, Ste. 3700, Chicago, IL 60661; kklassman@ hmblaw.com; (313)