“Diligence is the mother of good fortune,” or so Don Quijote told Sancho Panza. While Don Quijote spoke of knightly conduct and good governance, his words apply just as well to real estate transactions. I’ve previously posted a video about the terms that commercial leases should include, but what should prospective tenants consider outside the four corners of the lease document?
In this blog post, I’ll describe some of the investigations (or “due diligence,” as often called) a tenant should conduct before signing a lease.
Mortgages and Restrictions
When buying property, conducting a full title search and acquiring title insurance is advisable. A full title search is rarely required for leases, but tenants should still undertake some investigation into the Landlord’s title to the premises. The two key concerns are
- Mortgages and
- Covenants, conditions, and restrictions (sometimes referred to as “CCRs” or “declarations”).
Many shopping centers, office buildings, and other commercial premises are saddled with a mortgage, and these mortgages often impose restrictions or requirements on the landlord’s ability to lease premises. They may even require that tenants accept certain terms in their lease documents. Before signing a lease, a tenant should ask whether the property is mortgaged. If so, the tenant may want to see the lender’s form of subordination, non-disturbance, and attornment agreement to establish a relationship with the lender and to see a clear statement of the restrictions on the landlord’s ability to sign or amend leases or on the tenant’s ability to allege a landlord default under their lease.
CCRs can also be a sticking point in leases. It’s common for them to contain use restrictions and limitations on the construction or renovations of buildings. If not identified prior to lease execution, these restrictions can seriously impede a tenant’s ability to operate its business as expected. In some circumstances, obtaining consents or waivers from third parties with rights under the CCRs may be advisable before lease execution. Most landlords should be willing to deliver copies of, or excerpts from, relevant documents before the lease execution and to work with tenants to make sure their businesses comply with the CCRs.
Physical Condition of Property
A prospective tenant should also carefully inspect the condition of the premises before signing a lease. Many leases state that the premises will be delivered in their “as-is, where-is, with all faults” condition. Others may require the landlord to deliver the premises in a certain condition but still leave the tenant responsible for significant repair obligations. For example, a tenant may take possession of a space with a leaky roof but be required under the lease to keep the roof watertight and repair water damage. Additionally, a tenant’s proposed use or improvements to a space may necessitate additional changes, such as increases in plumbing, electrical, or HVAC capacity or installation of wheelchair ramps, grab bars, and other disability accessibility improvements. Having a clear understanding of what improvements the tenant intends to make and what the consequences will be can prevent or reduce unexpected expenses later in the construction process. Sometimes, the lease can be drafted to split these costs between the landlord and the tenant. I recommend that tenants perform a walkthrough of the premises with their general contractor, if possible.
Next Steps
This blog post has raised only a few of the myriad issues that might require investigation before signing a lease. Depending on the circumstances, a tenant could also want to investigate zoning compliance, parking requirements, common area maintenance standards and billing practices, and other matters. These issues can often be addressed before lease execution but, if they go unnoticed, can present a nasty surprise afterward.
Edward B. Woodall is an attorney at Venn Law Group who practices corporate law and commercial real estate, including leasing, financing, taxation, business structures, and dispute resolution. He is passionate about helping business owners solve a variety of complex legal problems and has performed more than 100 hours of pro bono work. In addition to his law degree, he has a background in history and Spanish.