Negotiating a commercial lease can be a daunting task; a task made even more time consuming for you and your attorney (and thereby more costly for you) when the business terms are still up in the air or, oftentimes, have not even been addressed between the parties. A letter of intent, or “LOI,” (also known as a memorandum of understanding, deal sheet, or, sometimes, just a term sheet) is a letter agreement between the parties in which they come to an agreement, up front, as to the most important business points.
A well-crafted LOI can save a lot of headaches and heartaches and, ultimately, is a crucial step in the lease negotiation process. It gives the parties a chance to flush out, usually (and preferably) even before the lease is drafted, the most important business terms. If the landlord and tenant can agree on the most salient of issues before the lease negotiations even begin, the parties can often take comfort knowing that the deal will, in fact, get done.
Here are some of the most important terms to include in your letter of intent, as well as some points to consider when negotiating such terms. Whether you are the landlord or the tenant, or you represent the landlord or the tenant, hammering out these details before the lease is drafted will serve your, or your client’s, best interests.
1. The parties. What entity will be the landlord? The tenant? Is either party an individual and not an entity? If you are or represent a landlord, and the tenant is a new entity or an entity with no assets, will you require a guaranty from the principal(s)? If the tenant is an individual, will you require a guaranty of the lease by another individual? If there is to be less than a full lease guaranty, specify its limitations as to scope, aggregate limits, and/or duration.
2. The Building. The LOI should accurately identify the building in which the tenant will lease space. At a minimum, a street address should be provided. A lot and block number can also be a smart detail.
3. The Leased Premises. The LOI needs to accurately describe the space to be leased. Details such as its location, dimensions, square footage, and the name of the former tenant in the demised premises (where applicable), are all helpful. You want to ensure that there is no confusion as to what space is being leased to the tenant.
4. Rent. Obviously, it’s all about money! The LOI should clearly identify the monthly “base” rent, as well as when and by how much it increases, if at all. Also, is the tenant paying a fixed amount each month only, percentage rent only (where the rent payable to the landlord is a percentage of the tenant’s sales), or both?
5. Additional Rent. Additional Rent generally includes all sums payable to the Landlord other than the monthly “base” rent, including, by way of example, for taxes, insurance, maintenance or operating costs, snow removal, and utilities. To the extent these items are being paid to the landlord, and not directly to the applicable authority (e.g., the tax collector, the insurance company, the utility provider, etc.), the LOI should set forth the tenant’s proportionate share of those expenses. Another good idea is to include a dollar-per-square-foot estimate for the additional rent expenses, if available. This allows a prospective tenant to be sure, when it takes on the responsibility and expense of entering into a lease, that it understands that its true total monthly occupancy costs will be more than just the base rent set forth in the lease.
6. Term. – the LOI needs to clearly state the initial term of the lease. When does it start? When does rent start? These dates are often not the same.
7. Renewal Rights. Does the tenant have the right to stay in the premises for a period longer than the initial term? The LOI needs to describe all renewal options (how many and for how long), as well as what the rent will be during those renewal options, and when the tenant must notify the landlord that it wishes to exercise its option to extend its lease.
8. Security Deposit. To the extent a security deposit is required, the LOI should state what it will be. Additionally, if the security deposit is to be increased each time the monthly base rent increases (for example, to provide that the security deposit will always be maintained at twice the monthly rent), then this needs to be stated here as well. Alternatively, if it is to “burn off” over time, say so as well.
9. Tenant improvement allowance. If the landlord is contributing to the cost of improvements to be made in preparation for the new tenant’s occupancy, the LOI should state how much. It is usually provided as a per-square-foot dollar figure. It should also state when the money will be disbursed to the tenant (for example, will it be paid in installments as construction progresses? Does the tenant have to lay out the money and then seek reimbursement or does the landlord pay contractors directly? Is the money payable only upon completion?) If there are restrictions on what the allowance can be used for, set them out in the LOI.
10. Permitted use. Exactly what kind of business is the tenant permitted to operate in the premises? Will it be a broad permitted use, thereby providing the tenant with the flexibility to change its business should the need or desire arise? Will it be a limited permitted use, thereby ensuring that the landlord is preserving its freedom to lease and utilize other premises at its property for other uses? Also to be considered is whether or not the tenant’s use will be restricted by exclusive use rights which may have been previously granted by the landlord to other tenants at its property. If so, also to be considered is whether the tenant will be bound only by exclusives existing as of the date on which the lease is signed, or all exclusives, including exclusives granted to other tenants after the date of this tenant’s lease.
11. Exclusive use rights. Speaking of exclusive use rights, the parties need to consider whether this tenant will be granted any exclusivity covenants in connection with tenant’s use of the leased premises. An exclusive use provision will protect a tenant from competition from other tenants in the center (and sometimes even outside the center) by restricting the landlord’s ability to lease other space to another tenant for this tenant’s same use. This is a critical issue, and is one that is commonly glossed over by the parties. If the tenant is granted any exclusive use rights, the LOI is the perfect place to clarify the nature and extent of the tenant’s exclusive use rights, as well as any applicable carve-outs (for example, LOIs will often contain a carveout for other tenants in the same shopping center who are occupying more than a minimum number of square feet) and, possibly most importantly, what are tenant’s remedies if the exclusivity covenant is breached.
12. Parking. How many parking spots will the tenant, its employees, and its customers, be permitted to use? Will they be reserved? If so, will they be marked as such, and at whose expense? Marking the tenant’s parking spaces is often best accomplished by marking it on the site plan, as mentioned in paragraph 16 below.
13. Signage. Where is the tenant permitted to hang its shingle, and at whose expense? Are there pylon signs or monument signs? A directory? If so, which spot(s), if any, and how many will be given to the tenant? This is another hot topic and is best clarified in the LOI.
14. Alterations. Is the tenant permitted to make alterations to its premises? Structural?, or only non-structural? Is landlord’s prior consent required?, and, if so, must any denial of landlord’s consent be reasonable, or may landlord make the determination in its sole discretion? Who will perform the work and at whose expense? What if the changes are non-structural and only cosmetic in nature? Will the landlord’s consent be required? What if they are structural? Again, these items need to be clarified in the LOI.
15. Assignment and Subletting. Yet another hot topic, the LOI needs to clarify whether, and to what extent, a tenant is permitted to assign or sublet its space. Will there be restrictions on the type of assignee (for example, minimum net worth requirements)? Will the tenant be permitted to sublease its space in parts, or only in its entirety? Will the tenant be released from liability after the effective date of an assignment of its lease? Will the landlord be entitled to all or any portion of the net proceeds received by the tenant in connection with any such assignment or sublease? Will there be a carveout providing that the landlord’s consent will not be required in connection with a transfer by the tenant to an affiliate? What about in connection with a sale by the tenant of all or substantially all of its business? Will the landlord have the right to recapture the premises after the tenant requests the landlord’s consent? All of these are often highly-negotiated topics. All parties’ interests are best served if these issues are clarified in the LOI.
16. Site Plan. It is a good idea to attach a drawing of the Leased Premises as well as the entire property in which it is located (a “site plan”) to the LOI on which the parties can identify and agree as to certain critical features for each party (for example, signage, parking, ingress and egress, protected area[s] in which one party or the other shall be prohibited from taking certain action[s]).
17. Nonbinding nature of LOI. This is a critical issue. A tenant doesn’t want the landlord shopping around for a better tenant while the tenant is spending its time and money negotiating a lease in good faith with this landlord. Similarly, a landlord doesn’t want a tenant to shop for better space during this time. So, it might be wise to clarify that neither party will negotiate with any other party during the negotiations between each other. The LOI should, however, explicitly state that it is neither a binding document nor a specific offer, and that it does constitute any intent to be a legally binding obligation. Remember, the purpose of the LOI is to confirm the parties’ desire to enter into business together, without replacing the negotiated lease itself.
18. Other. There are virtually dozens of other subjects that the parties can include in the LOI, including: the tenant’s right to go dark; either (or, sometimes, both) party’s right to terminate the lease prior to what would have otherwise been the expiration date; the landlord’s right to relocate its tenant to other premises; a clarification as to which party’s form of lease will be used as a starting point; a right of first offer or first refusal as to other available space; co-tenancy requirements; control over the site plan, etc. This article is only intended to be a guideline and to address the topics that seem to come up the most often.
Having now listed all of these items, the parties should also remember that LOIs need to be handled on a case-by-case basis. For a tenant without a lot of bargaining power, a landlord often will not want to spend the time or money drafting (or paying its attorney to draft) the LOI or, alternatively, the landlord will prepare its own LOI that contains only the bare minimum of business terms. However, the parties need to keep in mind the big picture and the ultimate goal, which is to get the deal done! If all is done right, the result will be an executed lease in which the business terms were agreed to in advance and the lawyers merely need to address the legal issues.