Leasing Nightmare: Buyer Beware

Note:  Blackacre LLP is a boutique fixed fee real estate law firm with a restaurant leasing specialty.  From its experience serving as counsel to numerous restaurant clients, Blackacre’s attorneys know that a good lease is crucial to a restaurant’s success, while a bad lease can doom an otherwise successful restaurant to failure.  In the coming articles, Blackacre’s attorneys will write on how to prevent a restaurant lease from becoming the next “Leasing Nightmare."

In the commercial real estate transactional world, the term “AS-IS WHERE-IS WITH ALL FAULTS” has become ubiquitous.  In the real estate purchase and sale context, nearly every purchase agreement contains a lengthy disclaimer (sometimes extending to a few pages in length) describing every possible diligence matter that could ever arise and repeatedly dismissing or waiving any liability in connection with such matters for the seller. The trend has been adopted by the counsel of nearly all sophisticated landlords, and leases now contain similar lengthy disclaimers describing how tenant has performed every possible piece of diligence it could have possibly performed and that the tenant is irrevocably satisfied in all respects with respect to all matters pertaining to the property. 

Without the assistance of sophisticated attorneys, many tenants read these provisions much like they read the latest iTunes terms of service – eyes glaze over and the terms are accepted as standard boilerplate.  After signing the lease with these “standard” terms, restaurant tenants eagerly get to work on the space planning and working drawings for their permits.  It is only during this stage that tenants often realize the Leasing Nightmare of these “buyer beware/as-is” provisions, as tenants are obligated to spend tens if not hundreds of thousands of unbudgeted dollars remediating existing defects at the property.  

Unfortunately, unlike most real estate buyers, many small restaurant tenants are ill equipped to both diligence and confront these issues and ultimately resolve these problems.  As discussed in this article, in order to avoid this potential Leasing Nightmare, it is critical to negotiate the exact condition of the premises and to resist this boilerplate disclaimer.  

Compliance with Laws

One of the most problematic areas of an as-is clause is the affirmation that tenant has fully investigated the property complies with all laws (with a specific emphasis on the Americans with Disabilities Act (ADA)) and tenant takes all responsibility for the lack of compliance. If the property does not comply with all laws, a tenant may find itself doubling or tripling its improvement budget to remediate such defects, which defects should have been the landlord’s responsibility to begin with.

In general, most building codes are applied at the time the relevant improvements are built and are not retroactive in nature.  In other words, a building built in 1985 likely complies with most laws existing as of 1985, but likely does not comply with many laws enacted thereafter.  The building is therefore considered as legal nonconforming (also known as “grandfathered”) and is allowed to exist as it stands until a new permit is pulled, in which instance the building must be brought up to code with respect to the improved portion (and sometimes other areas as well).  Even with respect to non-grandfathered building code violations, such violations are not likely to be enforced by the applicable municipality until a new permit is issued, as municipalities simply do not have the resources to continuously check compliance with building codes.

Especially with respect to buildings of older construction, tenants often discover the laundry list of items which must be brought up to code for both the common areas of the property and the premises. Unsurprisingly, many landlord forms even require the tenant to perform the compliance work to the common areas of the property caused by the simple act of the tenant pulling a permit.  It is not uncommon to encounter situations in the pre-leasing stage where the compliance costs for tenant would exceed a seven-figure budget.

In summary, improving an existing as-is premises up to code can involve exorbitant expenditures.  While in an ideal world restaurant tenants would carefully diligence these costs prior to lease execution, many restaurant tenants do not have the time, resources or knowledge to do so.  It is therefore important that tenants receive a landlord representation and commitment to deliver the premises in compliance with laws in order to make sure tenant can spend all budgeted dollars on actual enhancements to the premises and not compliance costs.

Hazardous Materials

Most landlord forms are very explicit in stating that landlord takes on no responsibility for hazardous materials and the tenant has adequately performed all desired investigations.  In reality, the cost of a restaurant tenant performing a robust environmental investigation onto the property is usually not economical. 

Accordingly, tenants should always obtain the landlord’s commitment to remediate all pre-existing hazardous materials in the premises and the representation that no hazardous materials exist at the time of lease signing.  Otherwise, tenants may find themselves closing business to remediate hazardous substances such as mold and asbestos.

Building Structure and Building Systems

Landlords additionally place the burden on the tenant to investigate the status of building structure (including the roof, slab, and load bearing walls) and building systems (including HVAC and fire/life safety systems).  A potential fault in the gas line to the premises or leak in the roof can stall tenant operations and require extensive construction and disruption to the tenant’s business in order to fix.  Landlords are much more familiar with these items and should take on the burden of representing that these items are in good condition.  

Landlord’s Work

While almost all commercial lease forms include as-is language, there is usually one major exception to this clause: the scope of work for landlord to perform.  Such scope is generally written to bring the shell of the premises into a satisfactory state for tenant to commence performing mostly non-structural restaurant specific work.  Tenants should ensure that landlord warrants the condition of such work.  Such work should also be carefully reviewed by a tenant’s design professional to ensure the scope of such work is adequate.  The scope should be defined as broadly as possibly to try obtain landlord’s commitment to remediate any of the above-referenced issues, if confronted during the performance of landlord’s work. 

Conclusion

Landlords and sellers alike continue to operate in a commercial real estate landscape that holds firm on the buyer beware mantra, placing all burdens of a transaction on the tenant and buyer, respectively.  Small restaurant tenants often do not possess the organizational infrastructure to fully analyze the conditions of the leased real property.  Compounding matters, it is these exact small tenants who can least afford to have a budget blown by spending precious resources remediating unforeseen problems with the leased real property.  

While such tenants would ideally spend the time and resources to fully diligence the property, the pressure to open new locations and lack of resources often prevents such diligence.  Therefore, to avoid this Leasing Nightmare, it is important for a restaurant tenant to work closely with an attorney to provide landlord representations and commitments with respect to the property and premises.  While the cost of legal advice and real estate diligence for restaurant clients may be significant, mitigating the risk of being obligated to repair massive property defects is a worthwhile and necessary investment.

Leasing Nightmare: Buyer Beware posted first on happyhourspecialsyum.blogspot.com