Suggested Revisions to the AIR Standard Lease Form

Suggested Revisions to the AIR Standard Lease FormAnyone involved in commercial real estate in California is undoubtedly familiar with the American Industrial Real Estate Association (“AIR”) standard lease forms. The ease and affordability of the AIR lease forms have garnered them immense popularity in California for both landlords and tenants alike. Generally, however, the parties merely fill in and sign the standard form while making little, if any, changes to the language of the lease.

So long as everything runs smoothly, landlords and tenants are perfectly happy with this arrangement. However, those parties that have engaged in lease disputes have quickly realized that the standardized lease form often fails to favorably address many of their specific needs. This is why, prior to using a standard AIR lease form, all parties to a lease should thoughtfully assess their interests and attempt negotiate appropriate revisions.

Although other articles have offered suggestions regarding items to negotiate in the AIR lease, we have attempted to present our own suggested revisions in a clear and concise format with special attention paid to the individual needs of the landlord and tenant.

PROVISION ONE – COMMENCEMENT DATE:

One of the first potential problem areas in the standard lease form is the “commencement date” section. Specifically, Paragraph 3.3, “Delay in Possession,” states that there is no penalty for the landlord for late delivery of the premises as long as the landlord delivers the premises to the tenant within 60 days from the agreed upon commencement date. The tenant’s only remedy is to terminate the lease within the 60-day period. The section also states that if the premises are not delivered within 120 days of the commencement date, the remedy is automatic termination of the lease.

The commencement date paragraphs can pose many problems for both parties. One problem may occur if a dispute arises about construction delays for tenant improvements to the premises. These problems are intensified if the landlord is responsible for the work because the landlord has complete control of the situation.

One more point of interest is how the commencement date is defined. Many times, it is defined as the time at which the landlord reaches “substantial completion” of the tenant improvements. This simply means that the landlord has finished sufficient work so that the tenant may move in and conduct business.

If you are the Tenant:

The situation is further exacerbated because tenants are often in a precarious situation when moving into new premises. They may be moving out of an old rental on a specific date, or have time sensitive arrangements for purchasing and moving furniture or hiring employees. Because of this vulnerable position, a significant delay can pose huge problems for tenants.

Thus, it is important for the tenant to negotiate the commencement date and 60-day delay provision. The tenant may attempt to negotiate for no delay, however most landlords will insist on some delay, even if less than 60 days. Actively negotiating the 60-day period will encourage the landlord to provide the tenant with timely access because the landlord does not want to spend time and money adapting the premises to the tenant’s requests only to eventually lose the tenant.

The tenant should also attempt to require the landlord to pay the tenant’s damages if the landlord delays delivery of the premises. Such revisions might include the landlord agreeing to pay damages for any holdover rent paid by the tenant as a result of the delay.

When the commencement date is defined as “substantial completion,” the tenant must insist that paragraph 3.3 be modified. Without revision, paragraph 3.3 only gives the tenant the right to terminate if the landlord fails to deliver possession of the premises within 60 days of substantial completion. With no modification to paragraph 3.3, the landlord could indefinitely delay completion of the work without any repercussions because the tenant’s 60-day right to terminate only begins after substantial completion. Thus, the landlord will only violate paragraph 3.3 if the landlord substantially completes the work and then fails to deliver possession. Thus, to protect itself, a tenant should negotiate a fixed date by which the landlord must deliver the premises or give the tenant the right to terminate.

If you are the Landlord:

The commencement date paragraphs may also pose problems for landlords. If the commencement date is based on substantial completion, and the tenant is responsible for completion of the work, the same problems may apply. To avoid this, the landlord might insist on shifting the construction delay risks to the tenant. A landlord could attempt to assign the commencement date to either a fixed date or the date the tenant opens for business, whichever comes first, whether or not the tenant completes the construction. This might prevent the tenant from continually delaying commencement of the lease.

PROVISION TWO – COMPLYING WITH APPLICABLE LAWS:

From a simple reading of the lease, it is often difficult to ascertain which party is responsible for complying with applicable laws (or “requirements”). The lease contains a maze of confusing disclaimers that may or may not be relevant in determining responsibility. Ultimately, the decision of who is responsible for complying with applicable laws may only be determined after examining two cases decided by the California Supreme Court in 1994. These cases, Brown v. Green, 8 Cal. 4th 812 (1994), and Hadian v. Schwartz, 8 Cal. 4th 836 (1994), outline the relevant factors that a court will consider in making such a decision.

In Brown and Hadian, the California Supreme Court held that despite the language in the AIR lease specifically placing the responsibility of complying with applicable laws on the tenant, a landlord may still be responsible for repair costs. In both cases, the court disregarded the clear and unambiguous language in the AIR lease form. Instead, the court applied a six-factor test for the tenant’s obligation to repair. The factors are as follows: 1) the relationship of the cost of the curative action to the rent reserved, 2) the length of the term and the time for the cost to be amortized 3) the relationship of the benefit to the tenant to that of the reversioner (i. e., the landlord), 4) whether the curative action is structural or nonstructural, 5) the degree to which the tenant’s enjoyment of the premises will be interfered with while the curative action is being undertaken, and 6) the likelihood that the parties contemplated the application of particular law or order involved.

The reasoning in Hadian suggests that if the lease is a net lease, then it may be held that the parties intended for the tenant to share in such repair costs. However, neither landlords nor tenants should assume that merely allocating the risk to one party in the lease will control which party will bear the risk. This will only be determined after examining the facts in light of the six-factor test.

If you are the Tenant:

Although the six-factor test is ultimately determinative, the language in the lease may be a relevant factor in determining the outcome. Thus, the parties should make sure the terms of the lease meet their desires and expectations.

A tenant should attempt to revise any language stating that the tenant bear the cost to repair or comply with laws if compliance is mandated after the landlord’s six-month warranty period expires. This is especially true in shorter leases where the majority of the benefit of compliance will go to the landlord. Additionally, a tenant should reject language that gives the landlord the right to terminate the lease if compliance is caused by factors outside the tenant’s use.

The tenant should also protect against language stating that the tenant will lose its lease for something that the landlord will be required to fix even after the tenant leaves. The tenant may want to revise the amortization period to cover the “useful life” of the item rather than the AIR form’s 12-year period. Finally, tenants should try to delete paragraph 49 or at least modify it to state that the landlord must warrant that the premises currently complies with disability laws or will comply by the commencement date.

PROVSION THREE – AUDIT RIGHTS:

Paragraph 4.2 of the AIR office lease form should also be examined closely. This paragraph includes a nonexclusive list of operating expenses that the landlord may charge the tenant and also lays out a few exclusions. Most parties assume that since the list is nonexclusive, further items may be charged to the tenant.

The AIR standard lease does not grant the tenant a right to audit the landlord’s books and records regarding operating expenses. However, while California case law does not give a tenant an implied right to audit, it is generally believed that a tenant may compel an audit during discovery after commencement of a lawsuit.

If you are the Tenant:

Many attorneys for tenants choose to include a list of exclusions from operating expenses in an attempt to clarify what expenses the tenant is paying. The tenant should examine this paragraph closely to make sure that the landlord does not use operating expenses as a source of profit.

If you are the Landlord:

The landlord should make sure that it keeps the inclusions and exclusions consistent in its leases. This way the landlord can avoid accounting confusion from differing leases. The attorney for the landlord should also be aware of any substantive exclusions added to the lease by the tenant that were not part of the original deal.

For Landlords and Tenants:

Because the AIR lease does not grant the tenant a right to audit the landlord’s books, it is beneficial for both the tenant and landlord to include some language about the tenant’s audit rights in the lease. Such additions should include the time and means of requesting and performing the audit, the qualifications of the individual performing the audit, the party that pays for the audit and if the tenant shall be reimbursed for audit costs if there is an error, and issues of confidentiality.

PROVISION FOUR – ASSIGNMENTS AND SUBLETTING:

Assignment and subletting are addressed in paragraph 12, Assignment and Subletting, and paragraph 36, Consent. As is, these sections state that the tenant has the right to assign or sublet to a third party as long as it receives the landlord’s reasonable consent. Although these sections are rather equal, each party may raise certain objections.

If you are the Tenant:

The tenant may notice that the standard lease does not allow the tenant to transfer to an affiliate without the landlord’s consent. If an assignment or sublet results in profits for the tenant, tenants will want to exclude transfer costs such as broker commissions, improvement allowances, downtime, legal fees, etc.

If you are the Landlord:

The landlord may notice that the standard lease does not address recapture rights that give the landlord the right to terminate the lease if the tenant attempts to assign or sublet. However, there is a separate addendum that addresses limited recapture rights. Most landlords will attempt to revise this section to make it unlimited. There is no issue of unreasonableness here, as the California Supreme Court has held that a recapture clause in a commercial lease is enforceable and is not subject to a reasonableness requirement. Carma Developers, Inc. v. Marathon Development California, Inc., 2 Cal. 4th 374 (1992). If the landlord does not add the recapture addendum, the AIR standard lease will not address situations where the tenant transfers for a profit or how the profit is treated. How profits are split should absolutely be defined by the parties.

The landlord should make sure that the tenant is not attempting to define profit in a manner that avoids paying the landlord its fair share.

The landlord should also address the situation in which the tenant accuses the landlord of improperly withholding consent to a transfer. Paragraph 12.1(e) states that a tenant may recover compensatory damages from the landlord in addition to obtaining injunctive relief. The landlord should include language stating that the tenant must seek a court injunction requiring the landlord to consent rather than sue for damages. Also, the landlord will want to delete the portion of paragraph 12.1(e) regarding compensatory damages.

PROVISION FIVE – SECURITY DEPOSIT:

If you are the Landlord:

Paragraph 5 outlines the situations in which the security deposit may be used by the landlord. This section must be revised by the landlord. In 250 L. L.C. v. PhotoPoint Corp., 131 Cal. App.4th 703 (2005), a California court held that under Civil Code §1950.7, the landlord may not retain the security deposit to cover damages for future rent owed under the lease. However, the court did state that in commercial leases, a tenant can waive §1950.7. Such a waiver would allow the landlord to apply the security deposits toward future rent. Thus, the landlord should add an express waiver of §1950.7 or any similar provision of law.

PROVISION SIX – REMOVAL AND SURRENDER:

Paragraph 7.5(b) of the standard form lease states that the landlord may require the tenant to remove alterations and utility installations so long as the landlord gives notice between 30 and 90 days before the end of the lease.

If you are the Tenant:

In response, tenants may want to add language forcing the landlord to give tenants notice of the need for removal of alterations and utility installations before the tenant makes them. The benefit of such language is that, before construction, the tenant can determine the costs of removal at the end of the lease and decide whether the improvements are worthwhile.

PROVISION SEVEN – DAMAGE OR DESTRUCTION:

For Landlords and Tenants:

Paragraph 9 of the standard lease gives the landlord the right to terminate the lease if damage costs exceed six months’ rent. This number is not based on any tangible factors and is not traditionally found in other leases. Therefore, depending on the specifics of the lease, the parties may want to alter this section to better suit their specific agreement.

PROVISION EIGHT – LIMITATION OF LIABILITY:

If you are the Tenant:

Paragraph 20 states that the tenant must only look to the project for fulfillment of any liability of the landlord regarding the lease. A tenant should attempt to eliminate this provision. However, if the landlord is not willing to delete this language, the tenant and its attorney should attempt to revise the section. The tenant should attempt to include language clarifying that the tenant can also look to the rents, issues, profits, proceeds, and other income from the project regardless if the receiver is the landlord or other. The tenant should also clarify that paragraph 20 has no effect on the tenant’s rights to withhold or offset rents.

PROVISION NINE – NONDISTURBANCE AND ATTORNMENT:

Under paragraph 30.3, the tenant’s subordination of the lease is subject to the receipt of a nondisturbance agreement regarding security devices that the landlord becomes a party to after the lease is executed. The lease however, does not cover security devices that the landlord enters into before the execution of the lease.

Furthermore, paragraph 30.2 of the lease states that a party that takes over the interest of the landlord after a foreclosure will not be liable to the tenant for the previous landlord’s acts or omissions. Additionally, the new landlord will not be subject to any offsets or defenses which the tenant might have against the old landlord. Even though this is a standard provision in most leases, it puts the tenant in a difficult situation if the landlord fails to pay the tenant improvement allowance or construct the tenant improvements.

If you are the Tenant:

The tenant should request that the landlord get a nondisturbance agreement from a lender to protect against termination of the lease upon foreclosure. This may be hard for the landlord to get, but the tenant should request it anyway.

PROVISION TEN – WAIVER OF JURY TRIAL:

Paragraph 47 of the AIR lease requires both the tenant and landlord to waive their rights to a jury trial in any action or proceeding concerning the property or arising out of the lease. This provision may be irrelevant however, because in Grafton Partners LP v. Superior Court, 36 Cal. 4th 944 (2005), the California Supreme Court held that predispute contractual waivers are not enforceable in California.

For Landlords and Tenants:

Because such agreements may not be enforceable in California, a landlord or tenant who wants to avoid a jury trial should include a separate provision in the lease requiring either judicial reference or arbitration.

PROVISION ELEVEN – ELIMINATE BROKER BENEFITS:

One interesting aspect of the AIR standard lease form is the information pertaining to brokers. Because the AIR lease form was drafted and funded by brokers, there is language in the lease that specifically benefits brokers but provides nothing for landlords or tenants. These provisions include Paragraphs 2.4, Acknowledgments; 15.1 – 15.2, Broker Fees; and 25, Disclosures Regarding the Nature of Real Estate Agency Relationship. Most of these provisions have nothing to do with the relationship of the landlord and tenant and should not be included in the lease. Such arrangements should be handled in a separate agreement between the landlord and the broker. Most attorneys will simply advise their clients to erase these provisions.

Although the AIR Standard Lease Form is an effective tool in facilitating efficient and straightforward real estate transactions, it often does not adequately address one or both parties’ specific needs. We hope that this article will serve as a valuable asset in assisting both landlords and tenants in negotiating a more appropriate and beneficial use of the AIR Standard Lease Form.