How to Negotiate a Commercial Lease from a Small Business Perspective

A few weeks ago, I published an article called How to Lien Real Estate Using a Writ of Attachment, which was basically advice from a California real estate lawyer to commercial property owners on how to protect themselves from defaulting tenants. Today, I write about the flip side of that coin – how a small business can protect itself before signing a new, long-term commercial lease.

Small business owners don’t often realize it, but signing a long-term lease for a commercial or office space is often one of the most significant — and potentially dangerous — decisions you make as a small business owner. If the business fails part way into the lease, the owner can be held personally liable for the balance of the rent due for the duration of the lease – which can amount to hundreds of thousands of dollars.

If you don’t have the money to hire a California real estate lawyer before you sign the new lease (which is quite understandable given the economy and limited finances of most small businesses), then you can follow the following advice to protect yourself from potential financial ruin which can come when you agree to a commercial lease which is heavily one-sided in favor of the landlord.

Sign the Lease Contract in the Name of your LLC or Corporation Only

The first piece of advice is also the most difficult. If possible, you should try to sign the lease in the name of the form of your business entity only. In other words, if you formed a LLC for your business, you should sign the lease between the landlord and the LLC only.  However, the catch is most commercial property owners are savvy enough to require that a small business owner provide a personal guarantee for the lease.

The commercial property owner knows that most business owners would rather keep all obligations in the name of the LLC or corporation only, so that if there’s a worst case scenario and the business fails, the business owner can just fold up the business without jeopardizing any of the business owner’s assets.

Most commercial property owners will require that the small business owner sign a guarantee that puts the owner on the hook for all debts which the business entity (i.e. the LLC, Partnership or Corporation) is not able to cover. If the landlord insists on a personal guarantee, then there is not much you can do. You can either agree, try to negotiate some other security, or find a new space.

Limit the Total Amount of Damages

Another option is to limit the total amount of damages which the business or business owner would be responsible for under the lease. You can simply select a hard number, such as $20,000 or $40,000, and indicate in the lease contract that in no event shall the small business owner be liable for more than that amount, including any attorney’s fees, costs, repairs, or commissions to re-lease.

If the space you are seeking to lease is in demand, then the commercial property owner is probably not going to agree to this provision. However, if it is a tenant’s market, then you may have a good chance of getting the provision included.

Limit the Number of Years In The Lease Contract

The next option is to limit the number of years in the lease contract, and to use lease options instead to achieve long-term security. From a small business’ perspective, if you are investing a lot in tenant improvements, then you may want a long term lease to ensure the landlord doesn’t kick you out after a couple of years and you lose the value of your tenant improvement investments.

However, a long-term lease means you are on the hook for more damages in the event of a business failure. Therefore, you need to balance the need for a long-term lease with the potential damages you could be held liable for in the event your business collapses. Lease options can achieve the long-term security without the liability.

Ensure You Can Assign the Lease

Finally, you should ensure you have rights to assign the lease.  If your business is failing, or your life situation has changed and you don’t have the time to devote to your business, you may want to assign the lease to a new owner. The commercial property owner will no doubt want to approve any new assignment, which is fine. Just be sure that approval cannot be unreasonably withheld.

You should also be sure you do not provide a personal guarantee to back up the incoming business, because you could be left holding the bag after that business fails, which is something you will have absolutely no control over.

If you are fortunate enough to be in a position that your small business is doing well enough to need new commercial or office space, then congratulations are in order. You are one of the lucky ones. However, as with any expansion or growth, there are new challenges and new hurdles which will require ongoing vigilance and caution.

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John Corcoran is an attorney with Plastiras & Terrizzi in San Rafael, California (Marin County).  He advises clients about real estate/land use, general civil litigation, and small business matters.  He can be reached at             (415) 250-8131       or [email protected]


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Photo credit: Flickr/U.S. Army