Term Sheet Tips for Tenants: What You Need to Know

It is common for commercial tenants to conduct their initial lease negotiations through their brokers and the landlords’ leasing agents, resulting in a term sheet that provides a skeletal understanding of their deal. Except regarding very large leases, attorneys are rarely asked to participate in term sheet negotiations, and subsequently, they often are faced with incomplete or ambiguous term sheets that make it more difficult to draft and negotiate a lease agreement.

Tenants who don’t want to bring their lawyer into initial term sheet talks may still avoid or minimize these term sheet problems, reducing the likelihood of a cratered deal and eliminating costly attorney hours spent on filling in the gaps of an incomplete or ambiguous term sheet.

Most importantly, tenant representatives should have a clear understanding with the landlord’s leasing agent about the economic terms of a deal, as well as any particular provisions that may fundamentally alter the total costs associated with the lease. Failure to reach agreement on these terms can stall or markedly slow the pace of negotiations on a binding lease agreement.

Of course, there is a tactical question of how much to negotiate upfront in the term sheet as opposed to “punting to the lease.” In most cases, the term sheet should contain an agreement on the basic economic provisions of the deal and any other terms that either the landlord or the tenant consider essential.

Ideally, the parties should succinctly clarify the following in a term sheet:

1. The Fixed Rent. This is the most material economic term for both parties.
2. Escalations. The parties should agree on any applicable escalations for real estate taxes and operating expenses, stating clearly the base year on which escalations are calculated (fiscal year, calendar year, or other). The parties should also agree on which operating expenses are excluded, such as certain capital expenses that landlords often undertake.
3. Security. Often, this is listed as a “TBD” item that depends upon the landlord’s review of the tenant’s financial statements. But this approach may cause issues during the negotiation of the lease, so it is best to address it as early as possible.
4. Lease Term Commencement. The term sheet should clearly state the commencement date for the lease and the obligation to pay rent. Also, it should be clear whether the lease term runs from the Commencement Date or the Rent Commencement Date.
5. Free Rent Period. Often, landlords offer free rent periods that are stated in terms of “months.” These periods should be expressed in a total number of days, a date certain, or an anniversary of a particular date to avoid confusion.
6. Landlord’s Contribution. The parties should agree on whether this will be paid upfront or on a pro-rata basis over time. They should also agree on whether it can be applied to so-called “soft costs.”
7. Expansion and Renewal Rights. There should be a clear agreement on when and how these rights can be exercised. Concerning expansion rights, it is important to agree on whether they are subject to or conditioned on any initial lease-up of the particular expansion space.
8. Assignment and Subletting Rights. The parties should also agree on any limits or conditions on the tenant’s right to assign or sublet without the landlord’s consent. Such terms can materially impact the tenant’s assessment of risk and value associated with the lease.

Other important matters that are tenant “deal breakers” should also be spelled out in the term sheet. For some tenants, this might include subordination and non-disturbance agreements that require lenders and/or ground lessors to acknowledge the tenant’s rights under the lease. For other tenants, certain amenities may be important to the happiness of their employees, such as bike storage space, fitness rooms, cafeterias, outdoor patios or the ability to allow dogs in the office.

While we often see amenities expressly included in term sheets, when it comes to the lease, many landlords do not want to obligate themselves to the continued operation of such amenities as they may decide to modify or discontinue certain amenities over the lease term. As such, if there is an amenity that is essential for a tenant, this should be expressly included in the term sheet, together with any penalties associated with the landlord’s failure to provide such amenity throughout the term of the lease.

A simple term sheet that covers the above essentials will provide a clear road map to negotiate and finalize a lease more efficiently. Not only will this make the attorneys’ lives a lot easier, but it will likely result in a lower legal bill, so everyone wins!