For most businesses, it makes better sense to lease an office space rather than to acquire one. Part of the reason has to do with flexibility - a growing business will soon find itself outgrowing an existing office space; the other has to do with the prohibitive cost of acquisition of an office space. This article discusses the various nuances of negotiating a lease for a commercial office space.
Lease areas: Typically, the leased area in an office complex is given as a super built-up area. Super built-up area includes the actual useable area within the leased space, the thickness of the walls, and the proportionate space of the common areas of the building. This is so because the lessee would have access not only to its immediate office space, but also to the common areas of the building (jointly with the other occupants). The actual area that is exclusive to the lessee and that can be used by the lessee is called the carpet area. It is advisable to seek details of the carpet area and to determine the office space requirements on the basis of the same. Lease deeds will typically provide the layout map of the relevant floor with the office space unit marked thereon. This is particularly so in case a floor has more than one unit that is being leased. In addition to the office space and the common areas, the lease may also include the right to a certain number of four wheeler and two wheeler parking slots in the premises. The number of parking slots available for each office unit is typically fixed. However, some lessor may provide additional parking spaces at an extra charge. These must be negotiated beforehand and provided for in the lease deed.
Parking slots may be provided within the building (i.e. basement/ floors that are constructed as parking lots), or may be situated in the open spaces around the building. In rare occasions certain parking slots may have limited ingress/ egress space, and would be suitable only for smaller vehicles only. A physical verification of the parking spaces is therefore advisable. If a parking space provided under the lease is not desirable, lessees may want to negotiate for an alternative parking slot with the lessor. Lessees must also consider if they require contiguous parking slots, and such requirement must also be informed to the lessor and recorded in the lease deed. No possession over parking slots is provided to the lessee, and the same is in the nature of a license-to-use only.
Condition of leased areas: Office spaces may be leased either in bare-shell or warm-shell conditions. Bare-shell condition implies that the premises are devoid of any interior furnishing, air conditioners, lighting, plumbing, etc. Bare-shell works best with lessees who intend to undertake significant design and planning of the space themselves (i.e. determine the layout of the air conditioners, the electrical wiring, location of plumbing pipes, etc.). However, most lessees would be better served with leasing a warm-shell premises which require secondary fit-outs before they can be occupied. These secondary fit-outs can be in the nature of rooms, cubicles, partitions, etc. In certain cases, premises may also come fully fitted and are ready-to-move-in. This implies that the scope of undertaking interior designing of the space is limited; however a fully fitted-out space also allows businesses to commence operations faster from a leased space.
Fit-outs: For bare-shell and warm-shell spaces, undertaking the fit-outs is the responsibility of the lessee. However, the lessor may insist that the fit-outs be conducted by persons nominated by the lessor. While certain contracts may provide these terms to be non-negotiable, other lessors may provide some level of flexibility to the lessee in choosing contractors to undertake fit-outs. The primary concern of the lessor with third party contractors are (i) the quality of the fit-outs keeping in mind the overall quality, prestige and goodwill of the building, and (ii) ensuring that the safety standards are met while undertaking the fit-outs; and that the materials used also meet the require safety standards (e.g. fire, health and environmental safety standards) as are being uniformly maintained in the building. These conditions may be provided in the lease deed as part of an annexure. They may also be provided as part of the house rules to be followed by the lessee.
Lease deeds also provide for a fit-out period which is typically rent-free. During this period the lessee is expected to complete the fit-outs at the premises. However, prior to the commencement of the fit-outs the possession of the premises is 'handed-over' to the lessee by the lessor. The hand-over date should be clearly provided in the lease deed. Delay in handing-over of the premises will adversely affect the ability of the lessee to timely commence the fit-outs, and will severely impact the date from which the lessee can start occupying the same. Consequently, lessees may negotiate pre-determined damages payable by the lessor in the case of delay in handing over of the premises. Further, in case of delay beyond a pre-determined period, the lease deed should also entitle the lessee to terminate the lease deed and seek the reimbursement of all sums expended by it for the lease (including any deposits paid, or costs incurred e.g. costs towards undertaking the due diligence of the premises, etc.).
Rent-free period: The lease deed should also clearly specify the rent-free period during which time no rent is payable by the lessee even though the possession of the premises has been handed over. The rent-free period is typically between 1 and 3 months, and is tied to the time expected to be taken for the fit-outs to be completed. Delay in completion of fit-outs, which is not caused due to an act or omission of the lessor, will not cause the rent-free period to be extended. However a delay by the lessor in effecting the handover of the premises will, in most cases, extend the rent-free period if as a consequence of such delay the fit-outs are also delayed. Specific terms as to this should be provided in the lease deed. Some lease deeds may provide that in case of early completion of fit-outs and consequent early occupation of the premises, the rent-free period will be decreased accordingly. That is, the rent shall become payable upon the early occupation of the premises, irrespective of the remaining rent-free period. However, such provisions are typically seen only in regards to long rent-free period arrangements (i.e. periods in excess of 3 months), and are more prevalent in the retail and entertainment space leasing rather than office spaces.
Lease period: Very often, commercial office space leasing period extend to nine years, with one or two renewals for additional periods of three years. Since the lessee may incur significant expenses towards the fit-out costs, a lesser time-period is generally not suitable. The renewal of the lease should be at the sole option of the lessee, and the lessor should be bound to renew the lease on the same terms (except with an increase to the monthly rent and security deposit). However, a lesser lease term should be perfectly acceptable in case the office space has been pre-fitted-out before hand-over. The lock-in period for a nine years lease term is typically three years; though some lease deeds may stipulate a shorter lock-in period. During the lock-in period the lessee is not entitled to terminate the lease deed for any reason other than on account of a material breach by the lessor. Lessors, on the other hand, are generally not entitled to terminate the lease deed, whether within or outside the lock-in period, except on account of a material breach of the lessee of its covenants under the deed, and which hasn't been rectified for a pre-determined period (e.g. lease rent or maintenance charges not paid for two months, or use of the premises that are contrary to the terms of the lease deed, etc.).
Operating times: Commercial office buildings operate within specified time limits. Operating times typically begin an hour before normal office hours, and end an hour after the end of typical office hours. Use of the premises before or after the operating hours may not be permitted. This is to ensure the safety of the building, and to ensure conservation of energy used in maintaining the common area equipment (e.g. lifts, escalators, lighting, etc.). However, in the event a lessee requires the office premises beyond the operating hours, the lease deed may provide for such usage subject to payment of additional hourly charges. These are typically added to the maintenance charges payable to the maintenance agency.
Energy load: Commercial offices that seat a large number of people will have high energy requirements for the HVAC, lights, servers, and other energy consuming equipment installed therein. While certain utilities can be enhanced easily (viz. water, internet bandwidth, etc.), it is not always easy to enhance the electricity load factor within a floor. This is because the sanctioned load for a building is distributed across the various floors/ units of a building, and there is no leeway left after the distribution to enhance the load for any particular floor without increasing the sanctioned load itself. Increasing the sanctioned load may be an expensive and time consuming process. Therefore, lessees must carefully determine their energy requirements before signing on the lease of an office space. Any enhancement of energy load should be notified to the lessor prior to execution of the lease deed and adequate confirmation should be obtained that the same would be undertaken within a specified time frame. Lessors may require the lessee to bear a part or all of the cost towards the increase of sanctioned load.
Energy back-up: At the same time, lessees must also ensure that the proposed premises have adequate power back-up. This is typically stated as the building having '100% power back-up', implying that the power back-up is equivalent to the full energy load of the building. Captive power generation units are common for large and even smaller office buildings and are meant to ensure smooth office operations. However drawing power from back-ups is relatively more expensive than those provided through the power grid. Therefore, lease deeds/ maintenance agreements will provide for the per-unit cost for the power provided by the back-up units, and these will be calculated using separate meters installed for the purpose.
Lease rent and security deposit: Lease deeds typically provide that the monthly rent would be payable in advance by the 7th day of each calendar month. The interest-free security deposit can be equivalent to between 3-6 months of rent. Commercial rent is enhanced every 3 years, as the lease comes up for renewal. The current market practice is to enhance it by 15% at the end of each 3 year period. The security deposit is also proportionately enhanced. Delayed payment of the monthly rent will typically incur a hefty interest. Certain lease deeds may also provide that upon repeated delayed/ non-payment of the monthly rent the lessor will be entitled to terminate the lease deed after having adjusted the outstanding amount from the security deposit. However, some lease deeds may restrict the security deposit only to damages to the premises by the lessee. This implies that the lessor will continue to have the claim in respect of the monthly rent and will not adjust the same from the security deposit.
Repair, maintenance and other obligations: Lease deeds create a distinction between the responsibilities of the lessee and the lessor in respect of repairs to the equipment and premises. The lessee is typically required to repair and maintain the fit-outs it has installed in the premises, and undertake only minor repairs to the premises (e.g. minor electrical and plumbing issues). Lessee should not attempt to repair the fire system, or the electrical system by itself, and the same is the responsibility of the maintenance agency nominated by the lessor. The lessor is also responsible for any structural or other major repairs or renovations to the building. The maintenance agency will also be responsible for the maintenance of the HVAC and other systems and equipment in the premises, including equipments and facilities provided in the common areas (e.g. lifts, escalators, power generators, common area lighting, security systems, etc.). The costs towards these are built in to the maintenance charges that are payable by the lessee over and above the lease rent.
Other obligations of the lessor typically captured by the lease deed include bearing the property tax, undertaking the insurance of the property, nominating a suitable maintenance agency and taking appropriate actions against the agency in the event of deficiency of services, and obtaining of necessary and appropriate permits and certifications in respect of the premises and equipment provided therein.
Transfer conditions: A common interest for lessees is the uninterrupted enjoyment of their office space. This is particularly so for lessees who may have spend significantly on fitting out the premises, and would not want their possession disturbed during the lease tenure. One of the manner in which this peaceful enjoyment can be hindered is if the lessor were to sell or transfer the property to a third party. Therefore specific terms should be provided in a lease deed to address this very issue. Lease terms should include that in the event of a sale or transfer of the property, the lessor shall ensure that the documentation entered into between the lessor and the third party buyer shall provide an obligation on the third party to allow the lessee to continue to be in possession of the premises under the existing terms for the duration of the lease period. This is a non-disturbance provision, and is enforceable against the third party purchaser. Pursuant to this provision, the lessor will also be required to inform the lessee of the potential sale or transfer of the property, and the third party of the terms of the existing lease. For many potential purchasers, a building already under lease presents a compelling reason to invest in such a property - i.e. for the continuing lease rentals. Therefore such third party buyers will view such a property positively, and will encourage the lessee to continue with the lease. However in the event the third party does not wish to allow the lease to continue, the lease deed should provide for adequate damages for the loss suffered by the lessee owing to such disturbance of its possession.
Force majeure: The major concern, now amplified by the ongoing Covid-19 pandemic, is in respect of force majeure provisions in a lease deed. Typical force majeure provisions are standard boiler-plate creations and cover events that are beyond the reasonable control of the lessee and the lessor. These may include any or a combination of earthquakes, typhoons, flood, fire, war, lockouts and strikes, riots, violence, tempest, acts of government or public agencies, civil disturbances, terrorism or act of god, order of government/judicial authority or any other events which cannot be foreseen, prevented or controlled.
However, force majeure conditions should also provide for instances wherein the use of the premises is prevented for any event beyond the control of the parties. Certain lease deeds may specifically provide for a full or partial waiver of lease rent in the event the lessee is prohibited from or unable to use the premises due to reasons beyond its control. The operative term is 'use' and not 'possess'. The property may remain in the possession of the lessee, but it may be prevented from using it. That is what should count. Force majeure conditions in a lease deed typically favour the lessee. In a maintenance agreement they favour the maintenance agency. However, there is an obligation on each party to ensure that they act in a manner so as to reasonably mitigate the adverse effects arising out of the force majeure condition. Even though standards may vary, but the general concept is that each party shall make commercially reasonable efforts towards mitigation of adversity.
Lessees should be careful about termination provisions that are provided in a force majeure clause. In case of significant investments made towards the fit-outs of a premises, termination of the lease may not be a viable option. In such cases it is even more pertinent to have a waiver of rent clause built in to protect the interest of the lessee.
Indemnification: In a lease deed indemnification provisions should be specific and separate for both the lessee and the lessor. The lessee may be required to indemnify the lessor for any damage to property caused to non-compliance of house rules, or in cases where the lessee uses the leased premises in a way that is contrary to the law, or the purpose for which it has taken the place on lease. Lessees may also be required to indemnify the lessor against claims made by third parties for loss/ damages suffered by them owing to the wrongful acts of the lessee at the leased premises (e.g. accidents caused due to lessees' negligence, etc.). Lessees may also be required to pay a penal interest on late payment of lease rent. Typical interest rates can vary between 12% to 18% simple interest per annum. At the same time, if the unpaid lease rent is automatically adjusted against the security deposit, lessees may negotiate to lessen or waive off the applicability of penal interest on such portion of the lease rent due.
Lessors, on the other hand, are required to ensure that the peaceful possession of the lessee over the leased premises is not disturbed during the lease term. Consequently, if for any reason attributable to the lessor the peaceful possession of the lessee is disturbed, then the lessor shall be obliged to indemnify the lessee for the same. This may include events such as inadequate right of the lessor to lease the property, non-payment of statutory dues (e.g. property tax) in respect of the property, failure to maintain the security of the building (including the structural safety of the building), or maintain adequate utility services at the building, etc.
Maintenance Agreement: In addition to the lease deed, the lessee will also be required to execute a maintenance agreement with a maintenance agency. As discussed above, the maintenance agency is appointed by the lessor for undertaking the property management and maintenance services at the building. The role of the maintenance agency is to ensure security, and maintenance of common areas and services in a building. Lessees are required to execute a separate maintenance agreement with the maintenance agency, and the agreement is co-terminus with the lease deed. Maintenance agencies may also be responsible for deploying and enforcing the house rules applicable in respect of a building. It is advisable to peruse the same prior to executing the lease deed.
The scope of the maintenance services cover the common areas, and the equipment provided therein. Common areas are areas that the lessee can use jointly with the other occupants of the building. These may include the external areas viz. porch, landscaped gardens, outdoor sitting areas, etc. or internal areas viz. foyer, halls, lifts, common toilets, passageways etc. Maintenance services will also cover the parking areas, and will include the provisioning of security services as well. The maintenance agreement may provide that the agency will be entitled to undertake the maintenance through specialised third party entities. However, at all times, the ultimate responsibility towards the maintenance should remain that of the maintenance agency.
The maintenance charges for the services are payable separately and may either be calculated on the basis of the super built-up area that is provided in the lease deed (typical for smaller properties), or on the basis of actuals plus a service fee (typical for larger properties) having multiple tenants. For newly constructed buildings the maintenance charges for the first year may be computed on per-unit-area basis. This is to allow the maintenance agency to determine the actual costs involved in undertaking the maintenance operations. Thereafter the charges are calculated on actual plus fees for the rest of the duration of the lease. Maintenance charges are typically payable in advance. While maintenance charges are subject to escalation at regular intervals, all cost-based charges are also typically subject to variation based on a rise or fall in the input costs. These are mostly costs associated with labour, fuel and energy. However, a threshold may be provided only after which a variance in charges will become applicable (typically ±20% in any year). In case of a decrease of cost, the agreement will typically provide for an adjustment in the maintenance charges for the following year/s. It is not very common for the maintenance charges once paid to be refunded. It must be noted that maintenance charges are not the same as utility charges. Utility charges are payable separately by the lessee for the utilities consumed by it within the office space.
A penalty may be imposed on a maintenance agency if they fail to restore maintenance services in a building for a long period of time (typically anything in excess of 48 hours). This penalty should be provided in the maintenance agreement.
In some cases, the maintenance agency also determines the location and specifications of signages that may be affixed on the building - typically on the façade walls. These are meant to ensure uniformity of signages, and ensuring the clean/ ordered look of a building. Lessees should understand the specifications before affixing signages as non-compliance may attract fines.
This post has been authored by Sayanhya Roy, Principal Associate with inputs from Anirudh Rastogi (firstname.lastname@example.org), Managing Partner at Ikigai Law.
Originally published June 8, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.