In today’s post, the tenth in our series “The ABCs of Commercial Real Estate Leases”, we pick up right where we left off with our discussion on Lease Clauses with a look at common clauses that begin with the letters I- M.

Insurance

The Landlord typically requires the Tenant to carry various forms of insurance, often in specific amounts or limits. Types of insurance that may be required include, but are not limited to:

  • Liability
  • Workers’ Compensation
  • Employers’ Liability
  • All Risk/Casualty Insurance
  • Business Interruption Insurance
  • Automobile Insurance

Dram Shop Insurance

Some tenants, most often restaurant operators, will be required to maintain Liquor Liability Insurance, often called “Dram Shop” insurance. Dram Shop insurance provides coverage for dispensers of alcoholic beverages against lawsuits arising out of bodily injury and/or property damage caused by its customers to a third party. A lease may also provide the Landlord’s insurance requirements.

Typical Commercial Real Estate Insurance Coverage

Liability: Comprehensive general liability insurance on an occurrence basis in the amount of $3,000,000 combined single limit, or a higher amount as the Landlord may require Workers’ Compensation in accordance with statutory law.

Employers’ Liability: No less than $100,000 per employee and $500,000 per occurrence.

All Risk/Casualty: Full replacement value on all additions, improvements and alterations to the Premises. Business Interruption: Loss of Rent coverage equal to 12 months.

Automobile Insurance: Comprehensive Automobile Liability insuring bodily injury and property damage, with minimum limits of $1,000,000 per accident.

Important Information to Look For In Insurance Clauses

  • Type of Insurance
  • Amount of Insurance
  • Is the Tenant required to self-insure?
  • Can insurance amounts be increased by the Landlord?

Late Fees/Interest

A charge assessed against a tenant for failing to pay rent when due. A Late Charge is typically a one‐time charge calculated as a specific dollar amount or a percentage of the amount due. In addition to or in lieu of a Late Charge, a lease may contain an interest provision, whereby the tenant is required to pay a specified interest rate on the amount due from the due date until the date paid.

Example of A Late Fee Clause

ABC Tenant’s lease allows the Landlord to charge a) a Late Charge equal to 5% of the amount due for any Rent unpaid for greater than 5 days from the due date; and b) interest equal to the current Prime Rate plus 2% for any unpaid Rent from the date due until the date paid. ABC failed to pay its Base Rent of $10,000, which was due on March 1st, until March 21st. On the next rent invoice to ABC, the Landlord included a Late Charge of $500 for March rent and an Interest Charge of $54.79, assuming a Prime Rate of 8% (calculated as $10,000 x 10% = $1,000 x 20/365).

Important Information to Look For In Late Fee Clauses

  • Amount
  • Rate
  • Number of grace days and notice requirements, if any
  • Waiver of Late Fee on one or more occasion within a specified period

Leasing Commissions

A fee paid to the leasing broker upon the successful execution of a lease agreement. In many cases, the broker’s commission is calculated as a stated percentage of the negotiated Base Rent, with the percentage often determined by the geographical market in which the real estate is located. The calculation mechanics of a commission are often not included within a lease, but rather within a separate Commission Agreement or Brokerage Agreement entered into between the broker and the landlord. While a lease rarely provides the mechanics of the commission calculation, and in many cases, the lease is old enough that the payment has been made already, it is important to know the names of the brokers should future obligations arise in the event of a renewal or expansion.

Example of A Leasing Commission Clause

ABC Tenant hires MNO Brokerage, Inc. to negotiate its lease at Realogic Tower. MNO successfully negotiates a lease with the Landlord, and pursuant to a separate Commission Agreement, is entitled to a leasing commission equal to 5% of Base Rent for the initial five years of a lease term and 2.5% of Base Rent for any years in the term greater than 5 years. The lease with ABC is a 10‐year lease requiring Base Rent payments of $100,000/year for years 1‐5 and $150,000/year for years 6‐10. MNO Brokerage would be entitled to a leasing commission equal to $43,750 [($100,000 x 5 x .05) + ($150,000 x 5 x .025)].

Important Information To Look For In Leasing Commission Clauses

  • Broker’s name and which party it represents
  • Amount of commission, if provided

Letter of Credit

The agreement of a bank on behalf of a customer to honor drafts or other demands for payment upon compliance with the conditions of the letter of credit. As they relate to leases, tenants are often required to post letters of credit in lieu of or in addition to cash security deposits as security for the payment of rental obligations to the landlord. A term that often arises in regard to Letter of Credit is “evergreen”. This refers to the expiration date of the Letter of Credit. If a Lease requires an “evergreen” Letter of Credit, that is one which has an expiration date but contains a provision that states it may be automatically extended for an indefinite number of periods until the issuing bank informs its beneficiary (the landlord) of its final expiration.

Example Of A Letter of Credit Clause

As a condition of leasing space in Realogic Tower, ABC Tenant is required to provide a $100,000 letter of credit as security for lease obligations over the five‐year lease term. The lease provides that the letter of credit may be for a one‐year term, renewable annually with the issuing bank. During the third year of the lease term, ABC defaults on the payment of its rental obligations in the amount of $55,000. The landlord notifies the issuing bank and exercises its right to draw on the letter of credit to cover the $55,000 of lost rental.

Letter of Credit vs Cash Security Deposit

Assuming sufficient collateral or the creditworthiness of the Tenant or a guarantor, the Tenant may have its bank issue a letter of credit (LOC) to the Landlord to secure the Tenant’s obligations under the lease. If the LOC is large enough, the Landlord may enter into a lease with a Tenant, such as a startup company, that the Landlord would otherwise refuse because of the Tenant’s lack of creditworthiness. From the Tenant’s perspective, a LOC may be preferable if the required security deposit is large. A LOC will not tie up large amounts of the Tenant’s cash. Cash that would otherwise be pledged as a security deposit can be used as working capital in the Tenant’s business. Also, the credit of the LOC’s issuer stands behind the obligation of the tenant. If the Tenant is insolvent and/or bankrupt, the issuer still must honor the beneficiary’s draws on the LOC.

Important Information To Look For In Letter of Credit Clauses

  • Type: Cash or LOC?
  • Interest bearing? (Note rate of interest and frequency of payment)
  • Scheduled reductions, if applicable
  • Substitution rights, if any
  • Form of LOC, if a specific form is to be used
  • Landlord’s timeframe to return deposit to the Tenant upon expiration/termination

And that covers common Lease Clauses that start with the letters I – M. In case you missed it, we covered the letters A – C and D – H in previous posts. Other topics we’ve covered in our “The ABCs of Commercial Real Estate Leases” series include Lease Basics, Gross Leases vs Net Leases and Operating Expense Inclusions and Exclusions.

If you’d like to learn more about commercial real estate leases, we offer a training class called “Understanding Commercial Real Estate Leases” that covers all the essentials. It’s perfect for those who are relatively new to real estate and looking to learn more about leases, or for someone more experienced who is looking for a thorough refresher course taught by an experienced commercial real estate professional. We also offer a course on lease abstraction, for those who want to learn or polish that skill.

By Terry Banike, Marketing Manager, Realogic