Legal Considerations
When it comes to a physical location/real estate, there are many legal considerations. Consider the tax requirements, water or environmental restrictions, and any nuisance laws. These can vary significantly and warrant your attention but here I will focus primarily on leasing and zoning.
Consider the client who wants to open a shop (or in my former client’s case – a bookstore) and they have decided that they would like to rent space in a strip mall. The zoning is already taken care of most likely (but inspections will still need to be done).
If your client wants to set up shop in a historical district, there will be more restrictions they will need to consider, such as rules regarding signage and renovations.
Leasing Property
Think about the lease agreement. These documents can be voluminous and contain language that you have never seen. Are any provisions negotiable? Some will be but there will likely be some that are not. Also, take stock of what kind of negotiating power you may have. Small, local businesses don’t have as much negotiating power as say Walmart or Sheetz. However, how much negotiating power you have can also depend on how many other places are currently available. Regardless, negotiating a lease takes considerable time so your client should be advised of such. If your client is in a hurry, then that will deflate your negotiating abilities too as you may need to concede provisions to move things along.
When reviewing a potential lease, my first step was to list all of the requirements that my client would be subject to during the duration of the lease. Once I had the list, I could talk to the client and see which things we needed to negotiate. Keep in mind that the lease that you are reviewing is very one-sided toward the landlord, so be on the lookout for things that you may want/need to negotiate. Some common terms are:
- Hours of Operation – If the lease is for retail space, it will likely have an operations covenant. In a mall setting, the landlord will want to have your client’s shop open when other shops in the mall are open. As such, it is common to have a section outlining what those hours are. But what if your client needs to close for some reason like repairs, renovations, remodeling, holidays, force majeure, weather, fire, pandemic, etc.? It’s important to address the ability to close (not meet the hours of operation covenant). If there is no language in the lease that addresses this, your client would be in default of the lease. As such, be sure you propose language to be included.
- Permitted Use – The lease will outline the permitted use of the premises. You will want to be sure that the scope isn’t written too narrowly. For instance, if my bookstore client’s lease said the permitted use was for a “children’s bookstore” but the entrepreneur wanted to expand and have books for all readers, then technically they could be in breach of the agreement. What if my client wants to sell toys and stuffed animals too?
- Exclusivity – Your client may want an exclusivity clause. This means that the landlord cannot rent out space to another lessee that will compete. For my bookstore client, we required that the landlord not be able to rent space in the strip mall to another bookstore. Together with this requirement we included remedies if this clause was breached: injunction, terminations of the lease, monetary damage, etc.
- Lease Term & Out Clause – The lease term is pretty much always negotiable. Commercial leases are for a lengthy duration, and many will have automatic renewal terms. This is great if the entrepreneur is successful and wants to remain in this location, but it is not great if the business fails or needs to shut down business before the end of the term. To protect your client, you need to negotiate the out clause (the clause that allows your client to get out of the lease early). Many out clauses will require the entrepreneur to be personally liable for the remaining lease payments if the business fails and cannot pay. Watch out for this and negotiate a way to avoid it. It will depend on the client’s business what you come up with here. Failing to pay or leaving early is a default so be sure to look at what all of the fees are that will be incurred if one occurs.
- Common Area Maintenance Costs – These are known as CAM and are part of every commercial lease. They require each tenant, including your client to pay a portion of the CAM costs (sometimes including building insurance and taxes). CAM costs examples are electricity for the parking lot lights, snow removal, landscaping, etc. Read the CAM costs provisions carefully so you can report them to your client. These costs are usually tacked onto the rent so your client will need to budget for these added costs.
- Additional Space Option – If your client thinks they may need additional space in the future, you may want to negotiate a right of first refusal if additional space becomes available. If you have this option built in, then the landlord has to offer adjacent space to your client before third parties.
- Assignment/subleasing – On the other hand, maybe your client will want to get out of the lease but the out clause is not friendly. We will want to be able to assign the lease, or sublease it, to someone else. Often the landlord won’t allow this without its consent but watch out for other requirements and be sure there is no prohibition. What if your client gets bought out by another company that wants to continue the business there?
- Indemnity – Watch out for the indemnity clause! Often lease agreements will provide for indemnification of the landlord if there is a claim for personal injury or property damage in the leased space. This means that if someone gets hurt in your client’s store, and the injured party sues you and the landlord, you will have to indemnify the landlord. In my experience there is no indemnity clause going the other way however. Negotiate one! Your client does not want to be liable for claims for injuries that occur in common areas or even in their space due to landlord negligence.
- Default provisions – Remember to closely scrutinize these provisions. What is considered default by your client and what happens when the default occurs? The lease will cover this in detail and in a manner that is very landlord friendly. Does your jurisdiction allow the landlord to lock out the tenant if they fail to pay rent? You and your client need to know these things. Also, you have to negotiate or include landlord default provisions as well. The landlord can default by failing to do something the lease required or breaching a legal duty to your client. What remedies will your client have if the landlord breaches?
Zoning
The following information and story were provided by Dickinson Law alumnus, Attorney Esch McCombie, McNees Wallace & Nurick LLC. He is one of my former students and my go-to for all things zoning related.
Zoning and permitting are often forgotten when an entrepreneur wants to set up shop, but they are incredibly important pieces to the puzzle. Seasoned business owners know that failing to secure the necessary zoning approvals and use permits will, at a minimum, delay an opening and, at worst, sink a fledgling business. Unfortunately, most entrepreneurs do not conduct the necessary zoning and permitting due diligence before entering into a lease or signing an agreement of sale. As a result, the deficiencies often are brought to light after much time and money have already been spent. The following is a story about an eventual client of mine – we’ll call him Bill. Bill’s story illustrates the problems that can arise if a business owner fails to conduct zoning and permitting due diligence early in their planning process.
Some years ago, Bill entered into a lease with a landlord for a brewery and brew pub. At the time, craft breweries were new in the region. Bill was going to renovate a very old brick warehouse into a beautiful pub. The renovation would cost tens of thousands of dollars and take many months because Bill had a day job and could only renovate on nights and weekends. The lease did not account for the time required to secure the necessary permits and approvals nor did it make it clear who was responsible for certain improvements that might be required to secure the permits or approvals. As a result, Bill began paying rent immediately – before he determined (a) whether the use was permitted and (b) whether building improvements (e.g. updates for safety, accessibility, etc.) were required.
A few months after signing the lease and beginning the renovations, the municipality informed Bill that bars were not permitted in the zoning district. Having already put thousands of dollars into renovations, Bill felt he had no choice but to try to secure zoning relief. In this instance, we were able to help Bill work out a favorable interpretation with the zoning officer. Based on the interpretation, Bill secured a determination letter that the use was permitted. Although we were able to do that for Bill, the legal fees were not expenses he had budgeted for the project. Bill was lucky, though, for he would have been out all of the costs of the renovations, and without a usable business location, had we been unable to secure the zoning relief he needed. (Most attorneys bill at an hourly rate and the time required to secure a favorable determination letter is significantly less than other options to address a zoning issue. For example, the zoning officer initially informed Bill that the path forward would be a public hearing before the zoning hearing board. Those hearings are legal proceedings and, while one may proceed without legal representation, it is highly discouraged. Had Bill required counsel for the hearing, his legal fees would have been in the thousands of dollars and probably in excess of $10,000.)
Three or four months later, the building inspector came to inspect the electrical work. He mentioned to Bill that the building would need to be sprinkled (i.e. have sprinklers installed). The cost to sprinkle the building was in the $250,000 range. Although the lease was unclear, the property owner agreed to install the sprinklers because of their permanent nature. But it was a large cost requiring financing and he planned to sprinkle another (more profitable) building first. As a result, Bill’s pub probably would not be sprinkled, and therefore could not open, for another four to six months. Bill was going to be a year into his lease and still not have an open brewery and pub. He was out of funds. He was frustrated. He decided to close up shop.
Had Bill conducted some due diligence in advance, he likely would have been made aware of both the zoning issue and the need to sprinkle the building. With that knowledge, he could have (a) added legal fees to his budget, (b) incorporated an “out” in the lease in case he could not secure zoning relief , (c) clarified whether Bill or the landlord would pay for the sprinklers, and (d) negotiated a reduction or elimination of rent payments until a certificate of occupancy was secured (i.e. the time at which all approvals and permits have been secured).
A few takeaways from Bill’s story in the form of advice for entrepreneurs:
- Don’t sleep on municipal, county or state approvals and permits. Reach out to the governing body, county, and applicable agencies early to create a good rapport and to determine what approval or permits are needed, if any, to open your business. If you can afford it, hire an attorney to do that for you because they will know what questions to ask, what statutes and ordinances to review, and how to potentially interpret those laws in your favor. The cost of hiring a professional early, rather than when your back is up against the wall, will likely save you much more than what you pay them.
- Budget reasonable time and expenses for your project. In Pennsylvania, securing a zoning permit, building permit or certificate of occupancy usually takes between a week and a month if all is in order from the start. However, there are times when one permit must be secured prior to requesting another. Zoning relief can take longer. A favorable zoning interpretation can be secured in a week or a few weeks. But if you need relief that requires a hearing, plan for a minimum of 90 days, and be prepared for 120-180 days or more. If the project has opposition, extended hearings and legal appeals of approvals can easily stretch to 8-12 months or more.
- Based on your budget and timing, an attorney will want to incorporate provisions into the lease or agreement of sale that protect the entrepreneur in case they need (or cannot secure) the necessary approvals or permits.
- Based on permitting needs, an attorney will want to incorporate provisions into the lease or agreement of sale that address who will pay for the improvements, dates by which the improvements must be completed, and rent abatement until the necessary approvals and permits are secured.