Tenant Leasing Illustrated
February 2013
Issue #13



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Madison Park
Hello,

The most effective way for a tenant to protect itself with respect to an operating expense escalation is to conduct a lease audit. In today's newsletter, we talk about four issues that you should address in your lease to maintain your ability to conduct lease audits with auditors that will be best able to provide this protection.

Sincerely,
Alan
Alan Katz
Mintz & Gold LLP 

 

You Cannot Win When Auditing the Harlem Globetrotters

 

I have always enjoyed the tricks and banter of the Harlem Globetrotters since back in their Meadowlark Lemon days.

Although known for comic basketball, some great players have played for the Globetrotters (e.g., Wilt Chamberlain and baseball star Bob Gibson) and the team played an historic role in helping break the color barrier when they twice defeated the NBA champion Minneapolis Lakers in exhibition games in the late 1940's.

Usually, the Globetrotters play their foils, the hapless Washington Generals (also known as the Boston Shamrocks, New Jersey Reds and other names), who in one forty year span lost to the Globetrotters more than 13,000 times. That almost sounds like my NY Mets!

What a luxury; unlike the rest of us, the Globetrotters get to pick their opponent! Nobody else is so blessed.

Hmmm, wait a moment. Is that correct?

Landlords often place limitations on a tenant's ability to conduct a lease audit by requiring that the tenant's lease auditor meet numerous requirements. In effect, they try to make the tenant pick the Washington Generals to do their lease audit.

As we have written in the past, a common rent escalation is to charge tenants their proportionate share of increases in the building's "operating expenses" over an agreed upon base year. The idea is to protect the landlord from rising costs over the term of the lease.

All seems very fair in theory. But the way "operating expenses" is defined and paid under the lease often results in operating expense escalations becoming an undue profit center for the landlord.

That is why so much time is spent negotiating the definition of operating expenses. But even after a hard fought negotiation that results in a favorable escalation clause for the tenant, operating expenses still can remain a large profit center for landlords.

How can this be?

Shhhh, I will let you in on a little secret. Most landlords do not ever read the operating expense provision when they invoice tenants for operating expenses.

Okay, okay, I realize that most people do not ever read any part of the leases we draft if they can avoid it, but in this case it makes sense.

In a building with multiple tenants and multiple operating expense provisions, it would be just plain inefficient to address each tenant's provision and most landlords and their management companies bill all of their tenants in the same manner.

How do tenants protect themselves? By conducting regular or semi-regular lease audits, and a decent lease will allow tenants access to landlord's books to conduct such audits and some dispute resolution process to address overpayments (and perhaps a return of the tenant's costs for more egregious errors).

A good lease auditor can make a huge difference - we have had clients whose auditors discovered errors in the six and even seven figures!

Landlords realize this and try to limit who can conduct the audit. Protect your right to an effective lease auditor by addressing the following four issues:
  • Do not allow the lease to restrict you to a firm of certified public accountants. Accountants do not necessarily have any particular expertise in reviewing lease operating expense provisions and are likely to have a junior person without commercial leasing experience review your lease. Make sure that your lease allows you to use a reputable lease audit firm.
  • Avoid restrictions on contingency fee arrangements. Landlords claim that lease auditors paid on a contingency fee basis go on "fishing expeditions" since they are paid based on a percentage of the actual savings. So what? If the lease's operating expense provision is being properly administered, the landlord should have nothing to fear. I have never understood the logic behind this landlord position (other than to limit the value of lease audits), although you should realize that landlords will often dig in their heels on this issue and it can be a point that is very tough for anyone other than the largest tenants to win.
  • Consider employing your lease auditor as a consultant. Even if you have no choice but to agree that the auditor reviewing the landlord's books will be an accounting firm that is not paid on a contingency basis, there should be no limit on any consultants that you retain to provide general advice or how they are paid. This means that the lease auditor cannot be on the front lines negotiating, but it can be providing background expertise to level the playing field for your accounting firm and/or attorneys.

    If the landlord does not permit a contingency arrangement, also make sure the lease permits your employees the right to review Landlord's books and records.
  • Consider "special ops" approaches. If you do not have the leverage to win some of the rights referred to in the bullet points above, take heart in that there are ways to avoid the weaknesses in some lease audit provisions while still remaining in technical compliance with your lease.
    • Many accounting firms have relationships with lease audit firms or would be willing to start a relationship with the lease auditing firm of your choice.
    • Some lease auditing firms are becoming accounting firms or at least developing accounting practices to avoid these common lease restrictions. Make sure that your lease does not limit you to particular accounting firms (e.g., "big four" firms or firms with over a certain number of partners, etc.).
    • You can agree to pay your lease auditor on an hourly basis and make up for large savings with a performance bonus that will get you both to the same place. This has the downside of requiring you to incur fees even if the auditor is unable to find any problems (just as the landlord wishes), but allows you to use a top tier lease auditor. Most lease auditors will not agree to this arrangement unless you have a long-standing relationship since they likely will not want to rely on your graciousness in providing a bonus.
Avoid being the Washington Generals when it comes to your lease audit by following these suggestions. Now, I have to excuse myself and go practice my half-court hook shot.

About Us

 

Mintz & Gold prides itself on providing the highest quality legal representation often associated with large law firms with the attention and reasonable costs of a smaller law firm.  Mintz & Gold's Real Estate Department has a national practice specializing in a broad range of commercial real estate law, with a particular focus on commercial leasing. We have extensive experience with respect to office, retail and shopping center leasing, and have represented major Manhattan landlords, national and multinational institutional tenants and national retail chains. Most of our attorneys practiced for many years at large institutional law firms before joining Mintz & Gold.

For more information regarding Mintz & Gold's real estate practice, click here.

For a list of representative transactions of Mintz & Gold's real estate group, click here.

For Mintz & Gold's website, click here.

Contact:
Alan Katz
katz@mintzandgold.com
Telephone: (212) 696-4848
Fax: (212) 696-1231



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This newsletter has been prepared for general information purposes only, and is provided with the understanding and subject to the user's agreement that it does not constitute the rendering of legal advice or other professional advice by Mintz & Gold LLP, and does not create any attorney-client or other special relationship. The content of this newsletter may be considered advertising under the ethical rules of certain jurisdictions and prior results do not guarantee a similar outcome. You should not rely upon this newsletter without seeking legal advice from an attorney licensed in the relevant jurisdiction(s). THE CONTENT OF THIS NEWSLETTER IS PROVIDED AS-IS WITH NO REPRESENTATIONS OR WARRANTIES, EITHER EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NONINFRINGEMENT. Additionally, the information contained in this newsletter does not constitute tax advice. Any discussion of tax matters contained in this newsletter is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter.

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