Jeffrey S. Johnson and Kristin N. Blenkush
For the uninitiated, commencing negotiations on a complex charter school lease can be overwhelming. These materials are intended to provide a basic overview of some of the most important provisions likely to be found in a charter school lease.
Leasing Guidelines Specific to Charter Schools
Because charter schools may not use state money to purchase land or buildings (Minn. Stat. § 124D.11, Subd. 7), gaining an understanding of basic leasing concepts is important. In addition to the general education revenue provided to charter schools, charter schools may be entitled to additional public funding through building lease aid. Under Minnesota law, charter schools may apply for building lease aid in order to rent a building or land for instructional purposes. Minn. Stat. § 124D.11, Subd. 4.
The Minnesota Department of Education reviews and either approves or denies a applications for lease aid using certain criteria specified by statute. These criteria include (1) the reasonableness of the price (the rent) based on current market values, (2) the extent to which the lease conforms to applicable state laws and rules, and (3) the appropriateness of the proposed lease in the context of the space needs and the financial circumstances of the charter school. Minn. Stat. § 124D.11, Subd 4. The department must review and approve or disapprove leases in a timely manner. Minn. Stat. § 124D.10, Subd. 17.
Charter schools are expected to make up the difference between state aid and actual rent by spending general aid funds. The rent provisions of leases for charter schools must be drafted and reviewed carefully by the charter school, as amounts received as building lease aid may not be used for custodial, maintenance, service, utility, or other operating costs.
Due to potential conflicts of interest and limitations involving “related parties,” charter schools need to pay special attention to who the landlord is under the lease. Charter schools may lease space from independent or special school boards which are eligible to be an organizer, other public organizations, private, nonprofit sectarian organizations, private property owners, or sectarian organizations if the leased space is constructed as a school facility. Minn. Stat. § 124D.10, Subd. 17.
Charter schools may not enter leases with related parties unless the related party / landlord is a nonprofit corporation under Minnesota Statutes Chapter 217A or a cooperative Minnesota Statutes Chapter 308A and the lease is reasonable. A “related party” is an affiliate or immediate relative of the other party; this includes an affiliate of an immediate relative or an immediate relative of an affiliate. Minn. Stat. § 124D.10, Subd. 23a(b)(1). The term “affiliate” means a person that directly or indirectly, through one or more intermediaries, controls or is controlled by or is under common control with the other party. Minn. Stat. § 124D.10, Subd. 23a(b)(2).
Charter school leases involving related parties must include the following statement (unless the landlord is a nonprofit or cooperative): “This lease is subject to Minnesota Statutes, section 124D.10, subdivision 23a.”
What are the “Premises”?
The lease must clearly define the exact space being rented by the tenant. Often this will include both a street address and a site plan showing a depiction of the premises, and sometimes it will include a legal description. The square footage of the premises should be included as well. From the tenant’s perspective, it is important to make sure the lease clearly defines the premises, and that the premises described in the lease matches the premises agreed upon by the parties. The tenant will also need to make sure that the premises include sufficient parking spaces, outdoor areas, and signage rights to allow the school to operate.
How long is the Term”?
There are many variables to consider in negotiating the term of the lease. In short-term leases, the tenant has the benefit and flexibility of being able to vacate, but on the other hand it may soon be faced with a decision on the desirability of moving—or that decision may be forced upon the tenant.
In a long term lease, the tenant may be able to negotiate more favorable terms, and also have the predictability of rent for the entirety of the term; but the flexibility is greatly reduced. The most appropriate term for your school will depend upon a great many factors, including whether and under what circumstances the lease can be renewed or extended.
The term of the lease is defined by stating precisely when the lease starts and when it ends in the lease. However, determining the actual commencement date of the lease is not always simple. The landlord’s ability to deliver the premises by a specified date will be affected by various factors, including, for example, situations where the premises are currently occupied and the current tenant fails to vacate before the starting date of the lease. The lease should state clearly what happens if the premises are not ready for occupancy by the specified commencement date. Further, if the premises are to be completed or remodeled prior to the commencement date, delays in construction, even those beyond the control of the owner, can impede timely delivery. These possibilities should be considered in advance, and the lease should be structured to address them.
Rent: is this a gross lease or a net lease?
The lease needs to specify exactly what is included in rent, and what items the tenant will have to pay for in addition to the rent. Most leases are gross leases, triple net leases, or fall somewhere in between. Unfortunately, not all leases will state explicitly which type they are, so you need to read the lease carefully.
A “gross lease” is generally all-inclusive, meaning that the tenant pays the landlord a flat monthly rate and the landlord is responsible for payment of real estate taxes, insurance and maintenance expenses for the building, the grounds, and all common areas. Tenant utilities may or may not be included within a gross lease, so even under a so-called gross lease, there may be add-ons or other additional charges.
In the more common “triple net lease” (also referred to as a “net lease”), the tenant pays a set rental amount to the landlord (usually referred to as “base” or “minimum” rent), but also pays a share of the landlord’s real estate taxes, insurance, and maintenance and operating expenses. For single-tenant buildings, the tenant’s “share” of these items will be 100%. The tenant needs to review the lease carefully in order to fully understand what items will be included in these expenses. The concept of “operating expenses is addressed in more detail below.
Understanding the difference between a gross and triple net lease is particularly important when comparing multiple spaces because it helps to ensure you are comparing apples to apples. And again, you need to make sure to read the lease carefully. Even in a gross lease, the tenant may be responsible for certain payments in addition to the base rent, and it is important to try to pinpoint in advance what these expenses could be.
How is Rent determined?
A commercial lease should clearly define what the rental rate will be for the entire term of the lease. In most leases, the annual rental rate increases from year to year either by a flat amount (for example, a certain percentage every year) or by reference to an exterior formula (say, in proportion to increases in the cost of living allowance).
What items are included in Operating Expenses or CAM?
A “net” or “triple net” lease will state the amount the tenant must contribute toward operating expenses (also known as “common area maintenance” expenses, or CAM) in addition to the base rent. Where specific amounts are not listed, the lease should state how such expenses are calculated. Typically, operating expenses include items such as the cost of snow removal, security for the property, landscaping, janitorial services, ongoing building maintenance, and building management fees. The simplest and most common method for determining a tenant’s share of operating expenses is to divide the number of square feet in the tenant’s premises by the total number of rent-able square feet in the building. Of course, commercial leases do not always handle things in the simplest manner, so the allocation of operating expenses should be reviewed carefully.
It is a good idea for the tenant to obtain information in advance from the landlord about the current budget for the building so that the tenant has an idea of what to expect for operating expense charges. The tenant may also request and negotiate that the landlord impose a cap on the amount that can be charged as operating expenses, or a cap on the increase in any given year, so that there is some additional stability in predicting rental amounts.
Tenants should generally seek to limit the operating expenses to those costs which truly relate to common areas of the landlord’s property. On the other hand, landlords will want this language to be as expansive as possible so that they can pass as many of their expenses as possible on to the tenant.
It is also worthwhile to negotiate an exclusion from operating expenses for capital expenditures. Tenants should negotiate this provision to provide that capital items will be amortized over their useful life, with the tenant paying only the portion of the expense that falls within its lease term.
Use: what can you do in the Premises?
The lease should specify what the tenant can and cannot do in the premises. As a tenant, you will need to make sure that your proposed “use” has been specifically approved by the landlord in the lease. Any unusual or out of the ordinary activities should be included in the “use” so that the landlord is aware and cannot claim a breach later when such unusual use is discovered.
Who is responsible for maintenance, repairs and replacements?
The lease should clearly define who is responsible for repairs in the premises, the building, the parking lot and the core structural building systems, such as plumbing, electric, heating, ventilation and air conditioning. The question here is not only who pays for the repairs, but who is responsible for making sure the repairs are made in the first place. In commercial leases, typically the tenant maintains the interior of the premises and any core building systems to the extent they are located within the premises, while the landlord maintains the structure of the building, the roof and the general mechanical systems of the building.
Who is preparing the premises for occupancy, and who is paying for such preparation? What if the tenant desires alterations later?
Prior to moving in and opening for business, the premises may require renovations in order to suit the tenant’s use. If any renovations are to occur, the lease should state whether the landlord or the tenant will make improvements to the premises. When the landlord pays for the improvements, the amount spent by the landlord is usually called an “allowance.” If improvements are contemplated, the lease must clearly state what improvements will be made, who will complete the improvements, when the improvements will be complete, the amount of any allowance, and when and under what conditions the allowance will be paid.
A related question is what alterations the tenant will have the right to make to the premises, and whether the landlord’s consent will be required prior to making such alterations. For the tenant’s convenience, non-structural alterations such as painting or installation of carpet should not require the landlord’s consent. One way to address this issue is to set a monetary threshold which provides that prior to meeting the threshold, consent is not required. Some leases provide, for example, that no landlord consent is required for non-structural alterations which do not exceed a certain amount, and that anything exceeding that threshold would require landlord consent.
These provisions should also identify which party will be responsible for removal of the improvements at the end of the lease term. This removal may be an expensive budget item and should be considered at the time the improvements are made.
Will there be a Renewal Option or an Expansion Option?
Commercial tenants often negotiate a right to renew or extend the term of the lease beyond the original term. If the lease does not include such an option, the tenant’s rights will not be superior to the rights of any other prospective tenant, and the tenant will certainly have to pay the going rate for a renewal. Options of renewal are usually at an increased rental rate.
Some leases provide that the renewal term will be at “market” rent. From the tenant’s perspective this is usually less favorable. If the rental amounts are chosen in advance, but market rent turns out to be lower, the tenant has the option of simply not exercising the renewal option or negotiating a lower rate. If the rental amounts are chosen in advance, and market rent turns out to be higher, the tenant gets the benefit of the lower rate. Conversely, if the renewal option just states that the renewal will be at “market” rent, the tenant is subject to the whims of the real estate market. Further, if the tenant exercises the option, and then the “market” rent determined by the landlord is much higher than the tenant expected, the tenant should have the right to rescind its exercise of the option.
It is also important to pay attention to how the option is exercised. For example, the lease may provide that the tenant must give notice six months or a year in advance in order to exercise the option. If the tenant forgets to give such notice, the lease may expire at the end of the original term, or the lease may be extended automatically in the absence of advance notice by the tenant. Consider your options carefully when negotiating a renewal option to make sure that you are not getting locked into a renewal term when you thought the lease was ending.
In multi-tenant buildings, tenants may negotiate a right to expand into additional space should extra space become necessary for the tenant’s operations. If you anticipate rapid growth, it would be worthwhile to consider an expansion option, rather than face a decision to relocate after a short period of time.
What rights will the tenant have to sublet or assign the lease?
There are many benefits to a tenant in incorporating a flexible right to sublet or assign the premises in the event the space is no longer needed. The right to sublease offers some flexibility in the event of unforeseen circumstances—either good or bad. A right to sublease or assign is usually restricted at least to the extent of requiring the consent of the landlord. This restriction is not objectionable if it includes the caveat that the permission will not be unreasonably withheld. Even then, there can be disputes over what is “reasonable.” Most landlords will require that the subtenant or assignee meet the same standards as the other tenants in the building and accept all the restrictions included in the original lease.
If the premises are subleased or assigned, the landlord may require that the original tenant remain responsible for the lease payments. If the new tenant defaults, the original tenant will be liable for the rents. It is worthwhile to negotiate this provision with the landlord, and to request that if the replacement tenant is strong financially, that the original tenant will be released from responsibility under the lease.
Where the lease is silent on the rights or restrictions regarding subleasing, tenants have the right to sublease the premises or assign the lease as a matter of contract law. Usually, landlords will want to limit such assignments or subleases to situations where the landlord has consented in advance to the transfer.
What Security will the landlord require?
There are three common methods that landlords use to secure the payment of rent under the lease: security deposits, letters of credit, and personal or corporate guaranties. Security deposits are the most common. The amount and extent of security required will vary depending on numerous factors, including the tenant’s financial history, whether the landlord is providing a free rent period or substantial construction allowance, and the number and strength of the guarantors.
The amount and type of the security required will generally depend on the creditworthiness and operating history of the tenant. It is not uncommon for a landlord to require some combination of the three. From the tenant’s perspective, it is best to reduce exposure on the security by negotiating a small deposit or letter of credit, or by capping the liability under the guaranty.
If the landlord insists on a large security deposit or letter of credit, or an unlimited guaranty, another option is to negotiate reductions in the amount of the security over the term of the lease. The landlord’s risk decreases as the term of the lease progresses, so some landlords will agree to reduce the security periodically throughout the term so long as the tenant has not been in default. Note that unlike residential leases, landlords have no responsibility to return interest earned on the security deposit to the tenant at the end of the lease term.
Who is responsible for compliance with the law?
Tenants should seek warranties from the landlord that the premises are in compliance with all laws, including environmental laws, local codes, and the Americans with Disabilities Act. Landlords will typically try to push this risk back to the tenant. A standard compromise is that the landlord is responsible for compliance (and the cost of compliance) with all laws affecting the premises and existing as of the commencement date of the lease, and that the tenant becomes responsible for such compliance from and after the commencement date.
What happens if there is an interruption in utility service?
Most tenants will not be able to function when utility services such as water or electricity are interrupted. Tenants should try to negotiate a lease provision stating that if such an interruption is caused by the landlord, the tenant shall have the right to abate the rent until it is restored. A standard compromise here is to give the tenant the right to abate rent after the utility service has been continuously interrupted for a given period of time (so that short interruptions are not grounds for a rent abatement). When considering the possibility of such interruptions, it is also a good idea for the tenant to consider business interruption insurance (and this is often required by the landlord).