The Comprehensive Letter of Intent:
A Key Tactic for Maximizing Tenant Favorable Market Conditions
By Pamela V. Rothenberg and Christopher M. Iavarone | Womble Carlyle Sandridge & Rice, LLP
Pamela Rothenberg
[email protected]
202.857.4422
Christopher Iavarone
[email protected]
202.857.4539
Pamela V. Rothenberg and Christopher M. Iavarone are real estate attorneys
in the Washington, DC office of Womble Carlyle Sandridge & Rice, LLP,
where they represent many tenants, including high growth companies, in
their commercial real estate and lease transactions.
Landlords and tenants often forego a detailed letter
of intent and go “straight to the lease” in an effort to
streamline and expedite their office leasing transactions.
However, that approach can actually have the opposite
effect. When parties do not take the time to accurately
reflect in a letter of intent their agreement on the key lease
terms, they often face more protracted and contentious
negotiations. More importantly from the tenant’s
perspective, by taking time at the letter of intent stage to
delineate its “must have” terms of the lease transaction,
a tenant enhances its ability to achieve key economic
and other material terms. This is particularly important
in today’s tenant favorable leasing market where a well
written and comprehensive letter of intent can aid the
tenant in confirming from the outset that a landlord will
be accommodating on the essential lease terms required
by the tenant.
This article outlines the key terms a tenant should
endeavor to include in any letter of intent for the leasing
of office space.
Economic Terms:
At a minimum, a letter of intent should summarize all
of the material economic terms of the lease, including
the lease term, annual and monthly base rent, the rate
at which rent will escalate during the lease term, and
any associated rent abatement. It should also reflect
the amount of advance rent and the security deposit to
be paid by the tenant at lease execution, whether the
security deposit may be posted in the form of a letter of
credit, and whether the security deposit will “burn off”
(i.e., be reduced) over time based on the tenant’s faithful
and timely performance of its obligations under the lease.
The landlord should confirm in the letter of intent the
amount of any test-fit allowance and tenant improvement
allowance it will make available to the tenant to plan and
build out tenant’s space, and whether the tenant has any
rights to apply any portion of the tenant improvement
allowance against other expenses, such as furniture,
fixtures and equipment, cabling, moving expenses or
future installments of base rent payable under the lease.
A letter of intent should also specify the proportionate
share of the building’s expenses (i.e., the tenant’s share
of property taxes, insurance premiums, and building
operating expenses including common area maintenance
charges) that the tenant will bear on either a full service
or triple net basis. Building expenses should be grossed
up to 95-100% occupancy. Where feasible, the tenant
should request an annual cap on increases in controllable
operating expenses to be borne by the tenant as well as
on the management fee to be charged by the landlord’s
property manager. The tenant should request that the
landlord provide a general estimate of the anticipated
amount of additional rent that the tenant will be required
to pay during the first year of the lease term. This will
enable the tenant to prepare a budget for its total leasing
costs for the space.
If any principals or affiliates of the tenant will be required
to guarantee the tenant’s obligations under the lease, this
1
should be reflected in the letter of intent, together with
any terms limiting or terminating the guaranty obligations
after the tenant has performed without default under the
lease for a certain period of time.
The Premises:
A letter of intent should specify the rentable square
footage of the leased premises and the building, the
associated calculation of the tenant’s proportionate share
of operating expenses and real estate taxes, and the
method used by landlord to measure rentable square
footage. Typically, this will be the Building Owners
and Managers Association Office Buildings: Standard
Methods of Measurement (ANSI/BOMA Z65.1-2010).
The letter of intent should specify whether the building
is LEED certified and if the tenant intends to pursue
LEED certification for the premises. If the tenant has
any special uses or security needs relating to the tenant’s
intended use of the premise, beyond the typical general
office purpose, these uses should be specified in the letter
of intent. Likewise, if the tenant has any specific use
issues that may affect the premises (i.e., a need for cell
phone boosters, satellite dishes, roof rights, riser rights, a
generator or plans to install heavy equipment that would
exceed the floor load capacities of the building), these
needs and the associated landlord imposed requirements
should be included in the letter of intent.
If the tenant is not accepting the premises in its “as is”
condition on the lease commencement date, the letter
of intent should detail who will be performing the
build out of the tenant improvements, the schedule
for tendering the premises for the commencement of
the associated construction work, and the timing for
substantial completion of the premises. Any construction
management fee or other consulting fees to be charged
by the landlord for the tenant improvement work
(including, optimally, an affirmative statement that none
will be charged) should also be addressed in the letter of
intent.
Coordination of the construction schedule for the tenant
improvements (or the date of tender if the tenant is
accepting the premises “as is”) with the tenant’s needs to
occupy the space is mission critical. The letter of intent
should specify an anticipated schedule and the remedies
available to the tenant if the landlord materially misses
the targeted completion date or date of tender. Rent
should abate for all periods during which the tenant is
not in possession of the space. In addition, the tenant
should specify in the letter of intent additional rental
abatement to accrue on a day-for-day basis for each day
of such delay, to be applied to the period after the date of
tender, as well as a termination right if the premises are
not delivered by a stated outside delivery date.
Rent commencement customarily occurs when the
premises are tendered to the tenant after the tenant
improvement work is substantially complete (when
the landlord is constructing the improvements) or
by a date certain (when the tenant is constructing the
improvements). The letter of intent should include
provisions that ensure that rent does not commence
sooner than anticipated by the tenant. For example,
if the tenant improvement work may be completed
sooner than the tenant is ready to begin paying rent, the
letter of intent should include a “no earlier than” date
for the commencement of rent irrespective of when the
completed premises are tendered to the tenant.
Subject to an annual monetary cap, a tenant should be
entitled to perform non-structural or cosmetic future
alterations to the premises without the consent or
approval of the landlord.
Lease Flexibility:
To maintain maximum flexibility to address both
anticipated and unforeseen changes in its space needs,
the tenant should include terms in the letter of intent
outlining the tenant’s assignment and subletting rights,
expansion and contraction options, lease term renewal
rights and, where achievable, early lease termination
rights. Although assignments and subleases are typically
conditioned upon landlord’s approval, the landlord
should not be permitted to unreasonably withhold,
condition or delay its approval for the same. Any sublease
or assignment profit (net of all associated costs incurred by
the tenant) should be shared equally between the landlord
and the tenant. Depending on the tenant’s strategic space
plan, the tenant may wish to limit or eliminate landlord’s
customary right to recapture the proposed sublease or
assignment space. The tenant should consider including
2
in the letter of intent express rights to consummate
merger and acquisition transactions (including IPOs), to
sublease or assign the lease to its affiliates or to enter into
office sharing arrangements with its strategic business
partners without the landlord’s approval.
If the tenant foresees a need for additional space during
the lease term, the letter of intent should include premises
expansion rights and a right of first opportunity in
favor of the tenant to negotiate for the additional space,
whether contiguous or not, that becomes available in
the building during the lease term. The rent payable for
expansion space, which is often based on the landlord’s
determination of the prevailing fair market rental rate for
such space, should also be specified.
The letter of intent should include renewal rights that
permit the tenant to continue leasing the premises
following the expiration of the initial lease term. The
economic terms of the lease for the renewal period,
including base rent, the rate at which rent escalates,
and the tenant improvement allowance should be reset
during any renewal period based on the prevailing
market economic terms for comparable leases in similar
buildings. If the landlord and tenant cannot agree upon
these renewal terms, the letter of intent should provide
that they will be established based upon a “three-broker”
method.
If the tenant anticipates that during the lease term it may
require more space than is anticipated to be available in
the building (based on the building’s lease stacking plan)
or if the tenant wants to maintain maximum flexibility to
leave the building before the end of the lease term due
to unanticipated changes in its space needs, the tenant
should include an early termination option in the letter
of intent. If granted, the landlord will typically require
the tenant to pay on termination some portion of the rent
that the landlord will lose if the tenant leaves prior to the
expiration of the lease term plus all unamortized costs
incurred by the landlord as a result of the termination,
including the unamortized portion of the tenant
improvement allowance and brokerage commissions. In
lieu of a full blown early termination right, the tenant
may consider a right to contract the size of the premises
during the lease term (i.e., give back a portion of the
space). If the landlord agrees to that provision, the tenant
will likely face monetary obligations similar to those
that would apply for an early termination option (i.e.,
repayment of some lost rent and all unamortized costs
incurred by the landlord for the portion of the premises
to be given back to the landlord).
The tenant should also clarify the obligations it will
undertake (or not), upon expiration or earlier termination
of the lease, for removing cabling and telecom wiring;
furniture, fixtures and equipment; and restoring the
premises to the condition it was in when tendered to
the tenant, as these obligations can result in material
unanticipated costs when the lease ends.
Ancillary Issues:
In addition to the economic and non-monetary terms
outlined above, the letter of intent should address several
ancillary issues. If the building in which the premises are
located has a parking garage or parking lot, the letter of
intent should detail the number of parking spaces that
will be available for use by the tenant and its employees,
visitors, clients and customers. If the tenant anticipates
requiring any reserved parking spaces, these should be
specified as well. The location and costs for the parking
spaces should also be reflected in the letter of intent.
The letter of intent should reflect the type of signage
to be provided by the landlord for the tenant’s benefit,
including building directory strips and entrance signage
for the tenant’s suite. If the tenant is leasing a significant
percentage of the building, the landlord should offer the
tenant exterior signage rights and these should also be
included in the letter of intent.
Typically the lease will include a subordination provision
clarifying that the tenant’s rights to the premises and
under the lease are subordinate to the rights of any
mortgagee holding a lien on the building. The tenant
will also be required to attorn to a successor owner of
the building (i.e., to accept a new owner as the landlord
under the lease) if the mortgagee forecloses on the lien
of its mortgage or accepts a deed in lieu of foreclosure.
The tenant should request in the letter of intent that as a
3
condition to its attornment agreement, the landlord will
obtain (or at the very least use commercially reasonable
efforts to obtain) a non-disturbance agreement in favor
of the tenant from the landlord’s mortgagee. Specifically,
this provision would require the mortgagee to provide
tenant assurances that, in the event that the mortgagee
or its designee becomes the successor owner of the
building, as long as the tenant is not in default, the lease
will not be terminated and the tenant’s rights to use the
premises will not be disturbed.
Customarily, a letter of intent is and should be non-binding
between the landlord and the tenant. Nonetheless, the
terms of letters of intent are generally respected by both
the landlord and the tenant in the lease preparation and
negotiation processes. Consequently, the more robust
and inclusive a letter of intent is, the more efficient and
cost effective the lease negotiations will be.
A well written and comprehensive letter of intent is an
important tool in a leasing transaction. It is particularly
critical in a tenant favorable marketplace since it enables
the tenant to confirm at an early stage in its negotiations
the key economic and other material terms a landlord
will agree to in the definitive lease documentation.
Womble Carlyle client alerts are intended to provide general information about significant legal developments and should not be construed as legal advice
regarding any specific facts and circumstances, nor should they be construed as advertisements for legal services.
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication
(or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii)
promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).
WCSR.COM
WOMBLE CARLYLE SANDRIDGE & RICE, LLP 1114_8519
©2014