7 Most Common Mistakes with Commercial Lease Agreements

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Leasing business premises is one of the most important decisions for a company to make. Apart from the fact that these agreements usually have the term of several years, the business premises should internally meet the requirements of the company, i.e., be appropriate for the number of employees, equipment used in the space, be representative for those who work there every day and for clients and other occasional visitors. The location certainly plays a paramount role. It is not uncommon for the adaptation works on the premises to be carried out for the future tenant before the handover of the space.

All of this requires quality negotiations before signing the lease agreement and, most importantly, a clear and comprehensive lease agreement that will protect your position in the best possible way. Therefore, we decided to outline the 7 most common pitfalls that may happen with commercial lease agreements, including not only those mistakes that may hide within the lease agreement clauses,  but also those that could appear during the negotiations phase. When we wrote this blog post, we had in mind a company (legal entity) as the tenant of the business premises, as most of the doubts come from that situation.

1. Lack of Time for Negotiations Does Not Benefit You

The first thing you should take into account is to start looking for the desired office place on time, i.e., leave yourself enough time to look at different options, but also to negotiate. Even with seemingly simple lease agreements where the duration can often be slightly shorter than the usual for this type of agreement (e.g., up to two or three years), negotiations can be long and exhausting, especially if the landlord and tenant do not have a common vision of remodeling the office space and bringing it to purpose.

A typical example of disagreement may be the need to install partition walls to separate the office space, for which landlords are not always willing to give consent. In addition, it should be borne in mind that architects and designers are highly important in this process, so it is necessary to plan their schedule (deadlines) in advance and align it with the duration of negotiations, as it may happen that the landlord seeks approval of plans made by architects and designers.

In practice, a problem may arise with the issue of insurance, who will provide the insurance for the office space and who pays for that insurance. In addition, it is important to be precise when insuring and from which risks the policy should protect. For example, typical risks are fire and water damage on electrical installations, and it is not uncommon to anticipate glass breakage as well, especially if a business space is full of shop windows and the like. A frequent subject of negotiations is also collateral, where a deposit is typical (more details below), although a bank guarantee may be provided.

These are just some of the issues that need to be resolved during the negotiations. That is why it is crucial to set aside enough time for looking for the premises and negotiations, which can take weeks, and for more complex leases even months. When it comes to the lease of the business premises, thinking ahead may spare you a lot of stress and save some time, so it is highly unrecommended to start looking for a new space a month before the expiration of the previous lease agreement.

2. You Forgot to do the Due Diligence on the Business Premises and the Landlord

When the preferred office space is found, the necessary next step is to do the so-called due diligence of real estate, i.e. a check of the legal status of the business premises. If the lease agreement is negotiated at a time when the subject of the lease is still under construction, it includes checking documentation such as a building permit, registration of the start of work, the subdivision plan study, etc., everything up to the use permits.

For the so-called “old” real estate, you must perform a check in the real estate cadaster. However, practice shows that there are frequent cases in which the factual situation does not match the legal situation, and the registered area and the actual area “on the ground” do not coincide, so this is something you should pay special attention to.

Due diligence also includes checking whether the landlord is also the owner of the business premises. It can happen that e.g., you are negotiating with a landlord who turns out to be a co-owner (or co-owner) of the business premises, i.e., not the sole owner. It is then necessary to properly regulate this issue in the agreement, in order to avoid later potential problems with other co-owners, i.e. common owners.

The problem may also arise if, during the inspection of the real estate in the real estate cadaster, you establish that the person who presents himself as the landlord is not the owner of the business premises. In that case, it is necessary to first examine the legal basis on which the person appears in the role of the landlord, whether they are, for example, an unregistered owner at the time of the negotiation (who may even be in the process of registering ownership, i.e., they have a legal basis for registration, such as a purchase and sales agreement or inheritance decision), or the lessor may be the tenant himself. If your landlord is actually the tenant of the property owner, it is crucial to examine whether their lease agreement allows for sublease, and under what conditions.

3. You Haven’t Made Any Factual Checks

The before mentioned due diligence does not only include checks performed by a real estate attorney, as a rule, regarding the legal status of real estate and property, but also factual checks.

Those other checks are in practice performed by architects, designers, engineers, and the like. Specifically, they include:

  • controlling electrical installations,
  • water supply systems,
  • checking the compliance of the space with the regulations governing fire protection,
  • checking elevators (if the company needs a lift of a certain size due to the transport of certain equipment),
  • sound insulation, etc.

It is often important for the tenants to be aware of the kind of communication they will have with the rest of the building where the business premises are located, whether they share the floor with someone else or they are alone. In other words, it is important to check how much interference can be expected from other people when using the space.

This issue is even more relevant if your activity is such that special regulations regulate all the conditions that business premises must meet (such as surgeries, clinics, etc.). Then it is even more important to control the space competently and professionally. Finally, it is important to think about whether people with disabilities are adequately enabled to reach your business premises.

In addition to the aforementioned, one of the frequently decisive factors determining whether you will choose a particular real estate may be the possibility of parking – if your business premises comes with a parking slot or a garage, do not forget to also regulate that by an agreement.

Finally, you should check (if it applies to you, and in most cases it does) what are the possibilities for placing your company’s logo on the roof or the building facade.

4. The Landlord’s Proposed Template Agreement Is To Your Damage

There are frequent mentions of lease agreement templates that are available online, which are in essence a “one model fits all”.

The situation may further get complicated if the landlord offers you their agreement with an explanation that it is a “usual template that fits all” and that there is no need to negotiate or change anything.

And while this premise is not true even in short-term lease agreements, it is, however, dangerous with commercial lease agreements. Each office space lease is a story for itself and is influenced by a number of factors: business activity of the tenant, level of security and protection required by the tenant (the first two items include sensitivity of the business activities, but also data located within the leased space), the budget which tenant allocates for this lease, the duration of the lease (as a rule, landlords are more flexible about adapting the space if the lease will be longer, and thus are more willing to allow the tenant major changes in space), the reputation of the tenant (landlords put more trust in reputable tenants and even require less deposit, compared to, for example, start-ups that may face this unfair discrimination).

Termination of the agreement is particularly well specified. While some agreements allow one contracting party to unilaterally terminate the agreement at any time without a specific cause, others do not provide termination without the other party’s guilt/responsibility for termination. In some cases, even penalties are provided for premature termination without cause. Therefore, this provision is so specific and important that it must inevitably be the subject of negotiations before it becomes part of the agreement at all because filling out templates is simply not an option. The issue of termination is additionally affected by the duration of the agreement, the amount of the deposit, and even the rent amount.

For instance, if your lease agreement stipulates that the agreement might be terminated with 60 days’ notice, be sure to inform the landlord on time of your intention to terminate the agreement. Certainly, you would not like to end up “trapped” in the old premises and obliged to pay the rent for it, while your new office space which suits all your needs is waiting for you.

Sub-lease is also an issue that often depends on how the landlord assesses the tenant, but also what activities the tenant would possibly engage in.

Speaking from experience, those provisions that go unnoticed in some lease agreements, become the lifeblood of negotiations and turning points in other agreements and can decide whether the agreement will be concluded at all.

5. You Have Not Anticipated Changes In the Future

Commercial lease agreements that are signed for a period of five or even more years require a plan for that period.

For example, what happens if another company buys the tenant during the term of the lease or if the same parent company (founder) of the tenant establishes another company that would like to become a tenant? Also, what will happen if the tenant’s ownership or management structure changes? All these issues require thinking about the possibility of assigning a lease agreement, but also about subleasing.

Some tenants may be interested in staying in the business premises longer, in which case, they should think about when in what way and for how long the lease term can be extended. At the same time, it is important to properly regulate whether this right belongs only to the tenant or to both parties because it poses a grave danger.

Certainly, the duration of the lease agreement is the most significant question to answer. In other words, you need to think carefully about whether you will really have the need and opportunities to stay on these premises during the agreed period. The clauses that stipulate the possibility of premature agreement termination are the clauses that are (most often) negotiated because it can be expected that the landlord wants some security in this field.

The possibility of premature termination without cause is additionally linked to the duration of the notice period, so this is another item that needs to be negotiated.

6. You Have not Precisely Regulated the Maintenance of the Business Premises

Although almost every lease agreement regulates (and the Law as well) that investment maintenance (e.g., repair of the roof or the building facade, etc.) is borne by the landlord, while regular (ongoing) maintenance (regular cleaning of dirt, bulb replacement, etc.) is borne by the tenant, these issues in practice can lead to a number of ambiguities if not precisely elaborated in the agreement.

We presented a specific example above when even regular maintenance is organized by the landlord (engaging a specialized cleaning agency for the entire building, and thus for the leased space), but at the expense of the tenant. Other combinations are possible as well. However, the key question is what happens if one side neglects its obligations? What happens if you inform the landlord immediately after the flood that the water pipes burst, and although the landlord is obliged to fix this, they do not react at all and leave you to wait with their team in the flooded offices? This certainly prevents you from working and thus causes you double damage, first of all by damaging the equipment and furniture in the space, and also prevents you from doing business and making a profit. Are you allowed to react on your own? If yes, within what period, under what conditions, and at whose expense? Can this non-compliance with the landlord’s obligation to react urgently for the purpose of investment maintenance even lead to the termination of the agreement? Finally, do you distinguish between emergency interventions and those that are long-term and necessary, but not urgent? These are all issues that must be adequately regulated in the lease agreement, in order to prevent major damage that may happen.

7. You Have not Considered the Obligation to Pay the Taxes

Taxes are the real cost associated with the lease of a real estate, and so should be taken into account when planning the budget for the lease, as well as rent and other costs (overhead, insurance, security, etc.).

The type of tax that applies to your lease, or that accompanies the lease (VAT or real estate income tax (by leasing real estate)) is determined by factors such as whether the landlord is a natural or legal person and whether it is in the VAT system. Another specific situation is when the landlord is not in the VAT system because the mentioned two taxes cannot be applied, but the rent is treated as the income of that legal entity and is finally taxed with profit tax. In any case, to be able to determine which tax is relevant for a particular lease, it is necessary to first determine from whom you are renting the business premises.

  • When VAT is applied, the general VAT rate for taxable turnover of goods and services is 20%.
  • If the landlord is a natural person outside the VAT system, the corresponding tax shall be the property income tax, with the 20% tax rate, while it must be borne in mind that taxable real estate income is gross income with fewer standard costs (or possibly actual costs prescribed by the law) in the amount of 25%.
  • In the last case, when the rent is treated as income of a legal entity that is not in the VAT system, regular corporate income tax is paid, with the corporate income tax rate being 15%.

Finally, although this is not the type of tax that is directly related to the lease (rent and costs), do not forget about the issue of paying property tax for the property being leased. Property tax is a real expense that accompanies the business premises as the real estate that is the subject of the lease, and it is recommended that it be regulated in order to avoid any doubt, especially when it comes to long-term leases.

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