Contributed By McGuireWoods LLP
The primary arrangement in Virginia to document the use of real estate for a limited period of time is a lease, in which a property owner (as “landlord” or “lessor”) grants a leasehold estate to an occupant or user (as “tenant” or “lessee”) for a stated period. This may also take the form of a sublease, where an existing tenant/lessee grants a “sub”-leasehold estate to another occupant or user (as “subtenant” or “sublessee”). The sublease is often on separate written terms and conditions, and is typically subject and subordinate to the primary (or “master”) lease.
Alternatively, parties may elect to enter into a license agreement, which is a contractual arrangement that can be similar in nature to a lease, depending on the terms negotiated by the parties. The primary difference between a lease and a license is that, at common law, a license is revocable by the grantor and does not grant any formal “property” rights. Licenses are typically utilized for more short-term uses where the parties do not wish to establish a formal leasehold estate.
Finally, parties may also enter into an easement for this purpose. Like a lease, an easement grants an interest in real property, and for this reason easements are most commonly used to grant rights of a permanent nature (eg, utility easements, rights of way, etc). However, temporary easements are utilized in certain circumstances (eg, temporary access/construction easements, crane swing easements, etc). Easements may be exclusive or non-exclusive in nature.
Commercial leases may be classified in several ways. A common means of distinguishing between different types of leases is with regard to rent structure. For example, in a “gross” lease the tenant pays a single rental amount that is inclusive of all of its monetary obligations to the landlord. Gross leases are often also “full service” leases, meaning that the landlord provides all utilities and other services to the premises, all of which are included in the base rent. Alternatively, in a “triple net” lease, the tenant pays a base rent and also its proportionate share of real estate taxes, insurance, and common area expenses pertaining to the property, such that the base rent payment is the “net” rent received by the landlord. There are numerous variations of these categories, all of which are subject to negotiation and modification by the parties to the lease. In one typical variation, sometimes referred to as a “modified net” lease, the tenant’s obligation to pay for a share of taxes, insurance and operating expenses applies only to the increases in those sums over the amounts payable by the landlord in a “base year” (typically the first year of the lease).
Another example is a “percentage” lease, in which the tenant pays base rent and additional rent as noted above, and also pays the landlord a percentage of its gross sales earned during a particular period, which may sometimes be limited to only a percentage of sales above a certain “break point”. Percentage leases are typically limited to certain kinds of retail leases, and the terms are heavily negotiated (including the applicable percentage and break point, the required accounting and reporting periods, the identification of what sales are to be included/excluded from the calculation, etc).
Leases may be also categorized according to the nature of what is being leased. For example, “space leases” are those in which the tenant leases space in an existing building or property, or perhaps even an entire existing facility. In contrast, in a “ground lease” the tenant leases only the land owned by the landlord. In that case, the tenant typically constructs all of its own improvements and owns those improvements during the term, including for tax and accounting purposes.
It should be noted that each of the foregoing categories are just general examples of typical categories and arrangements, and that parties are generally free to negotiate any manner of variations to suit their particular needs.
Rents and lease terms for commercial leases are not typically regulated in any material way. However, note that leases in which a city or county is the landlord are limited to terms of 40 years (except leases of air rights, which may be for 60 years). See Virginia Code § 15.2-2100. Also, creditor’s rights laws may impact certain lease terms, including the imposition of interest, etc.
As described above, the terms of a lease may vary depending on the identity of the parties, the nature of the use, the property being leased, and the various needs of the parties. Because commercial leases are not heavily regulated, the parties are free to negotiate virtually unlimited variations, depending on their particular circumstances. However, the following are examples of typical lease terms.
Length of Term: terms are sometimes as short as one year when needs are temporary, or even “month to month”. For most small retail and office leases, a typical term may be three to five years in length, often with one or more renewal options for similar periods. In contrast, leases in which significant renovations or investments are made, or in which significant incentives are offered (eg, anchor retail leases, headquarters office leases, etc), may have terms closer to ten years or more, also with renewal options. Ground leases are typically much longer, for at least 20-30 years (with options to extend), and sometimes as long as 99 years.
Maintenance and Repair: in a multi-tenant facility, a tenant is typically responsible for all interior, non-structural repairs and maintenance of its particular premises, while the landlord is responsible for maintaining the roof, foundation, exterior walls and other structural elements, and also the common areas (eg, parking, landscaping, common stairwells and elevators, etc). In multi-tenant facilities, landlords will often also be responsible for the maintenance of HVAC, electrical, plumbing, and other similar “systems” that serve the entire property, while tenants are typically responsible for any systems that exclusively serve their premises. In contrast, in a single-tenant facility the tenant may be responsible for all repair and maintenance for the entire property, including common areas, although landlords often remain responsible for certain key structural elements (eg, the roof). In some cases, landlords may also remain responsible for major capital replacements, including for HVAC or other systems. Finally, in a ground lease the tenant is typically responsible for any and all required maintenance or repairs.
Frequency of Rent Payments: m,ost commercial leases specify an annual base rent that is payable in equal monthly installments. However, parties are generally free to negotiate this, and rent may be paid quarterly, annually, or in any other manner. Similarly, in triple net leases or other leases with “additional rent” components, the tenant’s share of taxes, insurance and operating expenses are often paid monthly, based on the landlord’s estimated costs (and later adjusted when actual costs are determined). However, in some cases landlords reserve the right to charge these amounts in lump sums or as costs are incurred (eg, when taxes or insurance premiums are actually paid). In contrast, percentage rents are normally paid less frequently (eg, quarterly or bi-annually), depending on the negotiated reporting periods and given the administrative burden of calculating and reporting sales on a monthly basis.
Parties are generally free to negotiate variations in base rent as they see fit. However, under most commercial leases the base rent will increase at regular intervals over the course of the term, typically on an annual basis (ie, on each anniversary of the rent commencement date). However, these adjustments sometimes occur less frequently (eg, every three to five years, or at the time an extension option is exercised, etc).
In contrast, operating expenses and other “additional rents” are typically based on the landlord’s actual expenses incurred in a given year, so they typically do not vary on a regular schedule. Rather, tenants typically pay a fixed amount each month, based on the landlord’s estimated costs, and the parties make an annual adjustment once all final costs are known. However, in each new lease year the landlord may reserve the right to modify or increase its estimates, and thereby increase or modify the tenant’s monthly estimated contribution.
Parties are generally free to negotiate the manner in which rent may be changed or increased. A typical approach is to impose a fixed increase (usually expressed as a percentage of the existing rent) on an annual basis, usually effective on each anniversary of the rent commencement date. Another common approach is to calculate the increase based on the increase in CPI (if any) over the prior year. Parties may also wish for the rent to be fixed for several years at a time, but then for rent to be adjusted every three to five years, or at any time an extension option is exercised.
Parties may also require the rent to be adjusted to the “fair market rental value”. The means of determining the FMV can be negotiated, but the most common approach is some variation of a “three-appraiser” method, where each party selects an appraiser to calculate the FMV, and if they cannot agree then the two appraisers select a third appraiser, and the FMV is the average value of the three calculations, or the median value, or the value selected by the third appraiser, or some other variation on the foregoing. Adjustments of base rent for a renewal period are often determined in this manner.
At the time of writing, Virginia does not impose any tax specifically on the payment of rent, but it is not uncommon for a lease in Virginia to provide that, if such a tax is ever imposed, it will be paid by the tenant (particularly in the context of a triple net lease). However, landlords and tenants are of course subject to ordinary federal, state and local income taxes, franchise taxes, business taxes, and other similar levies.
Tenants will incur various costs at the start of a lease, which will vary depending on the nature of the lease, the condition of the space, and the nature of their business. At a minimum, tenants must typically deliver a security deposit (usually in cash, but sometimes in the form of a letter of credit) and also the first one or two months of base rent and additional rent, although this will vary depending on the creditworthiness of the tenant.
Tenants may also incur costs for the buildout or upfitting of their space, to prepare the premises for use and occupancy. In many commercial leases, landlords will offer an “improvement allowance” that may be utilized by the tenant for the performance of its work. The terms of these allowances are heavily negotiated, but common features include requirements that (i) the landlord must approve all plans and specifications, and the identity of all contractors, (ii) the allowance may be drawn down by the tenant at regular intervals (usually monthly) only upon the delivery of invoices, lien waivers, and other customary documentation, and (iii) the allowance must be utilized within a fixed period (eg, one year). In addition, many landlords require that the allowance may be applied only to the “hard costs” of construction, as opposed to soft costs such as architects’ fees, moving costs, or furniture costs. In some cases, however, parties may negotiate for all or part of any unused allowance to be applied to offset the base rent or to be applied as a “refresh” allowance later in the term.
The maintenance and repair of the common areas in multi-tenant properties are typically performed by the landlord. However, the costs of that work are usually passed along to the tenants as part of their additional rent obligations, where each tenant pays a proportionate share of these expenses based on its square footage. In some cases, a tenant may only be responsible for its share of the increase in these costs above the amount incurred by the landlord in a base year. However, tenants may negotiate detailed exclusions to the list of includable expenses, so that they are not required to reimburse the landlord for certain itemized costs.
Unless a particular service or utility exclusively serves a particular tenant’s premises, the provision of services and utilities to multi-tenant facilities is typically the obligation of the landlord. However, the means in which the costs of these services and utilities are paid depends on the nature of the lease. In a gross or full-service lease, the landlord provides and pays for all services and utilities, and the tenants pay only the base rent. In a “triple net” lease, the landlord will provide common area utilities and building-wide services, the costs of which are reimbursed by the tenants in proportion to their square footage. Tenants typically pay for their own premises-specific services, although this can also be negotiated.
Landlords may also provide utilities directly to a tenant’s premises, including electricity, plumbing and HVAC service, the costs of which are also reimbursed by the tenant. These reimbursements may be made on the basis of a tenant’s square footage, but in cases where these services are separately metered, or where the landlord deems that a tenant’s use is unusual or excessive, then the tenant may be required to pay based on its actual usage, or in some other manner. Similarly, in some cases (most commonly in large multi-tenant office buildings), landlords will often limit the provision of certain services to regular “business hours”, and charge additional costs for after-hours usage, especially for HVAC.
Telephone, internet and other similar telecommunications services are often obtained and paid for directly by a tenant, given that each tenant often has particular or specific needs. Tenants often have their own telecommunications systems installed at their own expense (including cabling and wiring, which must often also be removed at great expense) and will contract directly with the appropriate service providers.
In commercial leases for multi-tenant facilities, the landlord is usually responsible for obtaining and maintaining an “all risk” casualty insurance policy with respect to the improvements, and commercial general liability insurance with respect to its operation of the common areas. In a gross lease, the landlord bears all costs for such insurance. In a triple net lease, each tenant will reimburse the landlord for its proportionate share of the costs of such insurance.
In some circumstances, tenants will carry the casualty insurance on the improvements. This is especially true for long-term leases of single-tenant facilities, and also for virtually all ground leases (where the tenant is the actual owner of the improvements). In cases where the tenant insures any improvements, the tenant will typically name the landlord and its lender as additional insureds or loss payees, as their interests may appear.
Finally, tenants are often required to maintain insurance on their personal property, and also on any leasehold improvements or alterations made to the premises during the term. Tenants are also almost always required to maintain commercial general liability insurance, including coverage for personal injury and property damage, and including the landlord and its lender as additional insureds.
Most commercial leases limit the permitted use of the leased premises, whether for retail, office, warehouse, or other use. Office and warehouse leases may typically refer only to “general” office or warehouse use, while other kinds of leases are much more specific. For example, retail leases may contain very specific descriptions that address particular details of what may be sold, or how much space may be devoted to the sale of particular items, often to protect exclusive use rights that may have been granted to other tenants. These leases may also include a list of prohibited uses that are forbidden within a particular shopping center or development. Similarly, leases for industrial or manufacturing uses are often tightly controlled, given landlords’ desire to protect their property from environmental problems and nuisances.
In addition to limitations imposed by a lease, parties are subject to the zoning ordinances and regulations of the jurisdiction in which the premises is located. These may limit the permitted uses, or specify more prohibited uses. They may also include regulations on the number of required parking spaces, building codes, signage restrictions (size, height, etc), and any other number of issues.
Finally, a property may also be subject to recorded covenants, conditions or restrictions that impact its use or development. For example, properties located in retail shopping centers, office parks and industrial parks are often encumbered by a declaration of easements or covenants that control permitted uses, require approval of new development (typically by an architectural committee or other governing body), or grant utility, access or other easements to adjacent owners.
The extent of a tenant’s right to alter or improve its premises depends on the identity of the tenant and the nature of its lease. In a long-term ground lease where the tenant owns the improvements, there are typically few limitations (if any) on the tenant’s right to make alterations, provided they do not adversely affect the fair market value of the landlord’s property. Similarly, a credit tenant under a relatively long-term lease, or a tenant in a single-tenant facility, will have wider flexibility than a tenant under a short-term lease in a multi-tenant facility.
Where restrictions exist, there are some common features. Most landlords prohibit exterior or structural alterations, or any alterations that impact the HVAC, electrical or other building systems, without their consent. Even interior, non-structural alterations may be prohibited without consent if they are substantial in nature (eg, if they require a building permit, or if they exceed a certain dollar threshold). For permitted alterations, landlords typically require the right to approve the plans and specifications for the work, and also the identity of the contractor(s) performing the work. In the case of substantial additions, landlords may also require final plans or as-built surveys upon completion. In many cases, landlords also reserve the right to require tenants to post bonds or other security in advance of performing the work, and also that lien releases and other similar documentation be provided upon completion.
Finally, most commercial leases provide that the landlord may elect to require the tenant to remove the alterations at the end of the term, at the tenant’s expense, although the tenant may request that the landlord makes this election earlier in the term (eg, at the time the landlord consents to the alteration).
All residential leases in Virginia are governed by the “Landlord and Tenant Act” codified at Va. Code §§55-217 et seq. This Act also applies to non-residential leases, unless they specifically provide otherwise.
Note that residential leases are also subject to the Virginia Residential Landlord and Tenant Act, at Va. Code §§ 55-248.2 et seq.
Leases made by cities, counties and other governmental agencies are subject to various other laws and regulations that are too numerous to list here, but may be found in Title 15.2 of the Virginia Code, or in other enabling legislation for the particular agency or authority in question.
Many commercial leases provide that a tenant’s insolvency will give rise to an event of default under its lease. In some cases this is “curable”, but in many events it constitutes an automatic default, giving rise to all rights or remedies granted to the landlord under the lease or otherwise available at law.
Separately from the terms of a lease, an insolvency on the part of the tenant, and any rights of the landlord arising in connection with such event, will be subject to the applicable federal bankruptcy laws.
The most common form of security in a commercial lease is a cash security deposit. The amount of the deposit is negotiable and will depend on the credit of the tenant, the length and nature of the lease, the amount (if any) invested by the landlord in the space, and other factors. Deposits equal to one or two months of rent are common, although for large, credit tenants it is common for the deposit to be waived altogether. Landlords under commercial leases are typically permitted to comingle the deposit with other funds, and are not required to hold the deposit in a separate account. Deposits typically do not accrue interest. When a landlord is required to utilize any portion of a deposit, the tenant is often required to immediately restore the deposit to its full amount.
Security deposits may also be in the form of a letter of credit. Landlords typically require approval of the issuing bank and the form of the letter of credit, which can be heavily negotiated. In some cases, the parties may negotiate for the letter of credit to be reduced or returned to the tenant upon certain occasions (eg, the passage of time without a default, etc). Alternatively, the tenant may have the right to convert the deposit to cash.
Another form of security is a parent guaranty or personal guaranty, often issued by a parent company of the tenant, or a personal stakeholder in the tenant.
Finally, although less frequently required, some landlords may require additional security in the form of a lien on the tenant’s fixtures, furnishings, equipment and other personal property, which may be perfected by the filing of a UCC-1 financing statement. Also, landlords sometimes reserve the right to require additional or separate security in specific instances (for example, the posting of a bond or additional security before permitting a material alteration).
In some instances, parties may negotiate for a tenant to have a limited period of time to remove its property after a lease expires, but most leases require a tenant to vacate the premises and remove its property on or prior to the expiration date. Accordingly, in most cases a tenant does not have the “right” to occupy its premises after termination or expiration.
If a tenant fails to timely vacate the premises, it becomes a “holdover tenant”, which may result in the tenant becoming a month-to-month tenant, a tenant at will, or a tenant at sufferance, which enables the landlord to exercise varying degrees of termination rights (for example, a month-to-month tenancy may be terminated on 30 days' prior notice). In all cases, commercial leases typically provide that “holdover rent” will immediately begin to accrue at an increased rate, often as much as double the base rent that was payable at the expiration date. In addition to holdover rent, many landlords reserve the right to pursue a holdover tenant for other damages that may be suffered on account of the holdover, including consequential damages.
Finally, most commercial leases also specify that if the tenant fails to remove its personal property by the expiration date, the property will be deemed abandoned. In such cases, landlords usually reserve the right to remove, store and/or sell the property at auction, all at the tenant’s cost.
Commercial leases typically grant the landlord and the tenant limited rights of termination in the event of a material casualty or a condemnation. Also, long-term ground leases often include due diligence periods, permitting periods, and other contingencies in favor of the tenant that may allow the tenant to terminate upon the occurrence of certain conditions.
Otherwise, tenants typically do not receive a termination right, and in fact many commercial leases expressly provide that the tenant waives any right to terminate, even upon a landlord default.
In contrast, landlords often have broad termination rights in the event of a default of the tenant. Many defaults will not arise until after the expiration of a limited notice and cure period in favor of the tenant. However, some defaults are usually “automatic” in nature and may give rise to a termination right in favor of the landlord without any opportunity for the tenant to cure. Examples of “automatic” defaults include prohibited assignments or subleases, a failure to maintain insurance, abandonment of the premises, events of bankruptcy, and other similar, material breaches that are not easily curable.
A tenant can be forced to vacate its premises following a default, provided that the terms of the lease are first observed. As noted above, most commercial leases provide that a default will not occur until after the tenant has received a written notice and an opportunity to cure its breach. For payment defaults, there may be no cure period, or perhaps merely a grace period of five to ten days (ie, no notice to the tenant is required). For non-payment defaults, a notice/cure period of 30 days is typical, although sometimes the lease will permit additional time to cure breaches that by their nature cannot be cured within 30 days. However, as noted above, most leases also describe some non-payment events that result in an “automatic” default, with no grace period and no opportunity to cure.
After the procedures in the lease are observed, if the proper notice(s) have been given and no cure has occurred (if applicable), the process for evicting a tenant is typically the pursuit of an action for unlawful detainer. The basic elements of this action are as follows:
For more information on the foregoing, see, inter alia, Va. Code § 8.01-174 et seq., Va. Code §§ 8.01-470 et seq., and Va. Code §55-237.1.
One circumstance in which a third party may cause a lease to be terminated is a foreclosure by a lender of a deed of trust encumbering a landlord’s property. If a property owner defaults under a deed of trust and the lender forecloses, then any leases subordinate to the deed of trust are automatically terminated as a matter of law in the absence of a written agreement to the contrary. To prevent this, parties have a number of alternatives. This may be accomplished in the lease, and indeed many commercial leases expressly provide that the tenant will attorn to the lender, or that the tenant will even agree to allow the deed of trust to be subordinated to the lease at the lender’s election. Another approach is for the parties to enter into a subordination, non-disturbance and attornment agreement (“SNDA”) that expressly protects the tenant’s leasehold interest for so long as it is not in default under the lease. This is more commonly sought by tenants under longer-term leases, as landlords are often not incentivized to pursue SNDAs for smaller or short-term leases. In some cases, when negotiating a loan for a property with existing leases, landlords and lenders themselves may insist on the execution of an SNDA prior to making the loan, to ensure that the leases are subordinate but also to ensure that critical leases are not “wiped out” in the event of a foreclosure.
Leases may also be terminated in the event of a condemnation of all or part of the property by a governmental authority. Most commercial leases describe in detail the rights of the landlord and tenant to terminate the lease, including their rights to any condemnation proceeds. Most leases provide that all proceeds are the property of the landlord, but that the tenant may separately make a claim for lost property, lost profits, moving expenses, etc, as long as the amount payable to the landlord is not reduced.