05 Feb Commercial Lease Agreements Examined–Percentage Lease Provisions
For small business owners, particularly those involved in retail activities, the single most important document the owner may ever sign is their commercial lease agreement. But many commercial lease agreements, being assembled over time by the landlord’s lawyers, are replete with ambiguities, drafting errors, and clauses that may or may not apply. To be certain, most terms in a commercial lease agreement are fixed by the landlord and generally don’t get updated except when the law changes or the landlord is engaged in a lawsuit that necessitates a change in language. Those “necessary” changes often result in a less clear agreement.
Like most “modern” commercial contracts, the commercial lease is full of language that can be quite confusing. Often the overuse of words is unnecessary. Packing a commercial lease with words doesn’t make the lease better.
Over the course of a a few irregularly scheduled posts, I will examine some of the common terms of a commercial lease, attempt to parse the language a bit and then offer some suggestions that small business owners can suggest to their landlords to make everyone’s life a little easier.
Percentage Lease Terms
Many retail establishments have a percentage rent term, that is a type of rent where the tenants gross or net sales are used to determine a portion of the rent. The idea allows landlords to make a higher rental income for successful shops. The manner in which percentage lease terms are often drafted would make the Internal Revenue Service proud in their complexity. Here is an example of a percentage rent term in need of some work.
5. Percentage Rent
Lessee shall pay, as additional rent, a percentage rent (“Percentage Rent”) calculated as set out below.
(a) Within 45 days following the end of each Lease Year (as hereinafter defined), Lessee shall provide Lessor with a written statement certified by Lessee setting out Lessee’s total gross sales for the preceding Lease Year, together with a check for a sum equal to five percent (5%) of such gross sales, less the Base Rent for such Lease Year (if previously paid), and copies of the monthly state sales tax returns.
(b) “Lease Year” shall mean each period of 12 consecutive calendar months during the term of the Lease, commencing on the Commencement Date, provided that if the term shall commence on a day between the 1st of the month and the 14th of the month, the Lease Year shall be deemed to start on the 1st of the then current month. If the term shall commence on a day between the 15th and the end of the month, the Lease Year shall be deemed to start on the 1st day of the following month. Gross sales for the period falling outside of that period shall be adjusted and calculated pro rata on a daily basis.
(c) The term “gross sales” as used herein shall mean the total amounts received, whether for cash or on credit, for sales and services of every kind made upon the Leased Premises, less the amount Lessee is obligated to pay on account of all retail sales taxes.
(d) Lessee shall keep complete and accurate books and accounts of its daily gross sales in every part of its business operating at any time during the currency of this Lease in any part of the Leased Premises. Lessor and its agents and employees shall have the right at any time during regular business hours to examine and inspect all the books and accounts of Lessee related to gross sales, including sales tax reports, tax returns, or other reports to any governmental agency, for the purpose of verifying the accuracy of any statement of gross sales provided under sub-clause (a) hereof. Lessor may, at its option and no more than once in any consecutive 12-month period, cause an audit of Lessee’s business to be performed by a certified public accountant of Lessor’s choice. If such audit shows that any statement of gross sales previously made by Lessee is more than ten percent (10%) less than the amount of gross sales determined by such audit, the cost of such audit shall be borne by Lessee; otherwise it shall be borne by Lessor.
Confused? This 434 word behemoth demonstrates how many commercial leases read. If it were possible to track the changes of this provision, the evolution of the provision would be generally the addition of each subparagraph as disputes over the provision escalated.
Examining each provision in turn, the drafting errors and confusion created by the language become a bit clearer.
Lessee shall pay, as additional rent, a percentage rent (“Percentage Rent”) calculated as set out below.
(a) Within 45 days following the end of each Lease Year (as hereinafter defined), Lessee shall provide Lessor with a written statement certified by Lessee setting out Lessee’s total gross sales for the preceding Lease Year, together with a check for a sum equal to five percent (5%) of such gross sales, less the Base Rent for such Lease Year (if previously paid), and copies of the monthly state sales tax returns.
Although not specific to this term, the Lessee/Lessor naming convention itself is confusing. In the age of modern word processing and document assembly software, there is no need to using such confusing labels. The contract drafter should use the actual names of the landlord and tenant. If using formal names is too difficult even the terms Landlord and Tenant avoid the confusing similarity of lessee/lessor.
Next, this provision uses several terms that are defined after this provision, namely “Lease Year” and “gross sales.” (Base rent is defined earlier in the document.) The addition of subparagrpahs (b) and (c) make it clear that the drafters initially did not include definitions for those two key terms. If a provision is going to introduce and use defined terms, such definition should be either defined elsewhere in the document before the provision in question or defined first in the provision. Doing so eliminates that pesky parenthetical “(as hereinafter defined).” The term Lease Year is identified by the capitalization as an important term. But the single most important term here is gross sales and it is unclear how that term is defined until later in the provision. Even the importance of the term is hidden by not using the capitalization convention present elsewhere in the document.
What does “certified by Lessee” mean? Does it mean just a signature? Does it mean notarized? Does it mean certified by the Lessee’s bookkeeper or accountant? The contract should make it clear what certification means, otherwise parties are left to wonder or argue about the provision in a dispute.
Why does the landlord require all this extra paperwork? For example, the monthly sales tax forms submitted to the state (any state) includes the gross sales for the month. Why does Lessee need to supply a separate statement? Does gross sales include sales taxes? There is too much confusing information and questions here. Why not require either the monthly state sales tax returns or a “certified” statement.
(b) “Lease Year” shall mean each period of 12 consecutive calendar months during the term of the Lease, commencing on the Commencement Date, provided that if the term shall commence on a day between the 1st of the month and the 14th of the month, the Lease Year shall be deemed to start on the 1st of the then current month. If the term shall commence on a day between the 15th and the end of the month, the Lease Year shall be deemed to start on the 1st day of the following month. Gross sales for the period falling outside of that period shall be adjusted and calculated pro rata on a daily basis.
On the surface, this appears to be a reasonable term, until the last sentence. But the language of this subparagraph includes a fair number of “shall” statements, six of them to be exact. Shall is a term of obligation, not a term of definition. The attempt to deem a starting date is confusing at best. Even the smallest of businesses have available modern point of sale systems that track gross sales every day. Thus, it would be simpler to simply call a Lease Year a Lease Year and not try to move the commencement date around.
The final sentence is a mystery as to its purpose and as a result is probably extraneous. The ambiguity of “gross sales for the period falling outside that period” leaves the reader scratching their head. What period is being discussed? Simply due to its proximity to the rest of the paragraph, the sentence appears to require that gross sales in the “remainder” period after having a commencement date deemed are to be pro-rated. Yet, it is less than clear.
(c) The term “gross sales” as used herein shall mean the total amounts received, whether for cash or on credit, for sales and services of every kind made upon the Leased Premises, less the amount Lessee is obligated to pay on account of all retail sales taxes.
Finally, we get to the definition of gross sales that is so key to the entire provision. Note the lack of a defined term convention. Other defined terms, such as Lease Year, are capitalized, yet, this defined term is not. The phrase “as used herein shall mean” uses five words when the word “means” conveys the same meaning with far more economy. The odd language of “on account of all retail sales taxes” seems contrived and even colloquial.
(d) Lessee shall keep complete and accurate books and accounts of its daily gross sales in every part of its business operating at any time during the currency of this Lease in any part of the Leased Premises. Lessor and its agents and employees shall have the right at any time during regular business hours to examine and inspect all the books and accounts of Lessee related to gross sales, including sales tax reports, tax returns, or other reports to any governmental agency, for the purpose of verifying the accuracy of any statement of gross sales provided under sub-clause (a) hereof. Lessor may, at its option and no more than once in any consecutive 12-month period, cause an audit of Lessee’s business to be performed by a certified public accountant of Lessor’s choice. If such audit shows that any statement of gross sales previously made by Lessee is more than ten percent (10%) less than the amount of gross sales determined by such audit, the cost of such audit shall be borne by Lessee; otherwise it shall be borne by Lessor.
This subsection is longer than it needs to be, contains a number of redundant phrases and ambiguities. Some redundancies:
- “complete and accurate books and accounts”– it would be simpler to say “complete records”
- “Lessor and its agents and employees”– cleaner language would be simply “Lessor”
- “examine and inspect”– again, using one word would suffice, “inspect”
- “related to gross sales, including sales tax reports, tax returns, or other reports to any governmental agency”–it would be much simpler to say “any report to a governmental agency”
- “Lessor may, at its option”–this is a classic redundancy, the word may indicates optional behavior, so the better language would be “Lessor may”
The language in the last sentence “is more than ten percent (10%) less than the amount of gross sales determined by such audit” is confusing on its face. “More than ten percent less” invites confusion. The purpose of this clause is to ensure that the tenant is not cheating the landlord by paying less percentage rent that the Tenant is obligated to pay. A much clearer approach would be to say that “any deviation greater than ten percent” and then follow with the consequences.
Percentage Rent Term-Rewritten
The 434 word tangled morass of language above can be presented in a much more succinct manner and still convey the purpose of the Percentage Rent provision.
5. Percentage Rent
(a) For the purposes of this section, (1)”Gross Sales” means the result of all monies or credits received for all sales of goods or services made upon the Leased Premises minus all sales or use taxes paid by Tenant. (2) “Lease Year” means each period of 12 consecutive calendar months during the term of the Lease, starting on the Commencement Date.
(b) Percentage Rent is the result of 5% of Gross Sales for the each Lease Year minus Base Rent paid by Tenant during the Lease Year.
(c) No later than 45 days after the end of the Lease Year, Tenant shall pay Landlord the Percentage Rent and provide either (1) copies of all monthly sales tax returns for the Lease Year or (2) a statement of all gross sales for the Lease Year signed by both Tenant and Tenant’s bookkeeper or accountant.
(d) Tenant shall maintain complete records of its gross sales during the Lease Period. In order to verify any statement made pursuant to subsection 5(c)(2), Tenant shall allow Landlord to inspect during normal business hours all the records of Tenant’s gross sales, including any reports to any governmental agency. No more frequently than once per Lease Year, Landlord may retain an independent certified public accountant to conduct an audit of Tenant’s business records. If such audit results in a deviation in the gross sales amounts greater than 10% of Tenant’s statements to Landlord, Tenant shall pay the cost of the audit, otherwise, Landlord shall pay the cost of the audit.
The original of this provision is 434 words long. The rewritten provision is 260 words long, yet conveys the same ideas. The ordering of the provisions makes sense by defining important terms first, setting out the calculation, and then the obligations and conditions of the percentage rent.