August 2010 Archives

August 31, 2010

Understanding Your Lease - Common Area Expenses

Common Area Expenses (or CAM expenses) are nothing new in the commercial leasing business. However, new business owners are often caught off guard by the thought of the additional expense that sometimes is as high as the base rent itself, especially where there is so little control over how the expenses are managed. Leases that require tenants to pay common area expenses (including property taxes and insurance) are called triple net leases. It is common these days for landlords to pass on every imaginable expense to its tenants. So long as the landlord is passing on legitimate expenses that are necessary for the operation and maintenance of the common areas, there is nothing inherently wrong with the practice. However, prospective tenants should work closely with their attorney to carefully review the proposed lease terms to ensure they have a complete picture of the potential liability and that the landlord isn't using the CAM charges as an additional source of revenue. Ideally, tenants will negotiate for a gross lease that is inclusive of all landlord expenses. However, in most cases negotiating for a gross lease is difficult (if not impossible). Where a net lease is your only option, the following is a list of important considerations:

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Pro Rata Share: A tenant's pro rata share of common area expenses should be determined based on the tenant's leased square footage compared to the commercial property's gross leasable space, not "leased" space. In other words, the pro rata share is determined based on 100% occupancy. Landlords often seek to defer costs associated with empty space and will try and include lease language that calls for CAM charges to be calculated based on the square footage of "leased" space rather than "leasable" space. Tenants should seek to amend such language so that the landlord absorbs the expenses associated with empty space.

Audit Rights
: Tenants should try and negotiate for the right, upon reasonable notice, to audit the landlord's accounting records. Such clauses are common in commercial leases and allow tenants to ensure that the common area expenses are calculated correctly. Look closely at the lease language as these clauses typically set forth specific procedures for examination of records and for resolution of disputes. Sometimes leases limit the frequency of tenant audits. The more often you are allowed to audit, the better. At the very least, tenants should have the right to audit accounting records once a year within six months of reconciliation (the time landlords reconcile actual expenses with estimated expenses).

Management Fees: Management fees are common, especially in the retail setting. The practice is prevalent and prospective tenants should ensure that the lease clearly defines what the management fees are and how they will be calculated. Management fees should not exceed three percent of the property's gross receipts, and shouldn't include expenses for off-site personnel and overhead. In some cases, landlords seek both administrative and management fees. While this may be appropriate in some circumstances (i.e. landlord hires a separate management company to manage the property), it's important to clearly understand exactly how these fees are delineated and to make sure that the landlord isn't double dipping. Try and negotiate for limits on management fees. 

Clearly Defined Expenses: Ensure that the common area expenses are clearly defined in the lease. Vague and ambiguous language that doesn't spell out precisely what expenses will be included in CAMs leave tenants open to excess costs.

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August 20, 2010

Piercing the Corporate Veil

"Piercing the Corporate Veil" is a well-known phrase.  To the average American, it conjures up visions of corporate giants being slain by David.  This pejorative understanding has little practical value in today's business world.  In fact, "piercing the corporate veil" (holding the principals of a corporation or limited liability company liable for the debts of the company) is an all too real legal principle for entrepreneurs concerned with protecting their personal assets from the liabilities of their business.  Incorporation law has developed to encourage business development and risk taking.  Limiting owner liability (whether of individual owners or of parent companies) furthers this goal.  However, there are limitations to the protections provided.  First, it's important that companies fully comply with the legal formalities required to maintain their business entity to ensure personal insulation.  Second, the corporate veil may be pierced where one forms a corporation or LLC for the purpose of insulating personal assets, insulating the assets of another business or for some other unjust purpose.
 
The Deal.jpgIn California, courts will pierce the corporate veil when two requirements are met: 1) the Court finds unity of interests (the shareholders, or owners in the case of an LLC, treat the corporation as an alter ego) - this happens when shareholders treat the assets of the corporation or LLC as their own and/or use corporate funds to pay their private debts; and 2) the Court finds that allowing shareholders to dodge personal liability would sanction fraud or promote injustice.  

To answer these questions, courts look at numerous factors including: whether the shareholders/owners acted in bad faith; whether individual contracts were entered into with the intent of avoiding performance and hiding behind a corporate shield; whether assets have been diverted to the detriment of creditors; whether there is ownership and control of the entity by a few key individuals; whether the shareholders/owners and the corporation share the same office or business location; whether the shareholders/owners and the corporation share the same attorney; whether the shareholders/owners used the entity to procure labor, services and merchandise for others; whether the entity was adequately capitalized; whether corporate formalities were followed; and whether the result would be unjust should the court fail to pierce the corporate veil.  

While California courts are generally reluctant to pierce the corporate veil, they are not afraid to apply the theory where the above factors evidence injustice.  Entity shareholders and owners unsure about their personal protections should consult a business attorney
August 18, 2010

Understanding Your Lease - What Happens to Your San Diego Business After Landlord Foreclosure?

As the San Diego commercial real estate market continues to struggle, foreclosures are becoming more and more common.  The prevailing wisdom is that it's going to get worse before it gets better.  While this writer cautiously takes a more optimistic view, there can be little doubt that many San Diego businesses are being and will be confronted with landlord foreclosures.  Businesses invest more than just lease payments in the premises they occupy.  They make tenant improvements, invest in advertisements and marketing materials using the premises address, build customer loyalty and benefit from a well known and popular location.  Under these circumstances, being forced out as a result of a landlord's default would be disastrous.
 
1228340_architectural.jpgSo what does happen to a business when a landlord defaults on its loan?  The answer depends on the terms of the lease, when it was executed and whether or not it was recorded.  Senior commercial leases will generally survive foreclosure sales, especially where the commercial lease is recorded prior to the recordation of the third party encumbrance.  Tenant possession of the premises may also serve as constructive notice of the senior lease to third party encumbrancers.  However, where a trust deed or other encumbrance is recorded prior to the execution of the lease, the lease is subordinate to the trust deed.  In such circumstances, a foreclosure will extinguish the lease.  A foreclosure purchaser may then evict the tenant as an unlawful occupant.
 
Experienced commercial landlords and tenants, savvy business owners and those represented by commercial lease attorneys look to address these potential consequences before entering into long term leases.  Whatever the terms, it is sound business practice to record all leases including amendments and other related instruments.  If the parties are concerned with confidential terms, they may record a "memorandum of lease" which identifies the unrecorded lease, the parties, the property and the lease term.

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August 9, 2010

Do I Really Have To Pay Quarterly Taxes?

The answer to this question for most San Diego business owners is unfortunately yes.  The last thing any business owner wants to think about is taxes and nothing could be worse than thinking about taxes four times a year.  Yet putting money aside to cover a tax bill isn't the worst layout a business owner can make during any given year.  One way or another, Uncle Sam is going to get his percentage.  It would be better of course to keep those quarterly tax payments in the bank earning interest, but in the grander scheme of things the lost interest is negligible for most new and growing businesses.  Regardless, the IRS requires quarterly payments and exacts penalties and interest from those that ignore or are ignorant of the code.  

The big question then becomes, how much?  If you expect a first year loss or very limited net income and expect to owe less than $1,000 in taxes, you don't have to worry.  If you expect to owe more than $1,000, then you should pay quarterly estimated taxes to avoid penalties.  The IRS expects you to pay, at a minimum, the smaller of:  90% of the tax to be shown on your next year's return or 100% of the tax shown on your last year's tax return, if that return covered all 12 months of the year.  If your prior year's adjusted gross income exceeded $75,000 on your individual return, or $150,000 with your spouse, the 100% is changed to 110%.  

Taxes_911375.jpgExisting businesses can choose the second option and make quarterly payments that equal 100% of the prior year's tax payment (or 110% if the prior year's adjusted gross income was in the higher bracket) and forego performing complex calculations.  If your business is in its first year or expects to earn considerably less than the prior year and you are uncertain how to proceed, consult your accountant (preferably a CPA who should be an important part of your business' team of advisors).  You may also personally use the IRS 1040EZ worksheet to estimate your tax due for the following year, but you will want to be sure that you make a good estimate of your business' income.  A good accountant can ensure that you legally minimize your tax burden and avoid penalties.  

When you're ready to make your quarterly payments, use the 1040EZ and either mail in the payments with the Payment Vouchers as instructed or pay electronically (see the IRS Electronic Payment Options Home Page).
August 5, 2010

Support Your San Diego Business With a Team of Trusted Advisors

Starting and running your own San Diego business is as challenging as it is rewarding.  At every turn, business owners are faced with new obstacles and it often seems like every choice is a make or break decision.  This is precisely why it is so important that young and growing businesses are supported by trusted advisors.  A team of professionals experienced in banking, accounting, payroll, insurance and the law reduces the friction young and growing businesses are certain to bump up against moving forward.  While it obviously may not be practical for every new business to retain and/or hire a complete staff of professionals, understanding the important role each professional plays in the business world is essential.  As a business grows, having a complete team is the only way to ensure that the business is protected from potential liabilities.
 
939163___umbrella__.jpgBanking:  Choosing the right bank is especially important in those early months of operation.  At the very least, you want the branch manager to know you by name.  It's helpful to do a preliminary internet search and see what others are saying about the banks in your area.  Local community banks often offer more personalized service.  Ultimately, you want to know that you can get someone on the phone that knows you and cares about your needs.
 
Insurance:  No matter what type of business you run and whether or not you believe your personal assets are protected through the formation of a formal business entity (i.e. a corporation or a limited liability company), obtaining adequate insurance at the onset is a necessity.  Even where companies comply with the legal formalities necessary to ensure personal assets are protected from liability, no entrepreneur is interested in losing their initial investment as the result of a single event.  Workers compensation insurance (if you hire employees), health insurance, life insurance (especially for partnerships), general liability insurance, property insurance, auto insurance, and malpractice insurance are all important.  Finding the right insurance agent, particularly one that has experience insuring your type of business ensures that you obtain the proper types and levels of coverage.  Develop a relationship with an agent you trust.

Accounting and Payroll:  While many entrepreneurs see the hiring of accounting and payroll personnel as a luxury especially at the onset, as a business grows so does its need for accurate books and quality management.  The company's taxes, borrowing power and stability depend on fundamental accounting methods and compliance with state and federal employment regulations.  If it is impractical to hire accounting and human resource personnel at first, consider outsourcing the work.  There are exceptionally cost effective companies out there that cater to the young and growing business.  

Legal Services:  Because your business will make routine decisions that have legal consequences, it is critical that an attorney is on your team of advisors from the start.  Your attorney will provide invaluable guidance in determining levels of insurance coverage, determining the type of business entity to form, developing employee policies, complying with federal, state and local law and regulation, drafting and negotiating contracts and protecting your company's intellectual property such as your company's name.  This list is not exhaustive.  Develop a relationship early on with an attorney that you can trust, and ask that he or she give your business a legal check up.  This can usually be done for a reasonable fee.  Be sure that the attorney understands your business model, long term goals and marketing plan.  Talk to other business owners in your area for references. In the end, it is important that you are protected from unforeseen complications.  


A team of trusted advisors puts the expertise of multiple professionals at your finger tips, professionals that often work together to achieve your business goals.
August 2, 2010

Understanding Your Lease - Examples of Typical CAM Expenses

Commercial leases often appear daunting, especially to new and growing San Diego businesses. After negotiating the rent, business owners often feel they have little choice but to accept the remaining terms if they want to move forward. It is always advisable to consult with a commercial lease lawyer, but the thought of additional costs turn many away from this option. "Understanding Your Lease" is a series of articles designed to highlight important commercial leasing issues. The articles are intended to arm business owners with the ABCs of "commercial leasing", and are not intended as a substitute for professional negotiation. Most commercial leases are triple net leases. Along with the base rent, tenants are required to pay a pro rata share of the common area maintenance expenses (CAM expenses). The scope of these expenses varies from lease to lease, but is most often inclusive of every imaginable cost. See Understanding Your Lease - Common Area Expenses. In this article we briefly summarize the type of expenses included. It's important to review your lease and make sure you know what the CAM expenses are.

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Common area expenses typically include: repair and maintenance of the property's common areas; landscaping; exterior painting; parking lot paving, resurfacing, painting and lighting; roofing; repair and maintenance of central plumbing, electrical, sewage and HVAC systems; other repair and maintenance expenses relating to the property's common areas including renovation and redesign expenses; utility expenses related to the common areas; advertising and promotional expenses incurred by landlords; security systems and on-site personnel; permits, taxes, insurance and legal costs; and management and administrative expenses including the salaries of management personnel. On top of these expenses, tenants are required to pay all expenses directly related to the leased space including utilities, repair and maintenance of electrical, plumbing and HVAC systems, compliance with government regulation such as the American with Disabilities Act and are required to maintain a minimum level of general liability insurance.

Common areas typically include parking lots, landscaping, hallways, elevators and stairwells, lobbies, public restrooms, on-site management offices and other public areas. Ask to see CAM histories to help you get a better picture of what your future expenses will look like, and ask about anticipated renovations. These costs can be significant and you'll want to know what's on the horizon. Finally, management and administrative costs can be profit centers for landlords, particularly where both management and administrative costs are sought. Be careful that your landlord isn't double dipping. Work closely with your attorney to reduce uncertainty.