Most new businesses are required to enter into a commercial lease of one form or another. The owners of the business are typically presented with thirty to forty page leases set out in fine print on legal size paper. These standard leases are comprehensive and contain provisions that inexperienced business owners usually don’t fully understand. With proper scrutiny and research it is possible for the inexperienced owner to sufficiently navigate their commercial lease. However, this type of scrutiny (in essence due diligence) takes significant time and effort. Ideally, new business owners will instead consult with an experienced commercial lease lawyer before moving forward. Whether or not legal counsel is sought, it is important for all new lessees to be aware of certain pitfalls. This articles summarizes on the most common areas of concern:

967963_escalators_in_shopping_centre-224x300Common Area Maintenance (“CAM”) Expenses: In shopping centers and office buildings where numerous tenants share common space Landlords typically require their tenants to share the costs of maintaining these common areas. Shopping center leases are usually triple net (NNN) leases. Office leases are typically base leases. Either way, landlords are looking to pass on the costs of maintenance to tenants in one form or another. Common area expenses may include expenses associated with landscaping, sidewalks and parking lots, sprinklers, public address systems and music, bathrooms, signs, garbage collection, security and utilities for the common areas such as parking lots, hallways, food courts and any other areas where customers and clients gather or walk through. Most landlords also include an administrative and/or management fee. In addition to base rent, tenants will usually have a monthly CAM bill which represents a twelfth of the tenants pro rata share of the estimated CAM expenses for the year. At the end of the year, if the landlord underestimated the CAM expenses, the tenants are required to pay the difference to the landlord upon receipt of an invoice (the opposite is true if the landlord overestimated –tenants are refunded accordingly). It is vital that new tenants know precisely what these CAM expenses are, how they are calculated and the process for reconciliation of said expenses at the end of the year. Tenants should try and negotiate with the landlord towards ensuring that only legitimate expenses (expenses directly related to common area maintenance) are included. It is helpful to ask the landlord to provide CAM reconciliations for the last three years. This allows prospective tenants to better understand what these expenses are and how they grow over time. It’s also important to seek the right to audit annual reconciliations to ensure proper accounting. Finally, in some cases, tenants may be able to seek a cap on annual CAM expenses. The ability to negotiate for better terms of course depends on the parties’ relative bargaining positions.

Repair and Maintenance Obligations: It is not uncommon, particularly in retail leases, for landlords to require tenants to assume the obligations of all repairs and maintenance to the premises including repair and maintenance of plumbing systems, mechanical systems and equipment such as boilers and HVAC (Heating and Air Condition) systems. In a triple net lease, the entire obligation is shifted to tenants including sometimes full replacement of unrepairable equipment. The average business owner may first learn of this only after a major system breaks down and the landlord points them to the repair and maintenance provisions of the lease. An HVAC failure can have a devastating impact on a tenant’s business. The HVAC system must be repaired (or replaced) and the costs can be prohibitive. It’s important that tenants fully understand their repair and maintenance obligations before entering into a commercial lease. While it may not always be possible to negotiate better terms, it is important to at least try. If you fail, you at least have a better understanding of precisely what your obligations will be. For instance, it is not unreasonable to ask the landlord to warranty the premises mechanical systems and equipment for one or two years. It’s also not uncommon for landlords to agree to replace major equipment at its expense and to capitalize the expense over time so that the tenant pays only the annual capitalized portion of the total expense.

Dilution is a natural part of the corporate investment process, whether one invests in a startup or a public company that is growing. This article will provide a brief introduction to what dilution is, what causes it, and what effect it has on shareholders.

corporate-1213991-300x225What is dilution? Dilution refers to the reduction in a shareholder’s proportional ownership percentage in a company as a result of the issuance of additional shares. With the decrease in proportional ownership percentage, each shareholder’s voting rights also take a hit. The increase in the total number of outstanding shares leaves each shareholder with a smaller slice of the same pie. For example, let’s say that Company A that has 100,000 shares outstanding announces a secondary offering of 5,000 shares. The additional 5,000 shares will reduce the proportional ownership percentage of existing shareholders by 5 percent. The immediate effect of this dilution is a decrease in share price. If the share price before the secondary offering was $30, the company had a market capitalization of $3 million (100,000 x $30) before the announcement. After the dilution, however, the $3 million market valuation must now be divided by the new total number of outstanding shares, 105,000, which drives down the value of each share to $28.57. The long-term effect of dilution on each shareholder’s proportional ownership is hard to predict at the outset.

What causes dilution?

Remedies (types of relief sought by injured parties) can be either legal or equitable in nature. The recovery of money damages (monetary damages) is a legal remedy. An equitable remedy is designed to provide more flexible relief to aggrieved parties. The goal of equitable remedies is fairness. Injunctive relief where a court orders a party to do or refrain from doing something is a common example of an equitable remedy. In contract law, a common equitable remedy is rescission. The word “rescission” is derived from the word “rescind” which means to cancel. It seeks to restore the parties to a contract to the positions they held before they first entered into the contract. Rescission nullifies or “undoes” the contract which relieves all parties of their duties and obligations under the contract. Its effect can be analogized to restoring your computer to its factory settings. In California, there can be no partial rescission. The entire contract must be rescinded. A contract can be rescinded for a variety of reasons, including fraud, mutual mistake of fact or law, undue influence and duress. If the parties do not agree that a contract should be rescinded, the party seeking rescission will need to file a legal action to seek resolution.

steps-1229559-300x96There are numerous grounds for rescission. The following are some of the most common grounds upon which a party may rescind a contract:

Mistake of Fact or Law: If both parties entered into the contract based on a mistake of fact, the contract may be rescinded. The fact must be material to the contract. A fact only collateral to the contract will not suffice. Sometimes, parties may be mutually mistaken about a material fact. For example, if the contract is for the sale of a book that contains the original signature of the author, it would be a mutual mistake of fact if the signature was forged and both the buyer and seller believed it to be real. A unilateral mistake of fact may serve as the basis for rescission where the effect of the mistake is such that enforcement of the contract would be unconscionable. Similarly, a mutual mistake of law is grounds for rescission. A mistake of law exists where all parties believe they know the law as it pertains to their contract but are wrong (i.e. both parties enter into a gambling contract believing gambling is legal in their state). A unilateral mistake of law is not a basis for rescission except where one party misunderstands the law and the other party knowing this fails to clarify the misunderstanding.

There are a number of reasons why a business owner might be motivated to end a commercial lease early.  The most common reason is that a business is not doing well enough to keep up with the lease payments.  Other reasons include changes in the local market, the need for larger or smaller space, or the simple desire to move on to other endeavors. Whatever the circumstances, a tenant desirous of terminating its commercial lease early faces an uphill battle.  Commercial landlords count on tenants to maintain their lease obligations.  They enter into long term leases to avoid the costs associated with continually looking for new qualified tenants and more importantly to avoid the loss of revenue associated with empty space.  For this reason, landlords typically demand strong lease language discouraging tenants from early termination.  See “Assignment Clauses and Related Terms in Commercial Leasing”.

sky-reflection-1453027 (1)Once a tenant decides, for whatever reason, that it wants to terminate a lease early, it should proceed cautiously.  The best approach of course is to seek the assistance of an experienced San Diego commercial lease lawyer.  Whether or not you consult with an attorney, it’s important to review your lease terms carefully so that you have a clear understanding of the options available to you and/or the consequences of early termination. What are the necessary steps for assignment of the lease to a new tenant?  Does the lease give the landlord unfettered discretion in deciding whether to accept an assignee (a new tenant)?  How does the lease define damages for early termination?  Is there a recapture clause (a clause that allows the landlord to terminate the lease merely because the tenant asks the landlord to approve an assignment).  Of course, tenants may also seek other ways to avoid early termination such as proposing flexible payment options to catch up on rent, proposing temporary reduced rent, asking to be moved to a smaller space on the same property or seeking assignment approval.  It is of course best if you can successfully avoid early termination via one of these proposals.  However, they are easier talked about than accomplished.

In most cases, a tenant terminating a lease early is liable for any unpaid rent and the unpaid rent due for the balance of the lease term less mitigation.  Mitigation is the amount a tenant can prove could have been reasonably avoided had the landlord made an effort to re-lease the space.  From a practical standpoint, tenants without the resources necessary to hire an attorney and litigate the case most often find themselves facing default judgments for the full amount of the damages requested without any mitigation.  This is why ignoring the problem isn’t an option.  At the same time litigation is extremely expensive.  However, landlords are sometimes willing to informally discuss early termination terms that factor in mitigation so long as tenants are communicating an intent to find a fair resolution.  A fair resolution unfortunately does not mean that the tenant is going to like the outcome.  Objectively, fairness would require a tenant to be responsible for the actual costs associated with the landlords quest for a new tenant (past due rents owed including common area maintenance expenses (“CAMS”), all rents and CAMS to the date of a final agreement, all costs associated with finding a new tenant, the costs of rent and CAMS while the space is empty and if the new tenant pays less rent, the difference the landlord would have earned had it received the higher rent.  These costs can be considerable.  Moreover, landlords don’t always know how long it will take and they err on the side of benefiting themselves when negotiating early termination terms.

Assignment clauses are an important part of commercial leasing. They provide successful tenants an opportunity to sell their businesses and provide failing businesses the possibility of finding replacement tenants in order to avoid breaching their leases. Generally, landlords retain significant control over the process. This article focuses on lease terms that facilitate the assignment process and/or early lease termination for new and growing business owners interested in testing the waters. While landlords are resistant to the concept of “testing the waters”, they will sometimes work with new business owners in order to secure their tenancy.

time-flies-away-801503-mIdeally, commercial tenants, especially new and growing businesses, will seek more favorable assignment and early termination terms when negotiation the lease. Depending on the circumstances (some tenants will have more bargaining power than others), landlords may agree to be more flexible. While favorable assignment and early termination language is hard to come by for tenants generally, the following concessions are worth pursuing:

  • A cancellation clause that allows tenants to cancel their lease if specific income projections are not met within a certain time period such as on the six-month or one-year anniversary of the lease commencement date.

Generally, parties are liable for their own negligent conduct.  An indemnity provision in a contract reallocates this liability from one party to another.  Viewed practically, an indemnity clause shifts insurance obligations from one party (“indemnitee”) to another party (“indemnitor”). Under an indemnity clause, the indemnitor agrees to pay the indemnitee for losses resulting from a claim brought by a third party. Absent explicit language assuming the obligation to defend, the party providing indemnity has no obligation to provide or assist in defending claims. Almost every contract includes an indemnification clause. It is important to read the clause carefully when entering into a contract of any nature, as the precise language of the clause can make a dramatic difference in each party’s financial obligations.

meet-up-1538121A typical indemnity clause looks something like the following:

To the extent caused by A’s negligence or willful conduct, A agrees to indemnify B of and from all reasonable claims, losses, causes of action, damage, lawsuits, and judgments, including attorneys’ fees and costs, provided that such claims, loss, or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property. Party A shall indemnify B only for the percentage of responsibility for the damage or injuries attributable to Party A. Nothing herein shall be interpreted as obligating A to indemnify B against its sole negligence or willful misconduct.

Percentage rent allows a retail landlord to benefit from a tenant’s success.  In addition to the base rent, tenants will pay an additional rent based on some percentage of the tenant’s gross sales typically triggered by what is termed a “breakpoint”.  New tenants asked to pay percentage rent are typically troubled by the idea mostly because they see it as a way of being penalized for success.  Clearly, landlords benefit significantly from percentage rent reaping additional profits in times of economic boom while losing nothing during downturns. However, there is a synergistic effect that can benefit tenants.  Most landlords aggressively seek to maximize profits and creating the right tenant mix and shopping center atmosphere aids in increasing the revenue stream for all tenants thereby increasing the landlords rent.  In such cases, the landlord at least arguably is creating something of value for tenants.  The value of a landlord’s labors in this scenario is of course difficult to measure, but with an earnest effort it can unquestionably have a dramatic impact on shopping center sales. 
 

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Percentage rent is typically set at five percent (5%) of gross revenue but usually doesn’t trigger until some “breakpoint”.  The breakpoint can be arbitrarily set by the parties as a stipulated breakpoint (for instance at $1,000,000).  In this case, a tenant would be obligated to pay 5% of all gross sales in excess of $1,000,000.  If gross sales were $1,500,000, the tenant would owe as additional rent of $25,000 (5% of $500,000).  Many retail leases set the breakpoint at what is termed the “natural breakpoint”.  For the natural breakpoint, you divide the base rent by the set percentage (the typical 5%).  The natural breakpoint results in a percentage rent applicable to sales over and above the point in which the base rent would equal 5% of gross revenue.  In other words, the tenant is paying 5% of gross sales or the base rent whichever is higher.  If the breakpoint is not reached, the base rent is higher than 5% of gross sales.  If the base rent in the above example was $120,000 ($10,000 a month), the breakpoint would be $2,400,000 resulting in no additional rent due.  The landlord is then guaranteed a minimum rent no matter how bad sales are, but benefits when sales are good. Tenants benefit if the stipulated breakpoint is above the natural breakpoint but not if it is below the natural breakpoint.  In the above example, if the stipulated breakpoint is $4,000,000, the additional rent would be zero.  If the stipulated breakpoint is $500,000, the tenant would pay the base rent ($120,000) plus a percentage rent of $50,000 (5% of $1,000,000).

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Because of the inherent risk of fraudulent activity, the sale of stock is a highly regulated transaction by both state and federal authorities. Unfortunately, many corporate shareholders erroneously believe that privately held corporations do not have to worry about securities regulations because of the limited number of people involved and the relatively limited share worth. They often sell shares of stock either via oral contracts or hastily thrown together written agreements without consulting a corporate attorney. While it is true that smaller privately held corporations benefit from a number of exemptions to securities registrations, the directors, officers and shareholders of these corporations must still comply with numerous state and federal regulations when it comes to selling shares of stock. In fact, it can be argued that in the smaller more intimate setting of a closely held private corporation, the risk of fraudulent activity is particularly troubling. For more on exemptions to registration requirements, see “Exemptions to Registering Federal Securities with the SEC“. Given the inherent risk and associated governmental requirements, it is important that corporate officers consult with an experienced corporate attorney before issuing shares of stock.

the-other-one-1241639.jpgA well drafted stock purchase agreement not only protects both the seller and purchaser of stock, it ensures that the corporation is in compliance with securities regulations. It should evidence a transparent transaction. Full disclosure (offering complete access to corporate transactional and financial records) is the key to complying with securities regulations. The idea of course is to ensure that the purchaser is fully informed as to the risk associated with the investment. The stock purchase agreement will also set forth the price per share, the number of shares, whose shares are being sold, the class of shares being sold, the effective date of the transfer and other terms and conditions governing the sale. The stock purchase agreement should clearly define each party’s rights and obligations going forward.

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Landlords desire radius restrictions in commercial leases for two main reasons: where the landlord is entitled to percentage rent, a competing business within the restricted radius may dilute the landlord’s income; and more generally a competing business within the restricted radius can have a negative impact on the exclusive nature of the shopping center.  For example, a national fashion chain with a significant lure draws shoppers to the center – shoppers attracted to that particular chain.  Opening the same chain too close to the center threatens to dilute the landlord’s traffic.  Retail landlords take great care to manage the shopping center’s mix to maximize foot traffic.  For either reason, reasonable radius restrictions are legitimate in San Diego commercial leasing.  However, tenants should take care to ensure that these clauses are carefully worded to limit the restrictions.  Particularly, it’s important that the “radius” of the restriction, the term of the restriction and the scope of the restriction are all specifically defined.  

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Defining the Radius:  Most commercial leases tend to broadly define the distance covered by a radius restriction – usually to about a five mile radius.  In such cases, the parties may have different understandings as to how the radius is measured.  A five mile radius might mean five miles as the crow flies in any direction from the store’s precise location or it could mean five miles in any direction from the boundaries of the shopping center.  In addition, five miles as the crow flies in a specific direction could fall on the edge of a competing shopping mall.  In that case, opening up shop just feet away from the maximum distance would still have the negative impact the landlord was attempting to avoid in the first place.  Landlords and tenants can avoid this type of confusion by clearly defining how the radius is determined.  Stating where the radius is measured from is a good start.  Defining the area more specifically on a street-by-street basis or using particular landmarks is even better.  
The Term of the Restriction:  The term of a radius restriction typically coincides with the term of the lease.  However, problems can arise when a lease is terminated prematurely.  If the tenant has an early termination right, it’s important that the radius restriction terminate simultaneously.  It’s also common for tenants to start developing new opportunities in anticipation of the end of a lease term.  This would be a problem if the radius restriction broadly defines the restricted activity as “running, operating, investing in or developing” a competing business.

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One of the most misunderstood concepts in litigation is the concept of proof. San Diego business owners know when someone or some other business has committed a wrong. They know if a business partner has stolen from them, when a deal has been broken or when someone fraudulently induced them into a bad deal. Because of this confidence, business owners often walk into an attorney’s office expecting an unqualified validation of their claims. In some rare cases, it may be true that a party has a virtually guaranteed win. Unfortunately, in most cases, prospective litigants face numerous hurdles involving significant litigation fees and costs, legal hurdles (including defenses), damages and amassing admissible evidence (proof) all of which vary the risk of loss. This article provides a brief summary of issues of proof in California litigation.

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It’s the attorney’s job to evaluate the case and give the client a frank assessment of what lies ahead. A good attorney will be careful to qualify her assessment pointing out various problems that may lie ahead including potential problems with proof. The client tells his story and while the attorney is listening, she is picturing how admissible evidence will be gathered and presented at trial. This often creates a disconnect between attorney and client leaving the client feeling flat. However the business owner might feel, it is important that he accept his attorney’s frank assessment especially when he has talked with several attorneys who are all providing similar evaluations. In fact, an attorney giving different advice might be blowing smoke to do whatever it takes to engage the client. It’s extremely important for prospective litigants to understand that what they personally know and what they can actually prove with admissible evidence are not always the same. Accepting these realities is often complicated because of the client’s personal and emotional connection to the dispute.

There are two key types of evidence presented at trial: witness testimony and documentary evidence. Both types of evidence come with a host of evidentiary and foundational requirements that in their entirety are beyond the scope of this article. However, there are some important evidentiary issues that assist the lay person in better understanding what their attorneys are trying to accomplish:

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