Final Assessment: Loss Factors, Exit Strategies, and Use Clauses

Generally speaking, the majority of landlords consider their calculation of the rentable square footage (“RSF”) of a space to be non-negotiable.

From a tenant’s perspective, although not necessarily pleased to do so, the vast majority take an “it is what it is” mindset as to a landlord’s calculation of the loss factor (also referred to as “load factor”).

In certain markets, such as New York City, due to loss factor calculations including such things as the elevator shaft, a building’s lobby, stairways, public bathrooms, multi-tenanted floor hallways and other common areas, the rentable square footage a tenant is charged generally runs from a relatively low of 20% to quite possibly 40% or more over and above the usable square footage of a space.

“USF” stands for unusable square footage.

“RSF” stands for rentable square footage.

The “common area” of an office building can include such items as the building lobby, stairways, management office, a tenant’s private bathroom, hallways and elevator shafts.

A loss or load factor calculation is higher for space on a divided, multi-tenant floor when compared to that of a single-tenant user floor.

A loss or load factor calculation is greater for space on divided, multi-tenant floors because there is more common area on a divided floor.

Depending on the nature of the deal, marketplace, financial strength of the tenant, size of the space, and negotiating leverage that a tenant brings to the bargaining table, a large prospective tenant may request both (a) a verification of the RSF calculation by way of re-measurement or architect certification and (b) that the loss factor (also referred to as “load factor”) calculation be based on a locally, regionally, or nationally recognized measurement standard.

In certain markets, it would not be unusual for a tenant to request the inclusion of language in their letter of intent requiring the percentage used by the landlord for the loss factor calculation to not exceed a certain set amount.

If a retail space in an office building does not have access through a door within the space to the lobby of the building (effectively rendering their retail space void of any building common areas), a reasonable argument can be made by the tenant that the rentable square footage calculation be equivalent to the usable square footage calculation for their space.

As a general rule, a tenant improvement allowance being provided to a tenant by a landlord should be calculated using the space’s usable square footage, and not its rentable square footage calculation.

A carpet vendor or contractor should base their proposal for flooring of a space on the carpetable area of the space, and not the landlord’s rentable square footage calculation.

If a tenant is receiving an improvement allowance from its landlord, although it would most definitely prefer to have its space measured with a low loss factor (also referred to as “load factor”), one benefit of a higher loss factor is that attributable to the fact that its calculation is based on the higher rentable square footage calculation, and not a lower usable square footage calculation.

Generally stated, virtually all commercial landlords feel that it is their right to (a) receive all or the majority of rental profits from the space it leases to a tenant, and (b) control the “tenant mix” (i.e., who will occupy space in its building).

It is important for a landlord to insert language into its initial lease draft which allows a landlord the right to recapture and/or leaseback a tenant’s space if and when a tenant requests to assign its lease or sublease its space.

It is important for a landlord to insert language into its initial lease draft which allows a landlord the right to consent to a tenant’s request to assign its lease or sublet all or a portion of its space.

It is important for a landlord to insert language into its initial lease draft which allows a landlord the right to require the tenant entity, and any lease guarantors, to remain liable in the event of a lease assignment.

From a tenant’s viewpoint, in the case of an assignment of its lease involving (1) a sale of a tenant’s assets or business, or (2) a transfer to a related entity such as a parent, affiliate, subsidiary or franchisor, or a sublet to a permitted subtenant such as one for a permitted desk sharing arrangement, landlords should waive their right of recapture, leaseback, profit sharing and, subject to terms and conditions agreed to by landlord and tenant in advance, the need to obtain landlord’s consent.

From a tenant’s viewpoint, a narrowly defined “permitted use” provision limits a tenant’s right to sublet its space or assign its lease.

A tenant should counteract a narrowly defined “permitted use” provision in the initial draft of a lease by amending the language to be as broad as possible (e.g., changing “a nail or hair salon” to “a nail, wellness, hair and/or beauty salon, and/or other retail uses pertaining to the health, appearance, and/or fitness of both men and woman, with the ancillary sale of men and woman’s clothing and health related products”).

Tenant advocates should attempt to secure language that states that if the majority principal or principals of the assignee sign a guaranty similar in form to the straight, limited or good guy guaranty signed at lease execution by the principals of the assignor, then the assignor’s principals (i.e., the original guarantors) will no longer have any personal liability subsequent to the effective date of the assignment.

A common landlord condition and restriction found in a renewal option provision is to limit the exercise of the renewal and expansion options of tenant to the original named tenant only.

In a retail lease, the longer that remains on the term of the lease, the harder it will be for a tenant to extract a greater value from its assignee.

Tenant advocates should attempt to secure language that states any renewal and expansion rights contained in the lease must extend to any related entities and permitted assignees of the named tenant.

Subject to previously agreed upon terms and conditions, tenants should attempt to secure the right to a partial sublet (i.e., a desk sharing arrangement for up to 20% or more of the tenant’s space) without the landlord’s prior consent.

It is in the landlord’s best interest to provide the tenant with a broadly defined use clause.

Generally, landlords prefer to define the tenant’s use clause very narrowly in order to have control over its property, the profits derived therefrom, and its tenant mix.

A use clause has no impact on a tenant’s ability to assign or sublet its space.

For a tenant, a broad use clause enables the tenant to have greater flexibility when trying to assign or sublet its space.

A use clause which states “for any lawful retail dry or wet use,” is non-beneficial for the tenant.

Landlord advocates should include language into the lease along the lines of: “Tenant must agree that it and anyone holding through tenant shall not use, sublet or assign all or any portion of the premises to any subtenant or assignee who will use the premises or a portion thereof for certain designated uses nor for any other use which is substantially similar to certain designated uses” (with a list of the prohibited designated uses included in the lease).

In determining a tenant’s use, the landlord should not consider the exclusivity provisions that it agreed to with other tenants in the building.

The following usage restrictions are examples commonly found within commercial leases: (i) no federal, state or local governmental division or agency which generates heavy public traffic; (ii) no union or labor organizations; and (iii) no chemical or pharmaceutical company.

When evaluating whether to permit a certain type of use, landlords won’t ordinarily consider whether the use will increase operating expenses of the building or add to traffic in the lobby of the building.

Common remedies for landlords if their tenant breaches the exclusive use provision in the lease are the right to restrain the same by injunctive relief and/or terminate the lease.