In the Spotlight: Address Exclusions from Operating Expenses Prior to Lease Negotiations

Exclusions from operating expenses are frequently the subject of much wrangling between landlords and tenants in lease negotiations. Many sophisticated parties will deal with such exclusions in the Letter of Intent, a method which allows the business people to focus on the issue early, rather than having the lawyers argue about it during the lease negotiation.

One way for tenants with leverage to protect themselves against significant increases in operating expenses (and also to avoid some of the hassle of negotiating exclusions) is to agree upon an annual cap on tenant's liability for increases in operating expenses. Landlords may be willing to entertain such a concept, but generally will insist that any cap apply only to items that are not “controllable.” Letters of Intent will sometimes include a cap on “non-controllable costs” and leave the definition of “controllable” up to the negotiating lawyers. Not surprisingly, lawyers are quite likely to disagree on this point. It may be prudent for the parties to address the issue directly, rather than paying for their respective counsel to argue. At a minimum, controllable costs should expressly exclude real estate taxes, insurance, seasonal maintenance such as snow removal, sanding, etc., and utility costs. Landlords may also attempt to exclude wages and benefits pursuant to collective bargaining agreements, non-insured casualties, and legal compliance, but savvy tenants (particularly those with leverage) will not necessarily accept such exclusions to an expense cap. As in any other lease negotiation, the more attention given to the issue by the parties when the deal is struck, the less likelihood for misunderstanding when the lease is negotiated and executed.

Exclusions from operating expenses are frequently the subject of much wrangling between landlords and tenants in lease negotiations. Many sophisticated parties will deal with such exclusions in the Letter of Intent, a method which allows the business people to focus on the issue early, rather than having the lawyers argue about it during the lease negotiation.

One way for tenants with leverage to protect themselves against significant increases in operating expenses (and also to avoid some of the hassle of negotiating exclusions) is to agree upon an annual cap on tenant's liability for increases in operating expenses. Landlords may be willing to entertain such a concept, but generally will insist that any cap apply only to items that are not “controllable.” Letters of Intent will sometimes include a cap on “non-controllable costs” and leave the definition of “controllable” up to the negotiating lawyers. Not surprisingly, lawyers are quite likely to disagree on this point. It may be prudent for the parties to address the issue directly, rather than paying for their respective counsel to argue. At a minimum, controllable costs should expressly exclude real estate taxes, insurance, seasonal maintenance such as snow removal, sanding, etc., and utility costs. Landlords may also attempt to exclude wages and benefits pursuant to collective bargaining agreements, non-insured casualties, and legal compliance, but savvy tenants (particularly those with leverage) will not necessarily accept such exclusions to an expense cap. As in any other lease negotiation, the more attention given to the issue by the parties when the deal is struck, the less likelihood for misunderstanding when the lease is negotiated and executed.