Industrial and Warehouse Leases

When it comes to drafting an industrial or warehouse lease, you may be tempted to assign the work to your newest associate or to wait until the last minute under the assumption it will be straightforward to complete. Do so at your own peril! Although the space being leased is likely a boring tilt-wall box, the variety of potential uses for the building can make an industrial lease extremely complex. Under-negotiation of the lease by either landlord or tenant can result in unexpected costs and issues.

This article discusses five areas of industrial leasing that may need special attention during lease drafting and negotiation, depending on the facts at hand: maintenance and repair obligations, installation of specialty equipment, issues related to tax abatement and public financing, premises condition on surrender, and environmental issues. These topics, while hardly all-inclusive, represent general areas of concern where parties can run into unexpected issues, including disputes and litigation, which can be avoided through careful drafting and negotiation.

Maintenance and Repair Obligations

Your first instinct may be to rely on the familiar language of office and retail leases when drafting maintenance and repair obligations for the industrial space. Do not follow that instinct. Typical office and retail leases generally split the structural maintenance and repair obligations between landlord and tenant by making the tenant responsible for the non-structural portions of the premises, and the landlord responsible for the structural portions and common areas (with a carve-out for any damage actually caused by the tenant). Such a division of responsibilities makes sense only when tenants are using the space in a manner that will not result in any appreciable damage to the premises, an assumption that is not necessarily true for an industrial use.

Disputes can arise when a tenant's permitted use under the lease results in damage to the premises and the lease does not clearly assign responsibility for repairing the damage. As an example, a tenant leases space in an industrial building under a use clause that defines permitted uses as storing, warehousing, and distributing steel and steel-related products. Such use necessarily requires the tenant's employment of forklifts and heavy equipment, and both parties fully expect the tenant to use such equipment in the space. However, what happens when the tenant is using the space as permitted, and the slab begins to crack (not through any malfeasance of the tenant or landlord) as a result of a tenant's use? Under the typical office/retail maintenance and repair provisions discussed above, the landlord could argue that the tenant is responsible for repair of the slab (even though it is a structural portion of the premises) since the damage was caused by the tenant. Conversely, the tenant could argue that it could not have “caused” the damage to the slab since its activities fall within the permitted uses of the lease. This dispute can get more complicated if the tenant can argue that the slab was not designed to support tenant's use to begin with, but the landlord knowingly leased it to the tenant anyway.

These unresolved ambiguities can lead to disputes between the landlord and tenant and, ultimately, costly litigation. Operations at the premises could be at a standstill while the parties dispute who is obligated to make repairs, further imperiling the tenant's business and potentially leading to additional disputes between the landlord and tenant over tenant's obligation to pay rent while it cannot use the premises.

An industrial lease must be negotiated to address the interaction between the tenant's use and potential damage, repair, and maintenance obligations. If a tenant is going to use heavy equipment, the tenant should consider having the premises inspected to ensure that the slab will support the intended use. If a landlord contractually obligates a tenant to repair and maintain the structural portions of the premises, the landlord will need to ensure that such action does not negate any construction warranties, including the roof warranty, and it will need broad inspection rights to confirm that the tenant is complying with its obligations under the lease.

Installation of Specialty Equipment

Industrial tenants often have specialized uses for industrial spaces, which includes the installation and operation of specialized equipment. Such uses can require additional resources, like higher electrical or HVAC capacity, or special structural alterations that must be properly addressed in the lease. In such situations, tenants need to be familiar enough with the potential premises to ensure that the premises can be built-out: 1) within a reasonable period of time; 2) at a realistic cost; 3) without having to gut the space at the beginning of the lease term for installation; and 4) without having to remove what was done during the initial build-out at the end of the lease term. Landlords want to make sure that they do not get a space back that has a very unique build-out that is not attractive to other tenants or that will be expensive to rehab and restore once the tenant is no longer using the premises. Common examples of specialized equipment include conveyor lines, wet labs, and raised flooring.

Some general items the lease and construction work letter attached to the lease should address include upgrades to the base building, construction issues, and land use issues. If possible, detailed plans and schedules for the installation of specialty equipment should be included as an addendum to the lease. The tenant will want to confirm that the existing base building systems can be upgraded to support the specialty equipment and that the existing fire sprinkler system is adequate and/or can be upgraded at a reasonable cost. The parties should verify that the specialty use is permitted under zoning, land use, or other regulations and that proper permits are obtainable for construction and use. Potential construction disputes and delays can be avoided by: 1) agreeing on processes for dealing with construction delays; 2) having the landlord and tenant mutually agree on approved specialty contractors that can perform the work; and 3) having approved preliminary or final plans at the time of lease execution. If possible, detailed plans and schedules for the installation of specialty equipment should be included as part of the lease.

Additionally, the lease should address any specific concerns of the landlord and tenant regarding the installation of specialty equipment, including the right to use roof/risers/other portions of the project, security issues, and measurement of costs for above-standard use of utilities and other services. For example, the tenant may need access to the roof or riser space of the building to install support equipment. The landlord should require that the tenant perform any roof work in a manner that does not negate the roof warranty and does not interfere with the rights of other tenants to use their specific premises or the roof. The tenant will need additional access to the roof to maintain any equipment it has installed which access must also be similarly restricted.

Confidentiality Issues

If a tenant is using all or a portion of the premises for a confidential use such as a test lab, it will be important for the tenant to limit landlord's access to the affected space. This requirement creates unique security and confidentiality issues, and such arrangements should be addressed in the lease. The landlord will usually take the position that it owns the premises and needs unrestricted access. One compromise is for the tenant to give the landlord a key to use in emergency situations and to allow the landlord to enter the space on a limited basis to inspect it. Tenants in that situation often ask landlords to sign confidentiality agreements, but some landlords may not find such agreements acceptable. Also, tenants may want to provide their own janitorial service to the premises to have control over the security clearance of the cleaning personnel.

Heating Ventilating and Air Conditioning (HVAC)

It is highly likely that tenants installing specialty equipment will also need to install supplemental HVAC units and other high-energy equipment to support the use of specialty equipment outside of typical building standard hours. Landlords will want the tenant to pay for any increase in operating costs above “building standard” due to such usage, and oftentimes the solution is simply to install separate meters to measure tenant's actual utility usage. The parties will have to negotiate the cost of such installation contractually, whether the tenant will pay the utilities directly to the provider, and the allocation of any additional administrative costs or wear and tear on building systems that this use engenders.

Backup Generators

Tenants may also need to install additional equipment such as backup generators to support specialty uses. It is likely that the support equipment will need to be installed outside of the premises in locations such as parking garages or other common areas. As a result, landlords may want to charge tenants additional rent to use space outside of the premises. Furthermore, having equipment owned by a tenant outside of the premise raises security and maintenance issues that the parties need to address clearly in the lease. Additionally, landlords may want the right to require tenants to leave equipment like backup generators upon lease termination.

It is typical for landlords to provide in a lease that the landlord can make the decision regarding removal of outside premises equipment in its sole discretion at the end of the lease term since landlords may not know until that time whether such equipment is something that another tenant may find valuable in its operations.

Public Financing, Tax Abatement, and Development Incentives

If public financing, tax abatement, or other government incentives are used to finance the construction of an industrial building, the landlord should consider how a transfer of the building or tenant's interest in the lease could affect the financing chosen. Funding examples include tax increment financing, industrial revenue bonds, or tax abatements to finance projects like building in blighted areas or incentivizing large employers to move new operations to a certain region to create jobs. Depending on the type of financing obtained, certain ongoing requirements may be imposed on the owner and tenants of the property as a condition to maintaining the incentives, abatement, and/or financing.

Such requirements could include reporting requirements, minimum employment requirements (such as number of employees and minimum wages), use of governmental programs for hiring workers, and any number of other negotiated requirements. A failure to comply with all of the requirements, even the notice and reporting requirements, may result in a revocation of the financing, abatement, or incentive. In some cases, the revocation can be retroactive back to the initial financing! Attention should be paid to any associated financing, abatement, or incentives when drafting and negotiating industrial leases to avoid unintended financial surprises or disputes.

Premises Condition on Surrender

Once again, it is unwise to rely on the familiar office/retail language regarding condition on surrender of the premises because industrial and warehouse leases require greater specificity to address tenant removal and restoration obligations. The typical office/retail lease requires the tenant to remove “furniture, fixtures, and equipment” at the end of the lease term. In the industrial lease context, this general standard can cause confusion because it is often unclear what constitutes “furniture, fixtures, and equipment” in a high-level specialty build-out. Failure to address such ambiguity will leave landlords and tenants grappling with contentious factual determinations at the end of the lease, a time when their relationship is already strained by the tenant's departure and the landlord's need to deliver the premises to an incoming tenant in the condition required under that tenant's lease.

One way to avoid disputes upon lease termination is to specify what will need to be removed at the time of the landlord's approval of the tenant's construction plans. The tenant's restoration obligations should also be specified at that time. For example, if a tenant installs trenches, will it need to fill in those trenches and restore the slab and flooring as part of its restoration obligations? Additionally, the parties should consider the timeline for removal and restoration. If the removal and restoration will require an extended period of time, tenants should plan to stop operations prior to the expiration of the lease term unless the landlord permits the tenant to stay after expiration of the lease to complete removal and restoration. Landlords should be particularly careful to address these complex issues up front; otherwise, they could be stuck shouldering unexpected costs to restore the space or be delayed in bringing in a new tenant during a protracted dispute.

Environmental Issues

Once it is established that a tenant will likely be using hazardous materials, the parties should agree on how the potential environmental liabilities will be allocated between them. Landlords want to ensure that tenants are responsible for any contamination resulting from their use, and tenants want to limit their exposure to what is created under applicable law as a result of their use. You should avoid the temptation to leave liabilities unallocated just because they are unknown or not allocable in an acceptable manner to either party.

For example, neither the landlord nor the tenant will want responsibility for third-party contamination over which they had no control, but failing to allocate liability properly can lead to unwanted disputes and litigation. If you do leave liabilities unallocated, however, be careful to structure indemnities and waivers in the lease to exclude liabilities that are not allocated in the lease.

In addition to liability and indemnification, there are other specific areas regarding environmental issues that should be considered when negotiating an industrial lease. Landlords will want material safety data sheets for each hazardous material that the lease allows the tenant to keep at the premises, the right to conduct environmental audits during the term to ensure that the tenant is complying with laws in its use of hazardous materials, and a standard for clean up if remediation of contamination is required.

Both parties should establish the condition of the premises as of the lease commencement date, which can be done through a Phase I Environmental Site Assessment. In addition, a tenant should ask for representations by the landlord regarding the presence of hazardous substances and compliance with specified environmental laws, but the landlord, if willing to give such representations, will probably want to limit the representation to what is shown on the environmental site assessment without any independent obligation to inspect the condition of the premises. These issues should be addressed in a hazardous materials lease provision and negotiated carefully by both parties.

Conclusion

This article has presented only a few of the issues encountered when negotiating industrial leases, but hopefully it will serve as a warning not to underestimate the potential complexity of an industrial or warehouse lease. Just because the space may not be seen by customers or the general public does not mean that its lease should not be negotiated and drafted with thought and consideration of potential pitfalls. It is better to try to anticipate and avoid future disputes during the negotiation of initial documentation, a fact that is sometimes overlooked when dealing with industrial and warehouse leases.

Amy M. Mitchell is Senior Counsel at Norton Rose Fulbright and part of the Austin, TX, real estate practice group. Lara Kirkham is an Associate in the Austin office.

When it comes to drafting an industrial or warehouse lease, you may be tempted to assign the work to your newest associate or to wait until the last minute under the assumption it will be straightforward to complete. Do so at your own peril! Although the space being leased is likely a boring tilt-wall box, the variety of potential uses for the building can make an industrial lease extremely complex. Under-negotiation of the lease by either landlord or tenant can result in unexpected costs and issues.

This article discusses five areas of industrial leasing that may need special attention during lease drafting and negotiation, depending on the facts at hand: maintenance and repair obligations, installation of specialty equipment, issues related to tax abatement and public financing, premises condition on surrender, and environmental issues. These topics, while hardly all-inclusive, represent general areas of concern where parties can run into unexpected issues, including disputes and litigation, which can be avoided through careful drafting and negotiation.

Maintenance and Repair Obligations

Your first instinct may be to rely on the familiar language of office and retail leases when drafting maintenance and repair obligations for the industrial space. Do not follow that instinct. Typical office and retail leases generally split the structural maintenance and repair obligations between landlord and tenant by making the tenant responsible for the non-structural portions of the premises, and the landlord responsible for the structural portions and common areas (with a carve-out for any damage actually caused by the tenant). Such a division of responsibilities makes sense only when tenants are using the space in a manner that will not result in any appreciable damage to the premises, an assumption that is not necessarily true for an industrial use.

Disputes can arise when a tenant's permitted use under the lease results in damage to the premises and the lease does not clearly assign responsibility for repairing the damage. As an example, a tenant leases space in an industrial building under a use clause that defines permitted uses as storing, warehousing, and distributing steel and steel-related products. Such use necessarily requires the tenant's employment of forklifts and heavy equipment, and both parties fully expect the tenant to use such equipment in the space. However, what happens when the tenant is using the space as permitted, and the slab begins to crack (not through any malfeasance of the tenant or landlord) as a result of a tenant's use? Under the typical office/retail maintenance and repair provisions discussed above, the landlord could argue that the tenant is responsible for repair of the slab (even though it is a structural portion of the premises) since the damage was caused by the tenant. Conversely, the tenant could argue that it could not have “caused” the damage to the slab since its activities fall within the permitted uses of the lease. This dispute can get more complicated if the tenant can argue that the slab was not designed to support tenant's use to begin with, but the landlord knowingly leased it to the tenant anyway.

These unresolved ambiguities can lead to disputes between the landlord and tenant and, ultimately, costly litigation. Operations at the premises could be at a standstill while the parties dispute who is obligated to make repairs, further imperiling the tenant's business and potentially leading to additional disputes between the landlord and tenant over tenant's obligation to pay rent while it cannot use the premises.

An industrial lease must be negotiated to address the interaction between the tenant's use and potential damage, repair, and maintenance obligations. If a tenant is going to use heavy equipment, the tenant should consider having the premises inspected to ensure that the slab will support the intended use. If a landlord contractually obligates a tenant to repair and maintain the structural portions of the premises, the landlord will need to ensure that such action does not negate any construction warranties, including the roof warranty, and it will need broad inspection rights to confirm that the tenant is complying with its obligations under the lease.

Installation of Specialty Equipment

Industrial tenants often have specialized uses for industrial spaces, which includes the installation and operation of specialized equipment. Such uses can require additional resources, like higher electrical or HVAC capacity, or special structural alterations that must be properly addressed in the lease. In such situations, tenants need to be familiar enough with the potential premises to ensure that the premises can be built-out: 1) within a reasonable period of time; 2) at a realistic cost; 3) without having to gut the space at the beginning of the lease term for installation; and 4) without having to remove what was done during the initial build-out at the end of the lease term. Landlords want to make sure that they do not get a space back that has a very unique build-out that is not attractive to other tenants or that will be expensive to rehab and restore once the tenant is no longer using the premises. Common examples of specialized equipment include conveyor lines, wet labs, and raised flooring.

Some general items the lease and construction work letter attached to the lease should address include upgrades to the base building, construction issues, and land use issues. If possible, detailed plans and schedules for the installation of specialty equipment should be included as an addendum to the lease. The tenant will want to confirm that the existing base building systems can be upgraded to support the specialty equipment and that the existing fire sprinkler system is adequate and/or can be upgraded at a reasonable cost. The parties should verify that the specialty use is permitted under zoning, land use, or other regulations and that proper permits are obtainable for construction and use. Potential construction disputes and delays can be avoided by: 1) agreeing on processes for dealing with construction delays; 2) having the landlord and tenant mutually agree on approved specialty contractors that can perform the work; and 3) having approved preliminary or final plans at the time of lease execution. If possible, detailed plans and schedules for the installation of specialty equipment should be included as part of the lease.

Additionally, the lease should address any specific concerns of the landlord and tenant regarding the installation of specialty equipment, including the right to use roof/risers/other portions of the project, security issues, and measurement of costs for above-standard use of utilities and other services. For example, the tenant may need access to the roof or riser space of the building to install support equipment. The landlord should require that the tenant perform any roof work in a manner that does not negate the roof warranty and does not interfere with the rights of other tenants to use their specific premises or the roof. The tenant will need additional access to the roof to maintain any equipment it has installed which access must also be similarly restricted.

Confidentiality Issues

If a tenant is using all or a portion of the premises for a confidential use such as a test lab, it will be important for the tenant to limit landlord's access to the affected space. This requirement creates unique security and confidentiality issues, and such arrangements should be addressed in the lease. The landlord will usually take the position that it owns the premises and needs unrestricted access. One compromise is for the tenant to give the landlord a key to use in emergency situations and to allow the landlord to enter the space on a limited basis to inspect it. Tenants in that situation often ask landlords to sign confidentiality agreements, but some landlords may not find such agreements acceptable. Also, tenants may want to provide their own janitorial service to the premises to have control over the security clearance of the cleaning personnel.

Heating Ventilating and Air Conditioning (HVAC)

It is highly likely that tenants installing specialty equipment will also need to install supplemental HVAC units and other high-energy equipment to support the use of specialty equipment outside of typical building standard hours. Landlords will want the tenant to pay for any increase in operating costs above “building standard” due to such usage, and oftentimes the solution is simply to install separate meters to measure tenant's actual utility usage. The parties will have to negotiate the cost of such installation contractually, whether the tenant will pay the utilities directly to the provider, and the allocation of any additional administrative costs or wear and tear on building systems that this use engenders.

Backup Generators

Tenants may also need to install additional equipment such as backup generators to support specialty uses. It is likely that the support equipment will need to be installed outside of the premises in locations such as parking garages or other common areas. As a result, landlords may want to charge tenants additional rent to use space outside of the premises. Furthermore, having equipment owned by a tenant outside of the premise raises security and maintenance issues that the parties need to address clearly in the lease. Additionally, landlords may want the right to require tenants to leave equipment like backup generators upon lease termination.

It is typical for landlords to provide in a lease that the landlord can make the decision regarding removal of outside premises equipment in its sole discretion at the end of the lease term since landlords may not know until that time whether such equipment is something that another tenant may find valuable in its operations.

Public Financing, Tax Abatement, and Development Incentives

If public financing, tax abatement, or other government incentives are used to finance the construction of an industrial building, the landlord should consider how a transfer of the building or tenant's interest in the lease could affect the financing chosen. Funding examples include tax increment financing, industrial revenue bonds, or tax abatements to finance projects like building in blighted areas or incentivizing large employers to move new operations to a certain region to create jobs. Depending on the type of financing obtained, certain ongoing requirements may be imposed on the owner and tenants of the property as a condition to maintaining the incentives, abatement, and/or financing.

Such requirements could include reporting requirements, minimum employment requirements (such as number of employees and minimum wages), use of governmental programs for hiring workers, and any number of other negotiated requirements. A failure to comply with all of the requirements, even the notice and reporting requirements, may result in a revocation of the financing, abatement, or incentive. In some cases, the revocation can be retroactive back to the initial financing! Attention should be paid to any associated financing, abatement, or incentives when drafting and negotiating industrial leases to avoid unintended financial surprises or disputes.

Premises Condition on Surrender

Once again, it is unwise to rely on the familiar office/retail language regarding condition on surrender of the premises because industrial and warehouse leases require greater specificity to address tenant removal and restoration obligations. The typical office/retail lease requires the tenant to remove “furniture, fixtures, and equipment” at the end of the lease term. In the industrial lease context, this general standard can cause confusion because it is often unclear what constitutes “furniture, fixtures, and equipment” in a high-level specialty build-out. Failure to address such ambiguity will leave landlords and tenants grappling with contentious factual determinations at the end of the lease, a time when their relationship is already strained by the tenant's departure and the landlord's need to deliver the premises to an incoming tenant in the condition required under that tenant's lease.

One way to avoid disputes upon lease termination is to specify what will need to be removed at the time of the landlord's approval of the tenant's construction plans. The tenant's restoration obligations should also be specified at that time. For example, if a tenant installs trenches, will it need to fill in those trenches and restore the slab and flooring as part of its restoration obligations? Additionally, the parties should consider the timeline for removal and restoration. If the removal and restoration will require an extended period of time, tenants should plan to stop operations prior to the expiration of the lease term unless the landlord permits the tenant to stay after expiration of the lease to complete removal and restoration. Landlords should be particularly careful to address these complex issues up front; otherwise, they could be stuck shouldering unexpected costs to restore the space or be delayed in bringing in a new tenant during a protracted dispute.

Environmental Issues

Once it is established that a tenant will likely be using hazardous materials, the parties should agree on how the potential environmental liabilities will be allocated between them. Landlords want to ensure that tenants are responsible for any contamination resulting from their use, and tenants want to limit their exposure to what is created under applicable law as a result of their use. You should avoid the temptation to leave liabilities unallocated just because they are unknown or not allocable in an acceptable manner to either party.

For example, neither the landlord nor the tenant will want responsibility for third-party contamination over which they had no control, but failing to allocate liability properly can lead to unwanted disputes and litigation. If you do leave liabilities unallocated, however, be careful to structure indemnities and waivers in the lease to exclude liabilities that are not allocated in the lease.

In addition to liability and indemnification, there are other specific areas regarding environmental issues that should be considered when negotiating an industrial lease. Landlords will want material safety data sheets for each hazardous material that the lease allows the tenant to keep at the premises, the right to conduct environmental audits during the term to ensure that the tenant is complying with laws in its use of hazardous materials, and a standard for clean up if remediation of contamination is required.

Both parties should establish the condition of the premises as of the lease commencement date, which can be done through a Phase I Environmental Site Assessment. In addition, a tenant should ask for representations by the landlord regarding the presence of hazardous substances and compliance with specified environmental laws, but the landlord, if willing to give such representations, will probably want to limit the representation to what is shown on the environmental site assessment without any independent obligation to inspect the condition of the premises. These issues should be addressed in a hazardous materials lease provision and negotiated carefully by both parties.

Conclusion

This article has presented only a few of the issues encountered when negotiating industrial leases, but hopefully it will serve as a warning not to underestimate the potential complexity of an industrial or warehouse lease. Just because the space may not be seen by customers or the general public does not mean that its lease should not be negotiated and drafted with thought and consideration of potential pitfalls. It is better to try to anticipate and avoid future disputes during the negotiation of initial documentation, a fact that is sometimes overlooked when dealing with industrial and warehouse leases.

Amy M. Mitchell is Senior Counsel at Norton Rose Fulbright and part of the Austin, TX, real estate practice group. Lara Kirkham is an Associate in the Austin office.