Additional-Rent Reconciliation

Perhaps some of the most commonly scrutinized language in a commercial lease resides in the additional rent provisions, relating to charges to be recovered by the landlord from the tenant on account of operating costs and taxes. Commercial leasing lawyers are well aware of the emphasis placed on negotiating operating-costs provisions and carefully examining the particular items proposed as chargeable or excluded, as well as the timing and manner of payment for these expenses.

A prototypical definition of “operating costs” found in a landlord's standard form of net lease contains wholesale inclusion of charges of every nature and kind with respect to the landlord's operation, maintenance, repair, replacement, insurance and service provision in connection with the shopping center or project, with each item characterized as inclusively as possible. In many cases, tenants (or tenants' counsel) will expend much time and effort in seeking exclusions or otherwise limiting the scope of the inclusions and the generality of the additional rent language. Often, upon conclusion of these negotiations, the resulting provisions vary substantially from the original standard form.

In most net leases, the landlord provides the tenant with a forecast of annual additional rent in the form of estimated per-square-foot rates for both operating costs and taxes. The landlord then charges the estimated rates to the tenant on a monthly basis, concurrently with its collection of monthly base rent. At the end of each particular year to which the estimates relate, the landlord reconciles the actual costs incurred or chargeable on account of operating costs and taxes against the estimates to determine the nature of the adjustment that must be made. The difficulty is that these resulting annual statements often only provide a summary level of detail, and it is prudent for a tenant to examine the information with a view to determining its consistency with the terms agreed upon in the lease.

In some cases, annual statements may be prepared on a blanket basis without necessarily taking into consideration the negotiated nuances of each lease. In essence, it is possible that the identified line-item charges may simply be allocated to each tenant uniformly, on the basis of the landlord's precedent standard form, without customization for each tenant receiving the statement. For this reason, tenants are advised to request detailed supporting documentation to determine the accuracy and eligibility of the operating costs and taxes stated as being recoverable by the landlord — and review same in conjunction with the particularities contained in that tenant's specific lease. Indeed, it is often the case that, upon review by the tenant, any given annual statement may not be objectionable at first blush if the overall charge is consistent with the tenant's expectations, or is not a great departure from the amount of the estimate on a per-square-foot basis.

Negotiating Access and Disclosure Rights

The ability of a tenant to learn more about the contents of an annual statement and its supporting documentation should be explored during the lease negotiation process. Naturally, a tenant will want to seek as much disclosure as possible of this information, and several different approaches can be employed to achieve varying levels of access.

For a landlord, the desire for uniformity among its leases in a given shopping center drives the view that access and disclosure rights afforded a tenant should be as limited as possible across the board. The first position that should be taken by the landlord is essentially that the “statement is the statement” — the end. From a drafting perspective, the landlord's obligations relating to disclosure would be framed as limited to its delivery of the statement of actual costs to the tenant.

The ideal reconciliation scenario for a tenant, in contrast to the landlord's preference for brevity and simplicity, is an approach that provides the greatest possible access to the landlord's records: full audit and inspection rights. For tenants with clout, like anchors and large national-chain tenants, achieving some level of audit ability is a likely prospect.

In the event a landlord does concede audit rights to a tenant, it is prudent for the landlord to qualify the language carefully in order to place certain restrictions and conditions on what information the tenant may access; how and by whom it may be accessed; and for what periods and within what time frames it may be accessed.

A middle-ground approach to the tension between basic statement delivery and full audit rights might entail a right for the tenant to request copies of the landlord's records. This is a cost-effective, yet relatively comprehensive, method for the tenant to gain a window into the landlord's additional rent allocation process without the complexities of requesting and undertaking a full audit.

We continue our discussion in next month's newsletter.

*****
Lydia Pilch, a member of this newsletter's Board of Editors, is a partner at Goldman Sloan Nash & Haber LLP. Josh Rosen is an associate in the firm. The authors gratefully acknowledge the contributions of Jordan Barris, student-at-law.

Issues can arise in the context of additional rent reconciliations that occur pursuant to the provisions of a commercial lease. We examine herein specific concerns from both landlord and tenant perspectives relating to over- and under-payments of rent, improper charges, supporting documentation and auditing procedures, as well as potential bars to claiming recoveries.

In particular, we discuss the following issues: 1) The additional rent reconciliation process and thoughts on the interpretation of annual statements; 2) Matters relating to access, disclosure and audit rights and accompanying drafting considerations; and 3) Timing issues for recovery or overcharged or undercharged amounts in the context of the Limitations Act, S.O. 2002, c. 24 Sch. B (the LA) and the Real Property Limitations Act, R.S.O. 1990, c. L.15 (the RPLA).

Operating Costs and Reconciliation Statements

Perhaps some of the most commonly scrutinized language in a commercial lease resides in the additional rent provisions, relating to charges to be recovered by the landlord from the tenant on account of operating costs and taxes. Commercial leasing lawyers are well aware of the emphasis placed on negotiating operating-costs provisions and carefully examining the particular items proposed as chargeable or excluded, as well as the timing and manner of payment for these expenses.

A prototypical definition of “operating costs” found in a landlord's standard form of net lease contains wholesale inclusion of charges of every nature and kind with respect to the landlord's operation, maintenance, repair, replacement, insurance and service provision in connection with the shopping center or project, with each item characterized as inclusively as possible. In many cases, tenants (or tenants' counsel) will expend much time and effort in seeking exclusions or otherwise limiting the scope of the inclusions and the generality of the additional rent language. Often, upon conclusion of these negotiations, the resulting provisions vary substantially from the original standard form.

In most net leases, the landlord provides the tenant with a forecast of annual additional rent in the form of estimated per-square-foot rates for both operating costs and taxes. The landlord then charges the estimated rates to the tenant on a monthly basis, concurrently with its collection of monthly base rent. At the end of each particular year to which the estimates relate, the landlord reconciles the actual costs incurred or chargeable on account of operating costs and taxes against the estimates to determine the nature of the adjustment that must be made. The difficulty is that these resulting annual statements often only provide a summary level of detail, and it is prudent for a tenant to examine the information with a view to determining its consistency with the terms agreed upon in the lease.

In some cases, annual statements may be prepared on a blanket basis without necessarily taking into consideration the negotiated nuances of each lease. In essence, it is possible that the identified line-item charges may simply be allocated to each tenant uniformly, on the basis of the landlord's precedent standard form, without customization for each tenant receiving the statement. For this reason, tenants are advised to request detailed supporting documentation to determine the accuracy and eligibility of the operating costs and taxes stated as being recoverable by the landlord — and review same in conjunction with the particularities contained in that tenant's specific lease. Indeed, it is often the case that, upon review by the tenant, any given annual statement may not be objectionable at first blush if the overall charge is consistent with the tenant's expectations, or is not a great departure from the amount of the estimate on a per-square-foot basis.

Negotiating Access and Disclosure Rights

The ability of a tenant to learn more about the contents of an annual statement and its supporting documentation should be explored during the lease negotiation process. Naturally, a tenant will want to seek as much disclosure as possible of this information, and several different approaches can be employed to achieve varying levels of access.

For a landlord, the desire for uniformity among its leases in a given shopping center drives the view that access and disclosure rights afforded a tenant should be as limited as possible across the board. The first position that should be taken by the landlord is essentially that the “statement is the statement” — the end. From a drafting perspective, the landlord's obligations relating to disclosure would be framed as limited to its delivery of the statement of actual costs to the tenant.

The ideal reconciliation scenario for a tenant, in contrast to the landlord's preference for brevity and simplicity, is an approach that provides the greatest possible access to the landlord's records: full audit and inspection rights. For tenants with clout, like anchors and large national-chain tenants, achieving some level of audit ability is a likely prospect.

In the event a landlord does concede audit rights to a tenant, it is prudent for the landlord to qualify the language carefully in order to place certain restrictions and conditions on what information the tenant may access; how and by whom it may be accessed; and for what periods and within what time frames it may be accessed.

A middle-ground approach to the tension between basic statement delivery and full audit rights might entail a right for the tenant to request copies of the landlord's records. This is a cost-effective, yet relatively comprehensive, method for the tenant to gain a window into the landlord's additional rent allocation process without the complexities of requesting and undertaking a full audit.

We continue our discussion in next month's newsletter.

*****
Lydia Pilch, a member of this newsletter's Board of Editors, is a partner at Goldman Sloan Nash & Haber LLP. Josh Rosen is an associate in the firm. The authors gratefully acknowledge the contributions of Jordan Barris, student-at-law.