A Strong Letter of Intent Will Increase Your Leverage When Negotiating a Restaurant Lease
Before negotiating a commercial lease, the landlord and tenant typically sign a letter of intent (LOI), essentially an agreement in principle setting forth the important business terms of the deal. This short document, which specifies the space to be leased, what it will cost and other material terms to be reflected in the lease, is not a binding contract. But when lease negotiations begin, and you want a provision that is contrary to what was in the LOI, the opposing party will demand a concession in return. Therefore, a strong and well-thought-out LOI will strengthen your position when it's time to negotiate your lease.
Drafting Your LOI
After identifying a suitable location, a prospective restaurant tenant typically works with a real estate broker to draft an LOI for review by the landlord. Several turns of the LOI between the parties are common before it is finalized. Sometimes, tenants do not consult an attorney at the LOI stage but first, reach out to one when drafting the lease. After discussing the ramifications of the terms of the LOI with an attorney, the tenant may try to make a material change when the lease is drafted, which is often called re-trading. When one side re-trades, the other side will likely want a concession of its own – and the horse-trading will begin.
To avoid these issues, consult an attorney to either draft or review your LOI before you sign it, preferably before each “turn” of the document, but at a minimum, prior to sending the initial draft to the landlord. We provide our clients with LOIs that have form language containing numerous provisions.
Below are five important provisions that restaurant tenants should include in their LOI.
1. Lease Terms
Our restaurant clients interested in a 10-year lease will typically look for at least two five-year lease options to extend the term beyond the initial 10-year term. This provision, which gives tenants greater flexibility, should be specified in the LOI. If a lease expires in the fourth quarter of the year, we include a provision for an automatic extension for the holidays. Most restaurants enjoy a holiday sales bump from November through New Year’s, and extending the lease to January 15 will protect those holiday sales in the final year of the lease.
2. Assignments and Permitted Uses
Flexibility in your LOI is important in the event you decide to sell or relocate your restaurant. The assignment and subletting language in our form letters protect the tenant’s flexibility by stating that the landlord cannot unreasonably withhold consent if the tenant wants to sublet or assign the lease to another business for the location specified in the LOI, but no consent is required if all or a significant number of the locations are being sold. Landlords like to have a say in who their tenants are; therefore, it is an important element to specify in the LOI. The LOI should state that the property will initially be used for the tenant’s trade name and use and thereafter for any lawful restaurant or retail use. This will allow for changes to the trade name of the tenant and the permitted use.
3. Subordination to Lenders
You must indicate that the lease will not be subordinate to any mortgages or superior liens without a commercially reasonable Subordination, Non-Disturbance and Attornment (SNDA) agreement. An SNDA is an agreement between the tenant, landlord and landlord’s lender that accompanies many commercial leases and contains certain protections for both lenders and tenants. When a financed property is leased, your investment may not be protected if your lease does not require an SNDA.
The SDNA protects tenants by stating that in the event of a foreclosure, the tenant can keep its space and maintain all its rights under the lease if the tenant is not in default. As a tenant, you should always insist on an SNDA when signing a lease. If not, you could lose your leased space in a foreclosure, and without the proper language, important terms in the lease that were negotiated may be modified by an SNDA that is not commercially reasonable. The LOI should state that your lease will not be subordinate to future mortgages unless you get a commercially reasonable SNDA. This will require the landlord and lender to negotiate a reasonable SNDA with you if the property is refinanced in the future.
4. Delivery of Premises
A good LOI also will state that the landlord is responsible for delivering the premises with adequate utilities, from HVAC systems to a grease trap, for your operation This is particularly important because utility upgrades are expensive. For instance, changing a water line from one to two inches in diameter or upgrading electricity can cost hundreds of thousands of dollars. Further, when a property’s use is changed from retail to restaurant, the municipality could charge one-time tap or fixturing fees for services like water or sewers. The landlord should cover these charges, which should be agreed to in the LOI. Certain structural systems and utilities may need to be put in place before the tenant can start the restaurant’s buildout. If this is the case, a work letter in which the landlord specifies the construction work it has agreed to do should be attached to the LOI.
5. Code Compliance and Free of Hazardous Material
Your LOI should also reflect that the landlord agrees to deliver the property free of hazardous materials and in compliance with all laws and regulations, including the Americans with Disabilities Act (ADA). Bringing a property into ADA compliance can be a large expense and significantly impact the design of your restaurant, so it’s important that you do not have to trade for this when negotiating the lease. Even if you are taking the Premises “as-is,” these items should be carved out and remain the Landlord’s responsibility.
Ensuring you have a strong and well-thought-out LOI will give you more leverage and help ensure you can negotiate a favorable restaurant lease.
Eric D. Bernheim, a managing partner at FLB Law in Westport, Conn., represents local restaurants and national hospitality groups, as well as developers, municipalities, lenders, and individuals, in transactions of all kinds, including leases, acquisitions, dispositions and financing, in addition to handling zoning and land use matters. Contact Eric at bernheim@flb.law or 203.635.2200. For more information about FLB Law, click here.