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Wins & Insights

Tenant Leasing Illustrated – Feb 2012 – Term Sheets and Exploding Muffins

Term Sheets and Exploding Muffins

A few years ago, in a great moment in culinary history, my son Adam managed to blow up his muffins in a 6th grade class cooking project.

It seems the chef of the future did not read the recipe carefully enough and put in two cups of baking soda instead of two tablespoons. Although a hit with his classmates, this did not exactly endear him to his teacher.

Much like a recipe, a term sheet (including a letter of intent or deal sheet) allows the parties to agree on all of the major business points (i.e., the ingredients) necessary for a mutually acceptable lease.

Yet, considering that the term sheet can have a major impact on the eventual lease, it is surprising how little attention it often receives.

Why is this so? In part, because leases themselves vary so greatly in size, complexity, timing and relative leverage of the parties.

For a fairly straightforward (generally, but not always, smaller) transaction, a two or three page term sheet that covers the basic business points (e.g., rent, escalations, tenant concessions, term, use, security deposit) and allows the parties to move quickly to the preparation of the lease may be appropriate (and required by the landlord).

Sometimes timing constraints require that even more complicated leases move quickly without a detailed term sheet – we represented a tenant in a 60,000+ sf lease in a new construction building that went forward with a relatively brief term sheet because our client was coming in as a substitute tenant on a broken deal and both sides had every incentive to move right to the lease negotiation.

For a more complex (generally larger) lease, it is not unusual to see a more detailed term sheet running 10 to 20 pages, covering for example an extensive build out, expansion and renewal options, hvac/electricity capacity, assignment/subletting rights, special uses, etc.

As the dollars involved increase, it gets harder for the tenant to turn the ship around once it has committed to a location and gets further into the transaction (and has incurred design and legal fees). In this situation, both landlord and tenant will have the incentive to finalize difficult issues in the term sheet.

Which is the proper approach for your lease?

To protect yourself without compromising the transaction, remember the “Goldilocks Principle”:

  • Term sheets that are insufficiently negotiated and comprehensive can miss an important issue or put off too much until the lease negotiation when the landlord generally has more leverage (“too cold”).
  • Term sheets that are overly negotiated and comprehensive can result in additional costs and delay (and possibly the loss of the deal) for the tenant (“too hot”).

Just like your porridge, term sheet negotiation and detail needs to be “just right.”

How do you find the right balance for your particular transaction? There is no magic formula; the answer will depend on the specifics of each deal, the parties’ relative leverage and the prevailing market conditions.

However, no matter the size or complexity of the particular lease, keep the following four things in mind when negotiating your term sheet:

  1. Make sure that the term sheet is not binding.This may seem obvious. Almost every term sheet that will be circulated by a landlord will already provide that it is not binding, but without clear language to that effect a contract could be formed between the parties.
  2. Clarity in drafting is just as important at the term sheet stage as at the lease stage.Even if not binding, the language in the term sheet carries too much weight in shaping the final lease to take lightly. You can count on the landlord treating any language in the term sheet in its favor as if it were etched in stone. Mistakes and ambiguities need to be clarified.
  3. Remember that leverage will shift once the term sheet is agreed upon and likely not in your favor.Since the term sheet is the recipe that sets the parameters of the lease, there will be expectations that the ingredients have been agreed upon. It will be hard to make significant changes later on.

    To the extent possible and subject to the Goldilocks principle, raise the issues that you view as important as part of the term sheet.  Once you agree upon the terms, settle on a location and move on to the lease, the same business item that the landlord might have thrown in before for free will likely have a price (and at that point you may feel that it is a price you have to pay).

  4. Engage your leasing team while negotiating the term sheet.An experienced broker will properly lead the negotiations and cover the necessary business issues, but it is helpful to assemble and focus your full team (broker, architect/engineer, attorney, project manager and/or in-house facilities manager) at the term sheet stage.

    This is the perfect time to thresh out your most important concerns and allow each member of your team to understand his or her role and how best to work together. Each team member should review and provide input to the term sheet.

    For example, your architect/engineer may raise particular design or facilities concerns that you might not otherwise address (e.g., the need for rights outside the premises or for supplemental hvac) and a legal review will provide a different focus and attention to detail that can save time and money later on.

Remember; focus on the term sheet so that it becomes the recipe for a successful lease. In the meantime, Adam is always available to cater your next brunch.