Barry H. Josselson, A Professional Law Corporation, and
A. Lee Maddox DDS, A Professional Law Corporation
Abstract: The dentist’ office lease is one of the most critical legal agreement the dentist will sign in his or her professional career. Understanding the numerous economic and non-economic points of lease is integral to the success of one’s practice. This article discuses 10 key points that will ensure a fair and equitable lease agreement.
Unlike associateship relationships, which can be terminated, or partnerships/corporations with other dentists, which can be dissolved, the dentist’s office lease cannot be ended unilaterally by the tenant or breached without impunity without the dentist’s incurring substantial legal risk, liability, and economic fallout. Accordingly, the dentist’s understanding the numerous economic and non-economic poitns during the course of negotiations with the landlord and the dentist’s real estate attorney’s perusal of the dental lease are integral factors to the success of the dentist’s practice. Considering the following 10 key points will ensure a fair and equitable lease agreement and business relationship with the landlord for years to come.
The proposed lease submitted to the dentist is simply the landlord’s first offer of the terms of the contemplated relationship. Many dentists bleieve that beacuase the leaes offered to them is in writing or ina pre-printed form, it is not subject to modifcation or revision. Some dentists are wrongfully informed by their lieasing agents that their proposed leaes has been signed by all of the other tenants without revision (the incoorrect implication being that the lease must be fair; otherwise, tenants would not have signed it). Northing is further from the truth. All office leases are drafted in favor of the landlord; the only issue is whether the lease has been drafted slightly on-sided, moderately one-sided, or extremely one-sided in favor of the landlord. Lease provisions favoring the landlorder, however, will neither be prominently noted nor highlighted in the document. Instead, the dentist’s lease will be prepared by the landlord’s attorney or landlord’s real estate association to favor either their client or their constituents, respectively, and not to accentuate those lease provisions that have been intentionally drafted in favor of the landlord rather than the dentist tenant. Any agreement can be negotiated. An analysis of the lease and negotiation of the terms with landlord need not be acrimonious or hostile events, but simply the first steps in communication to the landlord the dentist’s desire to have the landlord-tenant relationship be fair and equitable. Recommendation: The dentist should always consult with a real estate attorney specializing in dental office lease before signing any long-term leases.
Options to Renew the Leases:
An option to renew is a wonderful tool to provide the dentist with flexibility. At the end of the lease term, the tenant has the “option” to remain in the premise by notifying the landlord of the dentist’s intent to stay. Or, to the contrary, if the dentist determines that it makes more sense to relocate to new premises, he or she reserves the right to leave without having previously entered into a longer-term lease. Options to renew, therefore give one the security of a possibly long-term lease without having to make a commitment to a long-term lease. most options to renew are for periods from three to five years. The value of one’s option to renew, however, can be severely limited by the landlord in the following ways:
1) Many leases allow only the original tenant to exercise the option to renew, not any buyer of the dental practice. This limitation will not be conspicuously disclosed in the document, Instead, most leases innocuously state the option to renew is “personal” or “unique” to the original “tenant” of the lease. If the proposed purchaser of one’s dental practice is not able exercise the previously negotiated option to renew, this could adversely affect the value of the practice, especially if there are only a few years left on the dentist’s current lease. The risk that the current landlord might not renew the lease to the prospective buyer on that the lease may be renewed albeit at a substantially higher rental rate is significant and should be avoided.
2) The determination of fair market rent can also be fraught with risk. A careful perusal of the rental rate forumula found in many options to renew reveals what appears to be an equitable definition of the fair market rental of the premises based upon current rents behing charged for comparable space in similarly situated properties. however, the dentist must examine more closely many of these formulas. Some will state that the rental rate shall be the greater of fair market rental or the last year’s rental rate. The result: In an escalating rental real estate market, fair market value shall provide the land lord with great upside potential. In a falling renmtal real estate market, if true fair market rents are below the last year’s rental rate paid by the dentist, the lease mandates that the rental rate paid by the dentist during the option period shall still be the last year’s rental rate (even though such rental rates could be far in excess of the lower fair market rental rate).
Assignment or Subletting of the Lease:
The assignment or subletting of the dental lease to a prospective purchaser is critical to the later sale of the dentist’s practice. Very few practices are sold to buyers who intend to move the practice to another location. Moving can cause substantial patient attrition as well as substantial costs in building out, a new office. Therefore, the dentist’s ability to assign or sublet her or her lease freely and without unreasonable restraint to the buyer is crucial. The landlord can limit the dentist’s ability to assign or sublet the lease in the following ways:
1) If the lease states that the landlord’s consent “may be arbitrarily with held,” withheld at the landlord’s sole discretion,” or other words. similar in effect, the landlord can unilaterally withhold consent at the time that the dentist requests the lease to be transferred to his or her buyer. No buyer of a dental practice will consummate a sale without locking a long-term lease securing the investment the buyer has just made. Moreover, sophisticated dental lenders will not lend money to purchase without the lease term (with an option to renew) being equal in length to the term of the practice purchase loan. instead, the lease should state that the landlord’s consent”shall not be unreasonably withheld”.
2) An increasing number of dental office leases provide that 100 percent of the rental income (received by the dental subletting the premises) in excess of the rent obligation due under the lease (by the subletting dentist) must be paid to the landlord. the dentist should try to delete such obligations or negotiate a lesser percentage than 100 percent. most importantly, the description of the “consideration” to be paid to the landlord should be limited to only sublease rental income and not any consideration for goodwill, covenant not to compete, or leasehold improvements received by the dentist when selling his or her practice. Otherwise, the landlord may legitimately claim a right to part or all of the practice sales proceeds received by the seller from the buyer of he dental practice.
3) The “recapture clause” gives a landlord the right to “take back” the premises even if the dentist has followed the protocol of first seeking the landlord’s approval of the proposed buyer of the practice prior to the transferring the lease. Such a recapture clause innocuously states that the landlord can consent to the assignment or, in the alternative, assign the lease to itself in lieu of the proposed buyer. Such recapture clause is placed in leases and is exercised by landlords in escalating real estate markets or in those situations in which the landlord is not able to withhold its consent to the proposed buyer. Such a “recapture clause” must be stricken from the lease document.
4) Rent increase and repayment of tenant improvements allowances can be costly hidden surprises. When a dentist assigns his or her lease to a new buyer, the buyer has purchased the dental practice in contemplation of paying rent under the lease according to the selling dentist’s rent schedule negotiated at the time when the selling dentist initially signed such document. more and more leases have language in the documents stating that “as a condition for the landlord’s consent to any assignment,” the landlord may raise the rent or be repaid by the selling dentist all the money which the landlord spent for the leasehold improvements in building out the seller’s dental office Such provisions are unacceptable and should be removed from the agreement.
5) All leases provide that the selling dentist’s assignment of the lease to another dentist will not release the seller from any liability if such buyer later defaults under the lease. The language that provides that the selling dentist shall remain liable should be deleted, especially since the landlord will have previously approved the buyer as a bona fide and qualified party to assume the seller’s lease.
We will be posting additional items to cover while negotiating your dental office’s lease. For more information, please contact Barry Josselson at (800) 300-3525