Articles

Medical Office Leases - Negotiating Key Issues

Shelley P. Morkovsky, Kathleen Quiroz and Jerry B. Cohen

M.D. News San Antonio (July 2009)

“An ounce of prevention is worth a pound of cure” – a phrase applicable in the practice of medicine and also in the practice of commercial real estate law. Having a commercial lease that properly suits your business is a key factor in the “health” of your medical practice. Therefore, before you enter into a lease for medical office space, you should carefully review and evaluate the terms of the lease and negotiate key deal points. If the broker or your prospective landlord tells you that the terms of the lease are not negotiable, do not be dissuaded. In the current real estate recession, you may have more leverage to negotiate desirable concessions or at least those that are deal breakers for you or your practice.

Limitations on Personal Liability
To limit personal liability, it is preferable that the tenant under a lease be a business entity (such as a professional association, limited partnership or limited liability company) rather than an individual. Leases typically identify the landlord and tenant on the front page and/or the introductory paragraph of the lease. If your professional association or other business entity will be the tenant under a proposed lease, make sure that each such provision properly identifies your entity as the tenant. Also, check the tenant’s signature block at the end of the lease. That signature block should include the name of the entity which will serve as the tenant and should designate the title (e.g., president) of the individual who will sign the lease on behalf of that entity. A defective signature block may give your landlord an opportunity to argue that the physician who signed the lease intended to incur personal liability.

If the named tenant is a business entity, the landlord will often require a personal guaranty from the physician or physicians who own that entity. If your prospective landlord demands such personal guarantees, you should consider negotiating limitations to those guarantees. For example, you may want to ask that each guaranty be limited to the guarantor’s percentage of ownership interest in the entity that will serve as the tenant under the lease. You may also want to attempt to limit the personal liability of the guarantors by negotiating the removal of any provisions calling for the joint and several liability of the guarantors. Under Texas law, a commercial landlord is required to mitigate damages from a defaulted lease. Thus, you might also want to ask that the personal guaranty be limited to a certain amount, such as six months base rent plus any arrearages, which would reasonably compensate the landlord for time spent securing a replacement tenant. Further, regardless of any other limitations you might negotiate, any guaranty required by your prospective landlord should be conditional upon the guarantor receiving notice that a default has occurred.

Common Operating Expenses
As a tenant, you want absolute clarity regarding all monetary obligations. Such clarity is not always possible when the landlord provides a mere estimate of what the “additional rent” (i.e., the tenant’s share of the operating expenses) will be. A landlord typically “passes through” to its tenants all of the landlord’s expenses for operating the entire building. Operating expenses can include items such as the landlord’s costs of insurance, taxes, electricity, and maintenance of common areas. There can be hidden traps for the unwary in this part of the lease. Pay attention to how your share of the operating expenses will be calculated. For example, if the lease states that your share of operating expenses will be your square footage divided by the total occupied square footage in the building, and you occupy 10% of a building which has 50% of its space filled, then you must reimburse the landlord for 20% of its operating expenses. This outcome can be prevented by insisting that the calculation be based on your portion of the leasable space in the building, whether or not the rest of the building is occupied.

You should also evaluate the items included in the list of operating expenses that will be passed through to you under the lease. Certain items should be carved out of common operating expenses, such as costs of a capital nature, amounts reimbursed by other tenants, and items not related to the operation of the entire building, such as broker fees paid by the landlord in connection with individual leases.

Restrictions on Use of Premises
Leases for medical office space often prohibit the tenant from providing in the leased premises certain medical and/or ancillary services such as clinical laboratory services and diagnostic imaging services. If your practice provides, or intends to provide, any of the services prohibited by your landlord, your lease must be revised (before the lease is signed) to permit your practice to provide the respective services in the leased premises.

Opportunity to Cure Defaults
Most leases contain both monetary obligations, such as the obligation to pay base rent, and non-monetary obligations, such as the obligations to maintain and repair the premises. Leases also typically define what constitutes a default of the lease and what remedies are available to the landlord in the event of a default by the tenant. Especially with respect to defaults of the non-monetary obligations established by the lease, it is not always readily apparent to the tenant when the landlord has deemed such a default to have occurred. Therefore, if your proposed lease states otherwise, it should be revised to provide that a failure to pay or perform will not constitute an event of default until the tenant has received notice of the failure and has had a reasonable period of time to “cure” such failure by making the payment or tendering performance.

Exit Strategy
A lease will include a provision which defines the duration, or term, of the lease. Agreeing to a long-term lease may get you a cheaper rental rate; however, before you sign a long-term lease, you should consider what will happen if you need to terminate the lease early (for example, if your medical practice fails to thrive in the leased premises or if your practice thrives so much that expansion becomes necessary). A straightforward exit strategy is a provision which would permit you to cancel the lease at some point in time (e.g., at the two year anniversary) if you are not in default under the agreement or upon the provision of prior written notice to the landlord (e.g., upon 60 or 90 day’s prior written notice). Another option would be to shorten the initial term of the lease but add renewal options exercisable by you that provide for a predetermined rental rate or a then-current market rate for the renewal term.

Most standard leases prohibit the tenant from assigning its rights or obligations under the lease and from subleasing part or all of the leased premises. If your proposed lease includes these standard prohibitions, or if it does not address your right to assign the agreement or sublease the leased premises, you should attempt to negotiate for the right to assign the lease (where a new tenant would “step into your shoes” under the same lease) or sublease the space (where a new contract would be entered into between your entity, as tenant, and a subtenant for all or part of the space). Either of these rights may limit your liability in the event you are forced to break the lease. At a minimum, you should attempt to negotiate for the right to assign the lease or sublet the space with the consent of the landlord, which consent shall not be unreasonably withheld.

Final Thoughts
This article is not meant to be an exhaustive list of all the issues that should be addressed when reviewing a proposed lease. Each lease will differ in its terms, and each physician practice will have its own tolerance for risk and its own unique needs and preferences. It is always prudent to enlist the help of an experienced real estate attorney before signing any lease or other contract pertaining to commercial real estate. You should be able to avoid many lease-related headaches by paying close attention to the terms of your next lease at the outset and negotiating those terms to suit your business with the help of an experienced commercial real estate attorney.

_________________________________________________________________________
Jerry B. Cohen and Kathleen Quiroz are Shareholders with Oppenheimer, Blend, Harrison and Tate, Inc. - a top ranked Health Care law firm in San Antonio and Kerrville. Collectively, they have served Corporate and Health Care clients for 38 years and have been recognized by their peers in the legal industry as leading attorneys at both the local and national level. Additional contributions in the development of the above article were made by Shelley P. Morkovsky an Associate in the Firm’s Real Estate practice group. Shelley is Certified by the Texas Board of Legal Specialization in Commercial Real Estate Law. You can reach the Health Care and Real Estate Practice Groups of Oppenheimer, Blend, Harrison and Tate, Inc. at 210.224.2000.

Copyright 2010, Oppenheimer, Blend, Harrison and Tate, Inc.