Most commercial leases contain terms that require tenants to pay additional rent. Additional rent is usually a share of the costs and charges incurred to operate the property. These costs can include municipal taxes, insurance premiums, repair and maintenance costs and common area utility charges. In any given year, these charges change and fluctuate. Landlords often provide an annual estimate which tenants pay subject to a year-end reconciliation. Lease terms governing these types of costs are often general in nature because it is not possible to contemplate all the variables and, at the same time, have the same additional rent provision apply to all the tenants in a commercial building.
As a general rule, tenants are obliged to pay their “proportionate share” of these types of costs. How do landlords calculate the “proportionate share”? Ordinarily, this is calculated based on the relative square footage occupied by each tenant. That makes sense for fixed costs such as taxes, insurance and common area utility costs. But what happens when one tenant obtains a greater benefit from these additional costs than others? Are the other tenants obliged to subsidize that tenant or is there a more equitable manner in which to allocate such costs? What authority does a landlord have to apply different methods of calculation for different types of common expenses?
A recent commercial leasing case provides an illustration of a landlord’s ability to change the method of calculating additional rent and an example of doing so based on the benefit received by the particular tenant as opposed to square footage. In this case, the tenant operated a hot yoga studio. The lease had an additional rent clause that required the tenant to pay:
“. . .its proportionate share of the Lessor’s costs and charges required in the general day-to-day operations of the property, . . .”
The lease also provided that for expenses charged to the building “as a whole,” the tenant agreed to pay its “proper and fair share of said charges.”
The tenant occupied 14.37% of the commercial space. As part of its business, the tenant installed nine showers, two steam generators, and other water-consuming equipment and fixtures. In all, the number of water fixtures in the leased premises went from four to 26. In addition, the tenant upgraded the municipal water connection from a ¾ inch pipe to a 2 inch pipe. This was all done without objection from the landlord. The building water consumption went up by more than 100%, as did the municipal water costs.
For the first two years of the lease, the tenant was charged additional rent equal to 14.37% of the overall operating costs, including municipal water charges. The landlord eventually figured out that water consumption and cost had shot up after the hot yoga studio began operations. Two years into the lease, the landlord sought to change the allocation of the water charge paid by the hot yoga tenant for 14.37% of that cost to an amount equal to the tenant’s proportionate share of the water actually consumed.
The tenant objected arguing that the calculation of “proportionate share” was based on square footage for all other expenses. To decide water cost using consumption instead made the lease ambiguous, inconsistent, unreasonable and unfair. Relying on the doctrine of contra preferentem (a doctrine of contractual interpretation where, in the case of ambiguous wording, the contract is interpreted against the party who drafted it), the tenant argued that since the landlord drafted the lease, he should bear the risk of any such ambiguity.
Though the amounts in issue were relatively small, the dispute ended up in court. The Court sided with the landlord and held that “proportionate share” could be calculated in any way that was commercially fair. Relying on the principle that commercial leases should be interpreted in accordance with sound commercial principles and good business sense, the court reasoned:
“. . . the only reasonable conclusion is that “proportional share” means that the tenant should pay for its fair share of the water it uses. To decide otherwise means the other tenants and the landlord will be paying for far more water than they use. If the words “proportional share” were to be based not on the appropriate or proportional share of water used by the tenant but on square footage, it would have been simple to state that in the lease."
If you think your “additional rent” is unfair, or if you feel other tenants ought to bear a greater share of common expenses than square footage ratios allow, then this case provides a persuasive argument in support of your position. It is also a cautionary tale about understanding your lease before you sign it. If you are unsure how additional rent is calculated, sort it out before you sign the lease. That will avoid an unpleasant surprise after the fact when your expected additional rent costs are much greater than you anticipated.
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