Commercial Tenants' Audit Rights
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In a net lease, a large chunk of your monthly rent is going to be made up of charges like building maintenance costs, common-area maintenance costs, tax bills, and insurance premiums that you’re expected to pay on faith. In truth, it’s very difficult for a landlord to be completely accurate in recording and allocating operating expenses. Depending on the size of the property and the number of tenants, there may be literally thousands of entries per year, on everything from the janitor’s monthly waxing of the lobby floor to the plumber who comes now and then to deal with the drains.
Large landlords in particular are apt to do a sloppy job of allocating operating expenses. The task is often given to low-level employees who do not check the leases of every tenant (even if they were to check the leases, they’d probably not find much enlightenment amid the dense, 8-point-type clauses). How, then, are these employees supposed to know, let alone apply, the exclusions that tenants have painstakingly hammered out? And don’t forget the temptation factor—when it’s not clear whether an expense should be passed-on, many landlords or their employees can’t resist giving the benefit to the landlord.
Unless you absolutely trust the landlord, there’s no way you can know whether the operating expense numbers are accurate unless you have the right to check. To do this, you need a clause in your lease giving you the right to hire a professional auditor to look at the landlord’s books—an audit right. The auditor looks for mistakes, either deliberate or inadvertent, including any failure to remove an expense that the landlord has been reimbursed for (such as collecting on an equipment warranty). Having an audit right in your lease can potentially save you hundreds—maybe even thousands—of dollars.
Don’t be surprised if the landlord -objects to your request for an audit right. Many will not take kindly to your request to peruse their books. If you’re desperate for this rental or the market is wholly against you, you may have to cave here and move on. But if you have any clout, consider using it now.
Meeting the Landlord’s Objections
To counter a landlord’s resistance to giving you audit rights, you might point out that if you have reasonable grounds to suspect significant overcharging, here’s what will happen if you don’t have an audit right: You’ll protest the charge, refuse to pay it, and start a lawsuit (or invoke the mediation or arbitration clause in your lease, if there is one). If the dispute boils over into arbitration or litigation, you’ll have the right, under the discovery rules of every state and most arbitration groups, to examine the landlord’s books. True, the two of you would probably settle the dispute, but not before spending much time and money on mediators, arbitrators, or lawyers. Now, if your lease gives you the right to see the landlord’s books before you turn to stronger measures, chances are that you and the landlord will resolve any dispute early on. If you’re able to press for an audit right, keep the following points in mind.
When Should You Look at the Landlord’s Books?
After your tenancy gets under way you’ll want to think about whether you should perform an audit. If you reasonably suspect overcharging—for example, the common area maintenance (CAM) costs come in one-third over your best estimates—the answer will be simple. But even in the absence of suspicions, if you can bear the cost of an audit you might want to check things over anyway. This will send a message to the landlord that you are serious about your rights.
Performing an audit at the end of the first year may result in your landlord being especially careful in the future. There’s another, very practical reason to audit the first year. As the “base year,” it will be the standard against which all subsequent costs are measured. If you reasonably suspect an error in, say, the seventh year of your ten-year lease and call for an audit of that year, you’ll want to know for sure that the first year’s figures were correct and, most importantly, available. Don’t rely on your landlord’s filing cabinet to have safely organized and secured those old records.
This article was excerpted from Negotiate the Best Lease for Your Business by Janet Portman