Prepare for Return of Funds If Commercial Condo Association Won't Approve Lease

Q: I recently bought a building comprised of several commercial condo spaces. A restaurant tenant has expressed interest in one of the spaces, but I’m apprehensive. The space is subject to the governing documents of an association, and restaurant tenants have more hoops to jump through, such as getting approval for improvements that typical retail tenants don’t need, like gas lines. The association has already determined that it won’t allow me to lease the space to a restaurant tenant if it can’t get those approvals. I’m concerned that the deal could fall through if the tenant isn’t able to get the required permits after I’ve paid for my agreed-upon portion of the cost of architectural plans and other initial lease costs. How can I protect myself?

A: You can specify in the lease that you’ll recoup all of the money you’ve laid out if the tenant has failed to get the permits required by the association. (Be prepared for a strong tenant to negotiate for a full return to apply only if the failure to get the permits is a result of its own fault.) As a compromise, you can also include reasonable timelines within which the tenant must provide its permits, and events that would be considered the tenant’s fault if it couldn’t get the permits. You can negotiate an automatic termination, so in the event the tenant can’t get approval from the association because of necessary permits or approvals from any other authority, the lease will immediately terminate and you’ll be free to rerent the space. And include a provision specifying which exact amounts the tenant will owe you for plans and other initial costs if the deal doesn’t work out, and how that amount will be calculated.

In a recent California case, a commercial condo space owner dealt with a tenant’s failure to get the association’s approval. In that case, the owner of two commercial condominium units in a shopping center signed a lease with a restaurant tenant. When the homeowners association that governed the condos learned that the tenant had been unable to get certain permits, it refused to allow the restaurant on the leased premises. The lease automatically terminated, allowing the owner to immediately rerent the space, but there was a disagreement between the owner and tenant as to the amount of money that each side was entitled to.

The owner hadn’t included any provisions in the lease that protected it in the event that the permits didn’t come through, but the tenant was savvy in negotiating a return of most of the money that it had paid in contemplation of being able to operate in the space. A trial court ordered the owner to refund the tenant for its security deposit, first month’s rent, and certain other expenses pursuant to the lease’s termination clause, for a total of $20,000. The owner was left with a space that had been tied up for several months with no rental income and improvements that needed to be removed.

The owner appealed, but a California appeals court upheld the lower court’s decision. It noted that the lease agreement included a specific provision regarding the landlord’s refund obligation regarding expenses: “If permit is not approved at a later date, due to food, grease trap, or gas line not allowed for the location, landlord and tenant will split the cost of architect drawings, health and building permits.” However, the lease didn’t specify alternative plans for reimbursement that would apply based on why the permits were denied [Luyen v. Phuong Pham, August 2016]. So make sure that you draft the lease so it addresses the reason that permits are denied and provides for the calculation of which party owes what amount according to the specific circumstances.