Four Things to Know Before Signing a Restaurant Lease

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on May 7, 2018 7:00:00 AM
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One of the most important contracts you will sign during your restaurant’s lifetime is your lease.  Although the widespread joke is that, even after a tough negotiation, the lease “lives in a drawer” for the next 10, 15, or 20 years, the reality is that a well-negotiated lease can save a restaurateur from substantial headaches down the line.  And the right clauses can go as far as to save a restaurant owner from losing his or her shirt.

This list is in no way exhaustive but we will focus on four important concerns that a savvy business person should raise at the early stages of negotiation before signing a restaurant lease.

(1) Be sure to draw out the more major business/monetary terms first, before beginning to negotiate the lease, in a “letter of intent.”

When parties agree upon initial terms of a commercial lease, the best course of action is to sign a “letter of intent,” or “LOI.”  An LOI is a short document that details the major business points of a deal before a full contract is prepared.  LOI’s are sometimes also referred to as a “memorandum of understanding” (or “MOU”) or a “term sheet.”

LOI’s are often non-binding and are used to make sure that all of the parties involved have reached a basic understanding of the transaction.  Despite the fact that an LOI may be non-binding, the terms listed in the LOI are usually not subject to further negotiations, so it is important to make sure they are fully agreed upon.  To renegotiate these terms further down the line is called “re-trading,” which in the industry is akin to “four letter word.” 

The reason an LOI is important is because, in theory, once the parties get past these terms and are in agreement, then the rest should be a matter of lawyers duking it out over the legal terms in the lease.  Without having these terms agreed to in advance, the parties run the risk that they may get deep into negotiation and incur legal fees without knowing if the “deal-breakers” are firmly in the rearview mirror.  It is in both parties’ best interest to agree to these salient deal terms before beginning to negotiate the lease.

(2) Have a good handle on all of the business/monetary terms.

As discussed above, it is important to lay out the business/monetary terms in advance of going to contract so that both parties have comfort in the fact that the major terms are agreed to.  A more nuanced part of this idea is that you should be sure to have a comprehensive understanding of all of the business terms that appear in the lease.  Here are a few monetary terms that are easy to overlook.

How much will you pay in “additional rent”?  Besides paying fixed rent each month, you will undoubtedly incur other charges under the lease, called “additional rent.”  Some items that fall under this umbrella are utilities (electricity, gas, water and/or sewer charges), operating expenses, and real estate taxes (depending on the state in which your restaurant is located, you may be responsible for a portion of the building’s real estate taxes).  It is important to review past bills for the building to make sure you understand what these charges may look like in the future.

Will your security deposit increase each year?  Sometimes, it will be buried in your lease that your security deposit increases every year in accordance with how much the rent increases each year.  For example, if your rent is $5,000.00 per month, you gave a security of three (3) month’s rent upon signing the lease ($15,000.00), and your rent increases 3% per year, then it could very well be written in your lease that, come year #2, you’ll owe your landlord another $450, which is the escalated amount of $15,000 x the 3% increase.  That type of increase will continue throughout the life of the lease.

Does your lease’s rental rate go to “fair market value” during the option period?  All too often, a lease is written in a way where, if you have a 5-year “option to renew” at the end of your lease, the rental rate resets to “fair market value.”  This means that if rental rates in the neighborhood have increased, even exponentially, your rent will increase along with the market rate.

(3) If part of your business model is to serve alcohol, make sure you can obtain a liquor license.

Different states have different rules surrounding obtaining alcohol licenses.  For example, in New York State, you cannot be located too close to a school or a house of worship if you would like to serve liquor and spirits. In this case, before selecting space, you would want to make sure you clear that geographical hurdle. 

In other states, you must purchase a liquor license from another license holder.  You would want to have a good understanding of any and all costs associated with purchasing a license.  One final example is that, in many states, you must not only receive approval from the state’s alcoholic beverage regulatory agency, you must also pass muster with the local residents, convincing them that you deserve a liquor license in a certain area.  Perhaps you are set on opening a bar in a highly concentrated area, but because of community concerns, the surrounding residents will not welcome you with open arms.  Since all states’ rules and regulations differ, it is imperative that you educate yourself about the state’s liquor laws prior to signing a lease if you wish to serve alcohol.  If there is a question as to whether you will receive a license, it would be best to negotiate for a contingency which would allow you to terminate the lease should you fail to receive a license.  Otherwise, you could find that you are legally responsible for a space but unable to make ends meet.

(4) Prepare to put some time and money into performing due diligence on the space.

The final, and arguably most important, thing to remember before signing a lease is that you should hire an expert to do a thorough inspection of the space and any related building code records. 

You should prepare to pay a professional to walk through the space and inspect the condition of the equipment and the restaurant itself so that you can have comfort in the fact that you are taking over a space that is issue-free.  In addition to peace of mind, a thorough inspection report will arm you with the hard data that supports your landlord sharing in the responsibility of improving the space, including the landlord performing any certain construction work for you. Depending on the findings, you may be able to leverage the report to receive additional rent abatement, and/or “tenant improvement allowance,” which is funding from the landlord to improve the space on the landlord’s dime.

Besides the actual walkthrough, it is also imperative to inspect the applicable building records to make sure that you clear any and all building codes and potential zoning issues.  It would be devastating to begin negotiating or to sign a lease only to find out that, for example, the city’s building code does not allow a restaurant in this particular space.  

By having a letter of intent, asking the right monetary questions, confirming the likelihood of securing a liquor license, and performing the proper due diligence, you can save yourself money and time down the line.

Helbraun & Levey is a full-service law firm focused on the legal and licensing needs of New York City's bar and restaurant industry. From start-ups to star chefs, we help our clients develop, grow and succeed with our extensive industry knowledge and client-driven, individualized approach to legal representation. We handle liquor licenses, investor agreements, commercial leases, corporate formation, all City and State licenses, partnership and employment matters and virtually every other issue that may arise during the course of business. 

Download Now: How to Identify Locations, Choose a Site & Negotiate Your Lease!         

Topics: Real Estate, Cost Reduction

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