Commercial Lease Audits
What are the benefits of a lease audit and when should you request one?
Please note that, while this article accurately describes applicable law on the subject covered at the time of its writing, the law continues to develop with the passage of time. Accordingly, before relying upon this article, care should be taken to verify that the law described herein has not changed.
I. What Is a Lease Audit?
Typically in a commercial lease, the property being leased is just a portion of a larger office building, shopping center, or other commercial complex. Lease expenses for such premises will include common area costs and building related expenses that are passed through to the tenants. These pass-through expenses may include, but are not limited to: cleaning, repairs, landscaping, utilities, taxes, management services, and other operating expenses. Such operating expense reimbursements can be a source of profit for landlords and it is important for tenants to ensure that they are not being overbilled for such expenses.
Accordingly, an important tool for tenants is a lease audit wherein a qualified professional audits the landlord’s books to evaluate and confirm that all pass through charges are permitted per the specific lease agreement and that the methods used to calculate the charges are fair and accurate. “A lease audit is the meticulous validating of all leasehold expenses issued by a landlord” to the tenant. See Edward Harris and Craig Fuller, "7 Red Flags That Should Trigger a Lease Audit," Arizona Attorney
at 22-26 (December 2012). “Unless you signed away your audit rights, auditing your landlord’s expenses is your right” and it is an important tenant tool that should not be ignored. Id.
II. What Are the Benefits of a Lease Audit?
Intentional or not, errors may occur in calculating and billing pass-through expenses. Tenants often underestimate the value of a lease audit but this is an important tool for tenants that should not be overlooked. The primary purpose of a lease audit is to ensure that the tenant is not being overbilled and that the bill is fair pursuant to the terms of the lease. Benefits of a lease audit may include: finding errors in billing calculations, revealing inaccurate billing procedures, determining if expenses are properly allocated, and assessing whether any improper expenses are included.
Commercial lease agreements are complex contracts and they are often intensely negotiated between the landlord and the tenant. While most commercial leases share a common structure, they are generally negotiated individually and contain unique terms and provisions that are specific to a particular landlord/tenant relationship. For example, one tenant may successfully negotiate for a limited definition of which costs are to be passed-through while another tenant is subject to a broader definition of allowable pass-through expenses. Accordingly, each tenant to a commercial property may have its own unique terms related to pass-through expenses that need to be calculated individually and appropriately applied to each tenant bill. Therefore, after spending time and money negotiating which expenses and the share of those expenses that the tenant is obligated to pay, the tenant should ensure that the landlord’s calculation of these expenses is correct and consist with lease provisions.
One of the principal benefits of a lease audit is to make sure that the lease is being interpreted and applied correctly for that specific tenant and its individual lease. Landlords may not always apply unique lease provisions but instead rely on the landlord’s standard lease language and may include improper expenses in the bill. Another error may be found in the misinterpretation of the specific lease terms, especially because building related and operating expense language is often not as clear as it could be leading to landlords apply an inconsistent approach. Operating expenses are not as easy to categorize as tenants may believe because they are often subjective in nature. Therefore, it is important to have a lease audit performed to fairly evaluate the charges and confirm all pass-through charges are permitted per the specific lease agreement.
III. What Type of Events Trigger the Need for a Lease Audit?
Auditing leases is something that should be done on a fairly regular basis. In addition, there are several events that should prompt a tenant to have the lease audited:
- Renewal or lease termination is contemplated
- Changes in building ownership or property management firm occurred
- Notable changes in building occupancy
- Building or Landlord experiencing financial difficulty
- Building renovations
- Significant change from previous year’s charges
- Receipt of limited detail or itemization with annual reconciliation statement.
See Edward Harris and Craig Fuller, "7 Red Flags That Should Trigger a Lease Audit," Arizona Attorney
at 22-26 (December 2012). If one of these events occurs, tenants should seriously consider having a lease audit performed to assess whether the tenant is paying the landlord more than is legitimately due pursuant to the lease.
IV. Lease Terms that May Affect Lease Audit Rights.
Details about a tenant’s audit rights are often set forth in the lease agreement. Accordingly, it is important for a tenant to review his lease to determine what type of audit rights are permitted. The lease clause related to lease audits may address details such as the timing, frequency, and duration of lease audits. Some leases may also include details related to where the audit shall take place, who pays for the cost of the audit, and who is permitted to conduct the audit.
Two important details to determine are the window of time to conduct a lease audit and the scope of the audit right. Some leases provide tenant with 30 or 60 days to question or audit the charges while some leases provide longer or shorter audit windows. It is essential for the tenant to understand when the audit window starts running and when it expires. Similarly, it is necessary to know whether a tenant is limited to only auditing the most recent year or if the lease permits a longer look back period. Therefore, a careful review of the lease should be performed prior to seeking a lease audit to determine the parameters of the audit rights.
To arrange for a consultation concerning your commercial real estate legal matter, please contact Robert Mitchell at firstname.lastname@example.org
or at (602) 452-2730.