Buyer Beware – Hidden Dangers in Using Form Contracts in Real Estate Deals

Form contracts account for more than 80 percent of all agreements used to complete business transactions today. That percentage may be even higher when it comes to contracts in commercial real estate transactions such as the ones companies sign to acquire corporate headquarters or satellite offices.
Unfortunately, many executives do not carefully review the specifics of a form contract before signing. Instead, they assume the form contract will be equitable to both parties. However, unless the form is an industry-neutral form such as one from the AIR Commercial Real Estate Association or Commercial Association of Realtors, terms in a standard form contract are generally designed to favor the party that presents it.
To limit a company’s risk, it is vitally important to be able to recognize and negotiate unfavorable provisions out of form contracts. This may necessitate a call to in-house or outside counsel with expertise in the area.
By negotiating the form contract presented to him, a savvy building owner in Los Angeles was able to collect 15 years of rent from an outdoor sign company even though the law prevented the sign company from ever constructing a sign on the building.
The building owner had been approached by a well-known outdoor sign company about leasing the roof of his building for a large billboard. After reaching an agreement on the rent amount and term of the lease, which totaled $750,000 over 15 years, the sign company presented the building owner with its “standard” form lease. The form lease provided that if the sign company could not obtain a building permit to erect the billboard, or if applicable building codes changed, the sign company could terminate the lease withno penalty of payment. The form lease thus placed this risk on the building owner.
The sign company was an expert in the field and familiar with the building permit process. The sign company was aware of a movement by Los Angeles City Council to ban all new signs. Since the possible ban did not affect existing signs, the sign company wanted to get this deal done quickly so it could construct the billboard before any ban occurred. Once the ban went into effect, existing signs would become that much more valuable.
The building owner did not immediately agree to the sign company’s form lease. Instead, the building owner (through his attorney) requested a different provision stating that the sign company had done all necessary investigation concerning city regulations and the availability of building permits. Because the sign company was anxious to acquire this site and complete construction of the billboard, the sign company agreed to replace its form provision with the building owner’s provision.
Immediately after the parties signed the lease, the sign company’s engineer re-measured the distance from the proposed sign location to the nearest competing sign. The sign company’s preliminary measurements had been inaccurate.
The sign company learned, after signing the lease, that the proposed sign location in the lease violated city codes providing minimum distances between billboard signs. The sign company therefore informed the building owner that the lease was terminated because the sign company could not construct the sign.
Believing that the sign company assumed the risk of any inability to construct its sign, the building owner filed suit in order to enforce the lease. The sign company vigorously protested, asserting that no court would require it to pay 15 years of rent for a location on which it could not construct a sign.
At trial, I argued (1) the sign company had knowingly assumed a foreseeable risk, and (2) the parties had re-allocated this risk to the sign company and away from the building owner.
The trial judge agreed with my position and ruled in favor of the building owner. The owner then recovered $750,000 for the entire 15-year term, despite the fact that no sign could ever be constructed. Additionally, the court awarded the building owner the attorney fees incurred enforcing the lease.
This example highlights the importance of carefully negotiating all contracts, especially those presented as the other party’s “form contract.” Such form contracts extend beyond real estate transactions, and could include executive employment contracts, lending transactions, and confidentiality or non-disclosure agreements.
You can be sure that the other party in a transaction will take the time and make the effort to carefully construct each provision in such an agreement to shift as much risk away from him or her as possible. Unless you are willing to assume all of that risk, you should spend the same time and make the same effort to re-allocate the risk back to the other side.