The Basics of Master Lease Agreements
A master lease agreement is a contract that usually covers an ongoing obligation between a lessor and lessee. Master lease agreements can be entered into for a real estate lease or even an equipment lease. These agreements are often used for commercial purpose only.
Master lease agreements are controlled by Article 2A of the Uniform Commercial Code for personal property, but they are also subject to Real Estate attachment laws for real property. For both real estate and personal property, the master lease agreement documents the general lease terms of the various leases that will be executed as part of the master lease agreement. This means that the master lease agreement identifies the down payment , monthly payment, purchase price, purchase option, commencement date, expiration date, rent lapse date, and rental rate that will apply to all leases that follow.
In commercial real estate deals, a developer may want to enter into a long term master lease agreement with a property owner for a property before the developer begins further analysis of the project. The developer may want to ensure that its property rights and development plans are protected, before any further analysis or development. In other cases, a master lease agreement is structured over a 1 to 2 year term, to allow parties to test an idea, before continuing with a project.
Essential Elements of a Master Lease Agreement
To form the basis of a master lease transaction, the lease document must delineate the basic terms and conditions before the specific agreements for each parcel of property (known as "schedules") can be entered into. This is typically accomplished in a separate master lease agreement with exhibits, in which the lessor and lessee agree to general lease terms and conditions that "master" the schedule leases covering the parcels of properties. Among the many aspects that may be addressed through a master lease are:
- the lease term;
- the lessee’s obligation to pay rent;
- additional rental payments, including the percentages, if any, of sales or gross receipts required to be paid by the lessee to the lessor in addition to the base rent;
- the responsibility of the lessor and lessee for payment of real estate taxes, maintenance, development of the property, liability insurance, and utilities;
- default provisions regarding rent and damage to the property; and
- the right and time period for renewal or termination of the lease.
The Advantages of Master Lease Agreements
Master lease agreements provide significant benefits to appropriately positioned parties as compared to individual lease transaction documentation. A master lease agreement permits a lessee to avoid negotiation of the detailed terms and conditions each time a lease transaction is entered into with respect to items of leased equipment. At the same time, a lessor receives the benefit of commitment from its lessee to lease specific items of equipment pursuant to, and in accordance with, the terms and condition of the master lease agreement. Importantly, master leases are written to permit the lessor to easily accommodate additions and deletions to its inventory on a regular basis and without unduly burdening the parties. Importantly, master lease agreements may contain terms permitting the lessor to enhance its security in letter of credit payments, purchase money security interests and, perhaps most importantly, the right to become the owner of any equipment the lessee has the right to purchase (although either party may seek to avoid any payment obligation to the other by electing not to purchase said equipment). On a macro level, master lease agreements provide the parties with a structure that avoids duplication of effort in the negotiation of terms and conditions that will address future transactions. In addition, removing the need to draft, negotiate and sign an individual lease agreement – complete with signatures at the end of each copy – simplifies and streamlines the transaction and reduces administrative burdens on the parties.
Master Lease Agreements versus Standard Leasing Contracts
Once a lessee has decided a master lease agreement is the best option, it is important to understand how these leases differ from standard leases. Here are a few ways a master lease agreement might be structured differently to ensure all properties or items are accounted for:
● Incorporation of Addendums: Because master leases agreements tend to cover multiple items or properties in one agreement, addendums can be added or removed from the agreement as needed. This way, if all covered items are not fully covered under the master lease, it can be adjusted to cover everything necessary without the hassle of a new agreement.
● Inclusion of Separate Schedules: Another option for covering additional items or properties is to include schedules in a master lease agreement. These schedules can be updated to reflect the most current property or item without having to write an entirely new master lease agreement. Schedules have to be properly numbered and referenced in each lease separately in which they are included. It is important for a separate schedule with a list of items to be referenced in the context of each list, so that there is no question about what is encompassed in each list.
● Subordination of Schedules: Master lease agreements may also include schedules that represent an entire section of a lease. These schedules can be added or removed from the master lease agreement without risks associated with what may happen in a lease of a single unit.
These are just a few examples of how master lease agreements can differ from the more traditional lease arrangement.
Master Lease Agreement Pitfalls
All real estate lawyers warn their clients about "standard" lease forms. Using a form with terms that are specifically tailored for the unique needs of a master lease could mean the difference between success and failure.
The following are some examples of the types of issues that should be considered when entering into a master lease.
- Insurance Coverages. Unlike standard lease forms, a master lease may require the lessor to make certain changes to their insurance policies, including to increase coverage limits and to add additional insureds. If you do not examine these requirements, the additional insurers omission may result in a default to the master lease.
- Tenant Defaults Under Subleases and Impact on Master Lease. If a sublease is not performing, how does that impact the master lease obligations? The parties should consider whether the subtenant should be required to cure the default under the sublease to avoid defaulting on the master lease. Alternately, consider whether the sublease may be terminated as a result of default and the assumption of direct lease with lessor, especially in an intervening bankruptcy lien situation.
- Storage of Documents. The use of a fairly common term that documents be kept at the property, when in fact all decisions are made by the parent company at their home office, may result in adequate documentation being unavailable locally to review at the property by lessor, lender , etc.
- Environmental Indemnities. A master lease may not be sufficient as an indemnity if environmental issues bios and the tenant effects a cleanup that is costly. The assignability of the master lease is important to consider, especially if the lessor will lose his right to have any claim against the tenant if a Chapter 11 filing occurs.
- Assignment of Receivables. The language should be clear on assignments allowed without consent or those requiring consent. There should also be consideration of whether the permission of the lessor is required or whether the lessor is permitted to withhold its consent in its sole discretion.
- Sale vs.potential sale of a property. From time to time the parties’ plans may exceed their expectations, in the case where a property has a lot of potential may entice offers that may be difficult to reject. Both parties should understand how to navigate a sale, especially if the lessor intends to receive some value in addition to the rent.
- Rent Concessions. The assumptions in the master lease are often incorrect if the rent is based on a projection of performance. How accurate has the property operated previously and what is the market rent is often more of an issue than the parties may realize.
- Changes in State or Local Laws and Permits. Often times the county or municipality will change the rules, zoning or structural requirements that impact the financial aspects of the project. The parties must understand risk associated with development cost, construction delays and professional fees due to delays or changes.
Creating and Negotiating Master Lease Agreements
Negotiating a master lease agreement generally follows a traditional lease negotiation process. In the context of leasing portfolios, the parties should assume that a pro forma lease will be the starting point for conversations but may make substantial changes to such pro forma. Again, the parties will need to engage in discussions with regard to issues such as rent, term, options, exclusivity, rights to expand, premises, use, net or gross lease, operating expenses, occupancy costs, fixturing, free rent, and security deposit.
In the context of leasing portfolios, the party assuming the master lease typically prefers to have the opportunity to review and comment on each individual lease prior to its assumption of such lease. The master landlord may also seek such ability in transactions where it is entering into a master lease of a property with more than one existing tenant.
Drafting of the individual leases in the portfolio can also be negotiated. For example, tenants may seek to use their own forms. While master landlords may resist this on both principle and practicality, renegotiation of the master landlord’s form can likely be successful. Given the vast number of leases in the transaction, the parties should consider consolidating lease provisions in uniform form language, with only the relevant variables specified in each individual lease rather than negotiating the individual lease provisions for each of the leases.
Legal Considerations for Master Lease Agreements
As with any legal document, parties must ensure that a master lease agreement complies with applicable laws and regulations. Real estate at its core is a property governed by the states. This means that while many leasing principles apply in all jurisdictions, certain issues are state-specific and must be addressed accordingly. The risk of entering into a master lease agreement that does not comply with the law is significant as it may mean the agreement is unenforceable or exposes a party to liability in certain situations.
Legal Counsel is essential to ensuring that parties enter into a master lease agreement that addresses issues specific to them , as well as those that must be addressed under applicable law. Counsel should ensure that the parties have all requisite rights to the property (e.g. a management company acting on behalf of the owner), that the master tenant can legally structure the various subleases contemplated under the master lease agreement. Although parties may think they are protected by other agreements they have entered into, circumstances may render those agreements ineffective and therefore require the parties to focus on the master lease agreement.