Tenants’ Obligation to Provide Financial Information Under a Commercial Lease
Commercial leases frequently include an obligation for the tenant to provide financial information to the landlord upon request. These provisions serve as a means for landlords to assess the financial health of tenants and any guarantors, which is crucial for managing risk and making informed business decisions. Understanding the nuances of these provisions is important for both landlords and tenants, as they involve considerations around frequency, confidentiality, and the type of financial information required.
What Are Financial Statement Provisions?
Financial statement provisions in a commercial lease outline the tenant’s obligation to furnish financial statements to the landlord. These statements typically include details about the tenant’s financial condition, such as balance sheets, income statements, and cash flow statements. For tenants with a guarantor, the provision may also require financial information from the guarantor. These provisions enable landlords to monitor the tenant’s financial stability, ensuring that they remain capable of meeting their lease obligations.
Key Considerations in Negotiating Financial Statement Provisions
Frequency of Requests
Tenants often negotiate to limit the landlord’s right to request financial statements to once per year or some other similar cadence. This limitation helps protect tenants from frequent disruptions and potential exposure of sensitive financial data. However, to the extent they are willing to agree to such a limitation, landlords typically seek carve-outs that allow for additional requests under specific circumstances, such as during a potential sale, financing, or ground leasing of the building, or upon an event of default under the lease. These carve-outs are essential for landlords because they may need to provide tenant financials to prospective buyers, lenders, or ground lessors as part of due diligence. Additionally, access to financial information during an event of default allows the landlord to assess the tenant’s financial condition and make informed decisions about lease enforcement.
Confidentiality Obligations
Given the sensitive nature of financial information, tenants usually require landlords to agree to keep the information provided confidential. These provisions typically mandate that the landlord keep the financial information confidential, except in scenarios where disclosure is required by law or necessary to achieve the landlord’s business objectives, such as disclosure to potential buyers, lenders, or ground lessors. This requirement protects tenants from the unauthorized dissemination of their financial data, which could potentially harm their business interests or market position. Landlords, while generally agreeing to such confidentiality, must ensure that their ability to share the information in the specified exceptions remains intact.
Type and Form of Financial Statements
The lease should clearly define the type of financial statements required and their form. For example, landlords may request audited financial statements to ensure the accuracy and reliability of the information provided. However, not all tenants generate audited financials in the ordinary course of their business, particularly smaller or privately-held companies. In such cases, tenants may negotiate to provide unaudited financial statements, certified by an officer of the tenant or prepared according to generally accepted accounting principles (GAAP). This negotiation point is important as it can significantly impact the administrative burden and cost for tenants. When negotiating a lease, tenants should ensure they can comply with the requirements for financial reporting set forth in the lease without incurring undue hardship.
In leases that include a percentage rent component, the obligation of the tenant to provide updated financial reporting takes on even greater consequence and the parties will negotiate in greater detail the nature and frequency of reporting that will be required from the tenant in order to appropriately track sales information so that percentage rent can be calculated.
Consequences of Non-Compliance
It is important for both parties to understand the consequences of failing to provide the required financial statements. Typically, non-compliance could be treated as a default under the lease, giving the landlord certain rights and remedies. Tenants should be aware of these potential consequences and ensure they have internal processes in place to comply with financial statement requests promptly.
Risk of Disclosure to Competitors
Because of a tenant’s obligation to disclose nonpublic financial information to a landlord, some larger tenants will seek to prohibit a landlord’s ability to sell a property to a competitor of the tenant because the tenant does not want to be in a position of being obligated to disclose confidential financial information to a competitor. Landlords however are extremely reluctant to agree to an limitations on their ability to sell a property and accordingly generally only tenants with extremely high bargaining power are able to obtain such a restriction.
Conclusion
Financial statement provisions in commercial leases are a critical tool for landlords to monitor the financial health of their tenants and manage risk. For tenants, these provisions require careful consideration to balance the need for privacy with the landlord’s legitimate business interests. Key negotiation points include the frequency of financial statement requests, confidentiality obligations, the type and form of financial statements, and the consequences of non-compliance. By addressing these issues clearly in the lease, both landlords and tenants can protect their interests and ensure a transparent and cooperative relationship throughout the lease term.
