Experience

Tenant Audit Rights: Do They Benefit Landlords Too?

By Edwin Chanin and Jill Schlick

In commercial lease negotiations, tenants frequently seek the right to audit their landlord's books and records if the tenant will be paying a share of the operating expenses or common area maintenance charges for the project. Which operating expenses or common area maintenance charges (commonly known as "CAM") may be charged to the tenant is often one of the most hotly contested lease issues. Tenants expect to pay their proportionate share of real estate taxes, property and liability insurance and the cost of routine maintenance and repairs. They seek to limit their obligation to pay for capital improvements, the cost of complying with building codes, the ADA and other laws, excessive management fees, the remediation of hazardous substances and many other items. After having spent time and money negotiating which operating expenses or CAM charges that they will be obligated to pay, tenants want to ensure that the landlord's calculation of their share of operating expenses or CAM charges is accurate and in accordance with the terms of the lease. Landlords typically resist tenants' requests for the right to audit the Landlord's books and records, but such audit rights, if carefully drafted to protect the landlord's interests, may actually benefit both parties.

Even if a lease does not grant the tenant audit rights, the tenant may have a common law right to an accounting of operating expenses or CAM charges. A Maryland court held in P.V. Properties, Inc. v. Rock Creek Village Associates Limited Partnership, 549 A.2d 403 (Md. Ct. Sp. App. 1988), that a shopping mall tenant was entitled to an accounting of CAM charges despite the absence of a provision in the lease requiring an itemized listing of such charges. The court concluded that this obligation on the part of the landlord arose from the implied duty in any contract that each party act in good faith. The court also based its judgment on the fiduciary relationship between the parties, reasoning that the landlord had a duty to account to the tenant because the landlord had exclusive control over all relevant records. Regardless of the terms of the lease, a landlord is well-advised, based on the P.V. Properties case, to provide its tenant with a description of how the tenant's share of operating expenses was calculated, rather than simply notifying the tenant of the tenant's total share of operating expenses.

Although tenants may be entitled to an accounting as a matter of common law, and landlords have a duty to act in good faith, tenants do not have the right to audit their landlord's records absent an express provision in the lease. Landlords generally seek to deny audit rights, but there are disadvantages to this position which are not at first obvious. If a tenant believes that its landlord's calculation of operating expenses or CAM charges is contrary to the terms of the lease, it may sue the landlord for breach of contract and effectively accomplish an audit through the discovery process. Of course, the rules of civil procedure are designed to prohibit fishing expeditions and a tenant must have some reasonable basis for suing. In addition, obtaining documents through discovery can involve considerable expense and difficulty, all of which establish threshold barriers to tenants who want to get supporting documentation, but lack specific audit rights. Nevertheless, it may be cost-effective with significant tenants for a landlord to avoid litigation by agreeing to a carefully drafted tenant audit rights provision.

More importantly, landlords may, through granting limited audit rights, restrict the time period during which a tenant may access the landlord's records to a period far shorter than the applicable statute of limitations for a contract dispute. In Minnesota, for example, the statute of limitations for a contract dispute is six years. Thus, a landlord could face a suit over operating expenses or CAM charges for up to six years after such expenses or charges have been paid, when it is far more difficult to locate records and personnel to prepare for litigation. A tenant audit rights provision that limits the time period in which a tenant may conduct an audit, and provides that such audit is the tenant's exclusive remedy, can eliminate the uncertainty associated with a lengthy statute of limitations.

Requirements for a well-drafted
tenant audit rights provision
From the landlord's perspective, a tenant audit rights provision should include certain protections. The tenant should be precluded from exercising its audit rights if the tenant is in default under the lease, or if the tenant has failed to pay the operating expenses or CAM charges in question. Otherwise, a tenant may rely on the audit process as a delay tactic. Another strategy to limit audits is to permit the tenant to exercise its audit rights only if the operating expenses or CAM charges have increased by a certain percentage over the amount of such expenses or charges for the previous year.

The tenant should also be required to maintain as confidential all documents produced by the landlord and the results of the audit. Landlords can thereby avoid the difficulties that may arise from the sharing of such information with other tenants. Because each tenant may have negotiated a different bargain regarding which expenses or CAM charges it is required to pay, the resolution of an operating expense or CAM dispute with one tenant may not be relevant to a dispute with another tenant. The audit right provision should also require that the tenant's auditor sign a separate confidentiality agreement for the landlord's benefit.

Lastly, landlords should prevent their tenants from retaining auditors who charge for their services on a contingency fee basis. An auditor whose compensation depends on the audit results is more likely to "throw mud on the wall and see what sticks," than employ a more reasoned approach in evaluating the landlord's calculation of operating expenses or CAM charges. These are just a few of the ways in which a well drafted tenant audit rights provision can actually benefit the landlord.

	Edwin Chanin practices in the areas of real estate and commercial law. He advises property owners and tenants on leasing and other real estate issues, including large-scale real estate transactions. He is a member of BOMA and is a Real Property Law Specialist certified by the Minnesota State Bar Association.
	Jill Schlick is a former member of Maslon's real estate group.