Wednesday, September 30, 2009

Intro to Lease Clauses: For the Landlord

Over the course of the next several weeks I’m going to discuss various lease clauses that should be included in commercial leases. But, as a lagniappe -– and as a way to find out if anyone is even paying attention -- like Click and Clack on Car Talk -- this week I’m going to include a puzzler that won’t be answered until next week. And for anyone who answers via a comment, you’ll have the psychic pleasure (or sadness) of learning whether you are right.

The question: Why are manhole covers round?

Now, on to the lease clauses. This week’s post will focus on those of importance to landlords.

First, of course, as a landlord, you need to decide what kind of lease to offer. There are three types customarily used in commercial leasing, namely,

  • a “full-service lease,” where the tenant pays basic annual rent but does not pay for any operating costs;
  • a “triple net lease,” where the tenant pays basic annual rent plus a pro rata share of the building’s operating costs and real estate taxes;
  • and a “base year lease,” where the landlord pays all operating costs and real estate taxes associated for a specific year - the “Base Year,” which is generally the first full calendar year following execution of the lease or the calendar year in which the lease is executed. The tenant pays a pro rata share of the increases in the building’s operating costs and real estate taxes for each year during the term following the Base Year.

    Retail leases can also include percentage rent (i.e., a percentage of a retail tenant’s sales from its premises) but that will be a subject of a future post.

    Second, landlords need to decide how Basic Annual Rent will be increased during each year of the lease term. Typically, increases can be based on a fixed percentage increase or tied to annual increases in a fixed benchmark, usually the Consumer Price Index (CPI).

    If choosing the CPI, the landlord needs to be careful which CPI to use because there are several, e.g., the “All Urban Consumers” Index (“CPI-U"), the “Urban Wage Earners and Clerical Workers” Index (“CPI-W”), and the “CPI-U, US City Average, All Items”; these indices are available to measure both national as well as regional trends. Regional indices tend to be more volatile than the national indices but may be more indicative of inflation in the area where the building is located.

    Another decision when using the CPI is whether a rent increase should be equal to 100% of the corresponding increase in the CPI or be a fraction of the CPI. Market factors will generally drive that decision.

    And, finally, when using the CPI, there should be a concomitant minimum increase regardless of the increase in the CPI. But what’s sauce for the goose is also sauce for the gander - if a minimum is imposed, landlords should expect tenants to ask for a maximum cap regardless of the corresponding increase to the CPI.

    Landlords should always include a provision that limits their possible liability for any type of claim made against a landlord to the landlord’s equity interest in the building. The personal assets of the principals of the landlord should not be placed at risk.

    Next week I’ll discuss lease clauses of importance to tenants -- and answer why manhole covers are round.
  • Wednesday, September 9, 2009

    Open Source Software & Its Legal Ramifications: What is Open Source Software?

    Barbara I. BerschlerI will be writing a series of posts that examine various issues related to open source software and legal ramifications for the average business owner -– not just those working in the IT field. Initially, I will address the main differences between proprietary software and open source software.

    More and more software is being written to respond to the explosion of computer driver services in business operations. So it is important to understand how that software is created, and what –- if any –- limitations to its use may accompany its acquisition by an individual/or business.

    Software is written by a programmer to operate a particular computer program. A business owner can either buy “off the shelf” software, like Microsoft Word or WordPerfect, or have some created for her special needs. What the business owner ends up with most likely is proprietary software. She pays for the use of the finished product -- and most likely is not given a version of the software to allow her to see “under the hood” of the program.

    To know the inner workings of the software requires having access to the source code, i.e., the programmer’s instructions which have been compiled into a format that the computer can understand.

    As part of the evolutionary process of writing software, a major path has emerged called open source software. So what does that term mean? It is software written by programmers to accomplish the same kinds of tasks as proprietary software. But using open source software means how the programmer obtained it, and how it can be further distributed may be subject to a set of requirements that are different from the proprietary version.

    Proprietary software is often obtained for a fee, is used or distributed under an extensive license, and, most likely, does not give the user access to the source code. In contrast, open source software is obtained for free and the programmer/or user can see exactly how the software was constructed because the source code is revealed. In addition, the user may freely modify and distribute the modified software.

    However, depending upon the originator of the software, there may be limitations placed on its further distribution. But unlike proprietary software, the object of such requirements is to advance the philosophical point of view of the author, rather than to seek an economic gain.

    Next time I will discuss why open source software was developed. If you have comments on this topic or suggestions as to issues you would like me to cover, please let me know.

    Thursday, September 3, 2009

    Choosing a Business Entity: Common Legal Entities


    In my last post, I talked about the benefits of forming a separate legal entity for your business. Once you’ve decided to set up a separate entity, you’ll need to figure out which type of entity makes the most sense. While not exhaustive, the following are some of the most common forms of business entities. Each type varies in terms of its ease in creation and maintenance and the tax consequences to the owners.

    Corporation:
    The corporation has, until recently, been the most traditional form of business entity. A corporation is owned by one or more stockholders who are issued shares of stock in return for their investment. Although in small businesses and family-run corporations, the stockholders may have a role in running the business, their role as stockholders is strictly economic. Absent extreme circumstances, such as fraud, a stockholder of a corporation is not personally liable for the acts or obligations of the corporation.

    The corporation is managed by a Board of Directors, which is elected annually by the stockholders. The Board appoints the corporation’s officers, including a President, Treasurer and Secretary, who are responsible for the day-to-day business affairs of the corporation.

    A corporation is taxed as a separate entity, meaning that it files its own tax return and pays taxes without regard to the tax status of the individual shareholders. However, if the corporation distributes a portion of its after-tax income to its shareholders in the form of dividends, each shareholder will pay a separate tax on the dividend received. This “double taxation” can be avoided if the corporation makes an election under subchapter S of the Internal Revenue Code. It is critical to consult with a tax professional for the rules and requirements relating to corporate taxation.

    Corporations must comply with many formalities (which, to the detriment of many shareholders, are often overlooked), including annual meetings of the stockholders, election of directors, keeping of minutes and a stock transfer ledger, all of which are typically set forth in the corporation’s bylaws. Some of the corporate formalities may be dispensed with if the corporation is set up as a “close corporation” pursuant to the provisions of Title 4 of the Maryland Corporations and Associations Act.

    Limited Liability Company:
    In recent years, an increasingly-popular alternative to the corporation is the limited liability company (“LLC”). An LLC is an unincorporated business organization with at least one “member.” Members may be individuals, corporations, partnerships, or other LLCs. LLCs have gained favor, especially among small businesses, because they offer the limited liability of a corporation but with fewer record keeping requirements and other formalities and, like a corporation, can be managed by non-member employees.

    An LLC offers the same liability protection for its members as a corporation does for its stockholders. This means that, absent fraud, self-dealing and the like, a member is not responsible for the debts, liabilities and obligations of the LLC.

    An LLC can consist of only one member. However, where there are multiple members, it is critical for the members to enter into an “Operating Agreement” which sets forth the relative rights and obligations of the members regarding contributions, distributions, allocations of profits and management of the business.

    LLCs are also favored because they offer the streamlined “pass-through” tax benefits of a partnership. This means that the entity is not taxed separately but rather passes through its income, deductions, credits, as well as other items, to its members. Your tax advisor can provide you with more information on the tax implications of operating as an LLC.

    Limited Partnership:
    A limited partnership is a partnership which includes one or more general partners, who are responsible for the management of the business, and limited partners, who have an economic interest in the partnership, but take no part in the management of the business. Limited partnerships are most commonly used in real estate ventures (although, in recent years, LLC’s are becoming favored alternative entities). Limited partnerships must comply strictly with the provisions of the Maryland Limited Partnership Act, Md. Code Sec. 10-101, et seq.

    General partners are personally liable for the obligations of the partnership. Limited partners, like corporate shareholders, are not liable for partnership obligations beyond their financial contributions. Unlike shareholders, however, except in unique circumstances, limited partners may not participate in the management of the partnership’s business –- another reason why LLC’s are becoming favored alternatives. There is no legal prohibition on the role of members in the management of the LLC’s business –- even if those members are merely passive investors.

    Limited partnerships are treated the same as partnerships for tax purposes.

    Again, this list is not exhaustive. There are other entities, such as professional corporations, limited liability partnerships and others, that may be more suitable for your business activities. A business attorney, working together with your tax advisor, can help you decide which form is most appropriate for your business.

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