Audit clauses trap tenants in accounting nightmares

Real Estate Weekly, Oct 20, 2004

Edward Harris and Steven Serota are the cofounders of Commercial Tenant Services, one of the nation's first and foremost authorities on lease auditing. They have conducted lease audits nationally and recovered hundreds of millions of dollars on behalf of tenants, including Fortune 500 companies.

In the highly cutthroat commercial real estate industry, brokers must demonstrate an understanding of lease "audit clauses" in order to maintain their long term relationships with tenants and their competitive edge in the marketplace. "audit clauses" create significant add-on costs to the tenant, which can result in the broker losing their client in any future dealings.

Leases usually contain an "audit clause," theoretically designed to protect both landlord and tenant from escalation charges. In practice, however, landlords often craft clauses that attempt to limit tenant rights by reducing dispute time frames, and/or set other unnecessary hurdles that increase lease audit costs and decrease the probability of an effective audit.

Tenants should not have to limit their rights to review landlord billings. Their savvy agents must recognize the impact of a landlord's carefully crafted "audit clause" before signing their lease.

Brokers should be knowledgeable with fair terms included in an "audit clause", which might include the following:

No limitation on selection of audit firm or compensation of same.

Overcharges exceeding a threshold (commonly 13%) require tenant's audit cost to be reimbursed.

Tenant should receive interest on all identified overpayments.

A minimum of three years should be alloted to dispute statements.

Prior years' books can be reviewed if recurring errors are found.

Base year books are always open for review to avoid unnecessary debate.

Two commonly found components that should be reviewed prior to execution of the lease are as follows:

Notice requirements are a landlord's attempt to limit the rights of the tenant to challenge billed overcharges. Item one may require that disputed landlord charges be stated within a short time after receipt of the detailed operating expense. However, it is not fair to limit the tenant's right to review and challenge operating expense charges. If a limit is to be written into a lease, we recommend three years as a reasonable amount of time for a tenant to act.

Auditor requirements are attempts to limit who may conduct a review of the landlord's books and the method of compensation for the auditor.

Audit requirements may dictate that the on-site rent audit be performed by a major accounting firm and/or a firm paid on a non-contingency basis. Many landlords use artificial restrictions like this to discourage audits by raising the cost of executing one. Clearly, a contingency fee lease auditing firm will generally not waste time on a claim that is not legitimate because it is only compensated for successful results.

Brokers and tenants must be aware of these and other clauses in order to make sure that they are getting what they bargained for.

Before signing a lease, it is strongly recommended that your client/ tenant contact a lease audit specialist such as CTS for review of the lease "audit clause."