Lease Auditing Revisited

More and more landlords are using excessive lease audit restrictions to win the "Battle of the Operating Expense Bulge." By now, it is certainly no secret that a growing number of corporate tenants have reaped sizable benefits and significant financial recoveries by initiating lease audits. The practice of lease auditing has become commonplace within the real estate industry for many reasons, not the least of which is saving and recouping improper or excessive operating expenses, real estate taxes, utility and other related pass-through costs associated with leases. The lease audit practitioners have made this exercise even more attractive by performing their services on a contingency basis, so that there is little to no financial risk to the tenant in having these opportunities explored. Moreover, the continued evolvement of lease administration processes, including those associated with required due diligence and testing procedures associated with the Sarbanes Oxley Act, have further won over tenants with respect to the merits of lease audits.

Landlord Reaction

Landlords, however, are increasingly fighting back in an attempt to prevent lease audits by insisting during lease negotiations that restrictive and draconian provisions are included in the lease document that greatly limit tenants from undertaking a lease audit. Historically, lease documents routinely have included some level of restrictions with respect to how and when lease audits can be performed. Mainly, this objective was achieved by allowing the tenant only a certain time period, perhaps as short as 30, 60 or 90 days, in which the tenant could notify, contest or audit its annual operating expenses once having received the final statement of annual reconciliation of operating expenses and real estate costs. Although this restriction (also referred to as the "lease audit window") can be useful in locking out tenants who were unaware of this restriction or were tardy in their notification efforts, at least there was a reasonable mechanism in place so that a prudent tenant could review such costs and challenge those seen as improper on a timely basis. Also, larger and more sophisticated tenants might hold out during lease negotiations for a period of six months to a year with respect to having a lease audit performed.

For their part, landlords have routinely claimed that audits are time-consuming and absorb valuable time from their staff and are unnecessary since their statements are reviewed by their own CPA firm. While noting that by most accounts 90 percent of lease audits do result in a financial benefit to the tenant, it should be acknowledged that landlords and their employees should be afforded some regard to their time and priorities.

Who Does the Audit?

Many landlords also require that the auditor be either a major or nationally-recognized CPA firm. The rationale for this restriction is usually based on the claim that they wish to avoid a "wild" or disreputable lease auditor creating havoc by "throwing some things on the wall in order to see what sticks." This claim is widely exaggerated, as most lease audit firms perform their duties in a professional manner and recognize that ultimately a successful recovery is only secured by full cooperation of landlord and tenant. It also should be understood that the landlord should not have the right to choose the consultant or limit the choice to certain firms.

Contingency Fees

Many landlords now seek to have the lease contain a clause requiring the lease auditor not to be compensated on a contingency basis. Many believe this is intended to reduce fees and by doing so discourage auditors to take on long-term assignments. On the other hand, landlords may use this restriction as a way to discourage tenants from having audits performed by shifting the focus of risk directly from the auditor to the tenant. On many occasions, this scenario has worked as many companies that otherwise would have been more than happy to have an audit performed, assuming that they have no financial risk, are unwilling to expend any dollars unless there is some prospect of a guaranteed return and no reputable lease audit firm can guarantee a recovery.

Concluding Thoughts

While negotiating a lease is always a challenge, given the adversarial relationship of the parties, tenants should seriously consider the impact of any restrictions with respect to lease auditing. Operating expenses are an important part of most leases and landlords are aware that a lease audit clause that includes such provisions as a short window (less than 90 days), limiting the audit to the "Big Four" accounting firms, or a non-contingency payment clause, means the tenant may encounter significant hurdles to in preventing unjustified charges. Regardless of the economic climate, business firms should periodically review all significant costs to verify they are being billed accurately.