Back in ancient times, perhaps a decade ago, when the entire issue of utilities was far more predictable, utilities were most often supplied by the applicable public utility company and billed directly to the user. Sure, there were some landlords who were supplying utilities and charging the tenant for the estimated or actual amount, depending on the service usage. But the landlord's billing of utilities was undertaken, for the most part, due to the complexity of the project and the inability of tenants to obtain separate utilities directly from the utility company.

Times have surely changed and now, only 10 years later, landlords are providing utilities much more often, due again to the complexity of the project but also due to the pressure on landlords to increase their profits, one of many outgrowths of the recent REITing of the commercial real estate market.

Before we can analyze the impact of the last few years, it is important to determine what a utility is, as defined today. This used to be an easy question with utilities being generically defined as electricity, gas and water; however, this too has changed. Landlords today are including within the utility definition items such as sprinklers, telephone, cable and broadband. Are these all appropriate utility inclusions? In the event that rent abates because utilities are lost, would it make a difference if any one of these utilities is not included?

It is fair to note that a tenant needs its entire package of utilities in order to operate its facility and, depending on the size and nature of the tenant, informational communications rival the importance of electricity and water. Without phone and communication lines, the tenant cannot communicate with its employees or its customers, nor can it handle daily operations. Landlords are pushing the envelope in an effort to capture additional rents, yet this may be at odds with the needs of the tenant. The tenant has a strong preference, in many circumstances, to purchase its communication utilities from a supplier of its choice, one which is designed to service its unique needs and one which would relieve the landlord of liability in the event that communications fail. This is an issue which all too often is handled incorrectly in the lease negotiation, as the negotiators are unaware of the peculiar needs of their client.

Unmistakably, all can agree that core utilities are electricity, gas and water. Most likely, the tenant would prefer to procure these individually, making arrangements with the utility company, public or private. In this case, the tenant will pay for the deposits, obtain the meter and make needed repairs, replacements or modifications. The tenant only needs to notify the landlord of the changes in the building and, absent any gross negligence on the part of landlord, the landlord will likely have no liability in the event of an interruption in service.

If the landlord supplies the utility, the tenant will often agree that the cost shall not exceed the amount equal to the cost the tenant would have paid had the utility been procured directly by the tenant. Two issues result. The first is that the lease needs to be clear as to the rate which is not to be exceeded. Is it the public utility rate or the public or private utility rate? Secondly, it needs to be clear in the text as to which party, if the utility is provided by landlord, is paying for the needed infrastructure in the building. Is it to be included in the utility rate? Was it included in the base rent quoted to tenant? What will happen in the event that there are needed repairs? Are these reimbursable operating costs? How are they to be reimbursed?

Additional rent is billed in many fashions. One allows the landlord to charge tenants for those operating costs which exceeded the base year. However, this might be fine if the landlord is going to pass through needed infrastructure improvements. And in the event the tenant is paying a percentage of the operating costs, and if the increase in operating costs is capped (an increasingly requested concession of tenant), the cap may be a problem to the landlord. Routinely, landlords who are willing to cap operating costs focus on the predictability of the consumer price index; but, shouldn't the landlord also be focused on those expenses like utilities which cannot be readily controlled? Additional exclusions from the capped charge might include security, insurance and snow removal. Even if the landlord is willing to cap the increases in the tenant's share of operating costs, the landlord should remember to have the charge uncapped in the first year of any option period. This is not necessarily objectionable to the tenant as the tenant is trying to obtain predictability. Full reimbursement in the first year of an option is not necessarily inconsistent with a cap.

Landlords in the business of supplying utilities should also focus on whether or not this impacts their ability to sell the property. One landlord may resell utilities to all of its tenants while another, the potential buyer, may not have the same abilities. Landlords can avoid this problem by drafting the lease to give them the right to supply utilities, not the obligation to do so. Again, the longer the lease, the more flexibility is required.

Landlords supplying utilities should also be prepared to deal with the issue of audit rights. How often can they occur? Must the results of the audit be kept confidential? Who can perform the audit (must it be an employee of the tenant or can it be an independent company, even one which receives its fee based on a percentage of the recovery)? Shouldn't the landlord receive a copy of any audit? How many years into the past can the tenant audit the utility? All of these are important considerations.

When dealing with utilities, other issues in the lease may well have an impact. For instance, if the landlord is supplying the utility, what happens if the tenant has the right of first refusal on adjacent space? Are utilities handled consistently? What if they must be split? If the right of first refusal is exercised, and if the entire space is to be governed by the lease which requires the landlord to provide the utility, who is going to expend the money to connect the new space to the utility source? And what if the tenant is concerned that the landlord cannot supply all of the utilities in a predictable fashion? Should the tenant have the right to have a back-up source of energy? If so, where might the pad be for auxiliary power? Does the tenant have to pay additional rent for the additional space?

There surely are other concerns; however, it would be fair to note that the landlord should not supply utilities unless it has given adequate consideration to the possibilities which might occur during the term of the lease. The landlord certainly has the right to attempt to augment his profit, but he needs to do so in a manner which properly addresses both the length of the term as well as the potential life cycle events which will impact the property.

Abe Schear is a partner with Arnall Golden & Gregory LLP, an Atlanta-based law firm.

©2001 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.