Landlords argue that time limits are important because they need to "close the books" for the year and that an open right to challenge charges leads to uncertainty and risk.  They also argue that it is burdensome to have a tenant look at more than the current year when validating charges.   

From the tenant’s viewpoint, however, short audit windows present practical problems that are difficult to avoid.  First, inadequate time leads to substandard analyses.  When a tenant agrees to a short window within which to contest a pass-through, there generally isn’t enough time to check for anything but very basic issues.  Second, short windows mean that the tenant cannot check more than one year at a time.  Given that many errors are only visible by studying multiple years of expenses together, a short time restriction makes it impossible to identify these errors until it’s too late to do anything about them. 

With respect to the argument that the books need to be “closed,” operating expenses and other costs almost always bleed over from one year to the next (isn’t the operating expense reconciliation done months after the year closes?).  Such formality is both unnecessary and unjustifiable.  Also, landlords keep books and records for internal accounting and tax purposes for many years, so arguing that the records are unavailable is simply not valid. 

No Contingency Fees 

Landlords often try to restrict the tenant’s ability to retain a firm where the compensation is based on the outcome of the audit.  Landlords contend that such contingency fee structures are inappropriate because they cause audit firms to focus on inconsequential items and become too aggressive. 

Actually the reverse is true: contingency audit firms have a built-in incentive to focus on the more material issues and to not pursue issues that are small or unlikely to be recoverable.  This makes them inherently more focused, more efficient and less burdensome to both landlord and tenant.  Also, a tenant can easily assuage the landlord’s fears during negotiations by agreeing it will supervise its auditors and that they will only act with the tenant’s consent and support.

From a simple business standpoint, it is also inappropriate for either landlord or tenant to restrict the other in who it retains or how they are compensated in these or any other efforts.  Restricting a tenant from retaining a contingency fee auditor is analogous to prohibiting the landlord from retaining a property management firm on a percentage-of-revenue basis because it provides incentives to drive more income from their tenants. 

CPAs Only

Landlords will argue that any audit must be done by a CPA firm.  They assert that this ensures that the audit will be performed professionally and that the results will be unbiased. 

This also presents difficulties for tenants, both with respect to compensation and with respect to expertise.  Most CPA firms will not or cannot work on a contingency fee basis, forcing the tenant to retain them on an hourly or fixed fee basis.  Furthermore, CPA firms generally focus on accounting issues and do not have the expertise when it comes to lease interpretation, market analyses or property management practices.  Thus, such a restriction can significantly hamper the tenant in its ability to validate anything but the accounting aspects of its charges. 

Records Must Remain Confidential

Landlords argue that their proprietary information must remain confidential.  They want significant restrictions on the tenant’s ability to share information with third parties.  In some cases they ask for confidentiality language directly in the leases, and in other cases they ask the tenant to agree to execute a confidentiality agreement at a later time. 

Most tenants would agree that such proprietary information should be kept confidential.  However, tenants must be careful that the restrictions in the lease do not hamper the tenant’s ability to obtain the advice it needs to enforce its lease.   Confidentiality requirements should be reasonable and should be spelled out directly in the lease.  They should not be deferred to a later time by language that says that the parties will agree to execute a confidentiality agreement later. 

Conclusion

Although landlords do not like having their pass-throughs challenged or their books audited, as long as they require tenants to contribute toward building operating costs, tenants must have a reasonable means to verify that the charges are correct.  Given the complexity of lease audit pass-through clauses, it is inappropriate for landlords to request (and for tenants to grant) unreasonable limitations on the tenant's ability to verify its costs. 

The landlord-tenant relationship is a dynamic one that spans multiple years.  Any procedural needs of the landlord are trumped by both parties’ need to make corrections along the way to ensure that the business deal stays on track.  

Sample Short Audit Clause

The following is a sample short lease audit clause that can be used and/or modified as appropriate: