If you have ever been involved with a physical, on-site lease audit of a landlord’s books and records, you would know that landlords hate them. Such audits require valuable resources, are intrusive, time-consuming and inefficient. With the widespread use of Adobe Acrobat® and various forms of digitized record-keeping, many landlords have found it preferable to send records to their tenants electronically to expedite the verification of operating expenses, CAM, taxes, insurance and sundry charges. This article will discuss the benefits and limitations of electronic data-sharing, and suggest sample lease language for that purpose.
Origin of the On-Site Audit Requirement
On-site reviews found their genesis in the days before electronic recordkeeping. A full audit usually requires access to trial balances, general ledgers, supporting calculations and source documents such as vendor contracts, invoices, purchase orders, cancelled checks and payroll records. Reproducing all of this documentation for multiple tenant audits was extremely burdensome. So, in order to accommodate tenant requests to perform reviews, the most efficient way to provide such records was to keep a set available at their offices for physical inspection.
How Sharing Digital Documents Benefits Landlords and Tenants
In recent years, many landlords have opted to send backups of their charges to their tenants electronically, rather than requiring them to go through the often long and complex audit procedures set forth in the leases. They find that doing so increases efficiency and employee productivity while reducing costs. Sending out records electronically also eliminates the disruption of the landlord’s office environment and daily operations caused by the presence of outside auditors. Furthermore, electronic data sharing allows property accountants to handle multiple tenant reviews simultaneously, resulting in increased productivity. As an added benefit, making records readily available promotes transparency and engenders a much more trusting tenant/landlord relationship.
From the tenants’ perspective, being able to initially review landlords’ records digitally reduces the cost of verifying charges by saving travel time and expenses and eliminating the need to copy and reprint landlord records. It also gives the tenant more time to perform a proper analysis of the charges, without the pressure of having to perform such analyses on site within a tight deadline.
What about landlords’ needs to keep their records confidential? In truth, annual operating expense/CAM data is not very proprietary and much of it is routinely disclosed on a non-confidential basis anyway, which effectively breaks any seal of confidentiality. Every tenant receives the annual results, at least in summary form, on a non-confidential basis, and this is regularly reviewed by numerous tenant employees, outside accountants, consultants and lawyers. Many landlords report their operating costs to BOMA and similar data warehouses. Much of this data is shared with brokers, consultants and lawyers as part of the marketing and leasing process. Some of the more proprietary information (e.g., building revenue and expenses) is often disclosed as part of tax appeal proceedings, and is regularly reported to investors, lenders and insurance companies. If any of the landlord entities is publicly-traded, such data is part of its normal public filings. There is very little confidentiality the landlord is protecting by restricting a tenant’s examination of its books and records to only an on-site viewing.
Furthermore, notwithstanding these multiple points of disclosure, a landlord can always require the tenant party to execute a reasonable non-disclosure agreement, which is a routine requirement in lease auditing.
So Why Not Eliminate On-Site Audits Altogether?
Although all leases should include a requirement that landlords must provide tenants with digital copies of their books and records, the tenant should still be able to perform an on-site audit where appropriate. Tenants often like to interact with their landlords in person, and an on-site review enables the parties to focus on key issues and discuss the intent behind certain provisions. Furthermore, an on-site review can provide the Tenant with additional insights as to building operations and other physical attributes of the site.
Sample Lease Audit Language to Provide for Electronic Record-Sharing
The following is a sample lease audit clause that can be used and/or modified as appropriate:
Review of Records
In order to verify the accuracy and validity of the charges set forth in the Operating Statement, the Tax Statement and any other charges imposed on Tenant for Additional Rent (collectively, the “Charges”), Landlord shall, upon Tenant’s written request, provide Tenant with digital copies of the records as are relevant thereto, including the general ledger, escalation worksheets, invoices, canceled checks, contracts and other supporting records (collectively, the “Records”).
Should Tenant find the digital information insufficient to reasonably substantiate the Charges, Tenant shall have the right to conduct an on-site examination of Landlord’s books and records upon reasonable written notice to Landlord. Landlord shall make the original versions of the Records available for inspection at the Building management office during normal business hours. During such inspection, Tenant shall be entitled to make copies of the Records as needed. Tenant agrees to maintain the confidentiality of all copies of the Records it obtains from Landlord.
Landlord shall maintain accurate books and records for the Charges in accordance with generally accepted accounting principles consistently applied, subject to adjustment as provided in this Lease, and shall retain the Records with respect to each year [including the Base Year] for no less than the period required by applicable federal and state tax rules and regulations with respect to the retention of financial records.
If after its review Tenant disagrees with the Charges, Tenant may send a written notice to Landlord of such disagreement specifying in reasonable detail the basis therefor, the amount it claims was not due and the amount of any refund it is claiming. Landlord and Tenant shall attempt to resolve such disagreement amicably, subject to either party’s right to avail itself of the dispute resolution procedures set forth in this Lease. Tenant may withhold the amount of any disputed amounts pending resolution, subject to the Landlord’s right to require that such withheld amounts be held by Tenant’s attorney in escrow in lieu thereof and paid to the appropriate party upon final resolution of the disagreement.
NOTE: This clause is not intended to provide legal advice, and parties are urged to consult with their respective legal counsel prior to using it.
The next time you are negotiating a new lease, modifying an existing lease, or arranging to review charges billed, consider the addition of a provision to arrange for reviewing the details of Operating Expense and CAM charges through the review of digital records. Doing so will enhance both landlords’ and tenants’ efficiency and productivity.