Stop Giving Away Your Audit Rights

It happens all the time. A tenant discovers an overbilling in its rent but can’t do anything about it because it missed the 60-day deadline for notifying its landlord. Or it simply wants to audit its occupancy costs as a matter of good business practice but can’t justify the up-front cost because the lease requires it to hire and pay for a lease auditor on an hourly basis.

Tenants need to understand that these restrictions have no legitimate purpose, and that they do nothing more than inhibit them from achieving the normal and fair business goal of ensuring that the landlord is charging them properly. After all, lease clauses relating to tenant reimbursements for operating expenses, taxes and utilities can be complex. And even though tremendous time and effort goes into drafting these clauses, when it comes to applying them to real-life building expenses, there is often wide room for interpretation. Furthermore, it is impossible for landlords to administer these clauses perfectly all the time; they often have multiple leases to manage, each with different terms.

Given the likelihood of errors, agreeing that bills will be binding unless objected to within a short time after receipt, or that they will only be audited by “Big-4″ CPA firms paid on an hourly basis, greatly inhibits a tenant’s ability to enforce its leases and costs it money.

For example, where the tenant has agreed to only challenge bills within a short window, it generally doesn’t have time to check for anything but the most basic issues. More subtle but nonetheless significant errors go undetected. Furthermore, many errors are only visible by studying multiple years of expenses. A short time restriction makes it impossible to identify these errors until it’s too late to do anything about them.

Landlords will argue that time limits are important because they want to “close the books” for the year. However, operating expenses and other costs almost always bleed over from one year to the next and there is no real need to segregate the years so formally. The landlord-tenant relationship is a dynamic one that spans multiple years, and both parties need to be able to make adjustments to keep the business deal on track. Not only is the landlord’s claimed need to close the books not valid, it is also dwarfed by both parties’ need to ensure that the lease is operating as intended.

The other common requirements—that the tenant only use a CPA firm to review the landlord’s books and records and that the audit be conducted on a non-contingency hourly basis—serve no purpose other than to handicap the tenant by creating hurdles toward the the identification and correction of errors. CPA firms generally focus only on accounting issues, and restricting audits to such firms prevents tenants from being able to employ experts who specialize in digging into lease language and other issues beyond that scope (besides, most lease audit firms have CPAs on staff). Furthermore, if a tenant must retain an independent CPA firm and spend thousands of dollars in order to check its bills, it most likely will not do so except in very limited circumstances.

Landlords often contend that contingency fee structures are inappropriate because they cause audit firms to focus on inconsequential items and become too aggressive. However, in actuality 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 not valid. 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 assuring it that its auditors will be supervised and will only act with the tenant’s consent and support.

Furthermore, landlords use their own accountants and property managers to issue these bills. Why should they be able to dictate the nature and fee structure of the tenant’s experts?

Thus, given the complexity of lease audit pass-through clauses, it is inappropriate for landlords to request (and for tenants to grant) limitations on the tenant’s ability to freely verify the costs to ensure that the deal stays on track.

Sample Audit Clause

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

Tenant’s Audit Rights. 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”), Tenant shall have the right, upon reasonable written notice to Landlord and at Tenant’s sole expense, to examine or have Tenant’s representatives examine the records as are relevant thereto, including the general ledger, escalation worksheets, invoices, canceled checks, contracts and other supporting records (collectively, the “Records”). Landlord shall make the Records available for inspection at the Building management office during normal business hours, and Tenant shall be entitled to make copies of the Records as needed. To expedite such review, Landlord shall forward to Tenant copies of reasonable portions of the Records upon request.

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 keep copies of the Records for each year including the Base Year for the duration of the Lease Term, as extended, and for three (3) years thereafter. Tenant agrees to maintain the confidentiality of all copies of the Records it obtains from Landlord. 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. If it is finally determined by agreement or otherwise that Tenant’s liability for Charges was overstated, Landlord shall immediately repay such overpayment together with associated interest at the rate of _____%.

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.

*For a more detailed discussion of lease audit rights, see our Articles, “Negotiating Lease Audit Rights” and “Audit Deadlines Come in All Forms.”