Audit Clause Pitfalls

Guest Article by Walt Batansky of PointLine, Inc., Tampa, FL
Alliance of Tenant Representatives
Friday, February 10, 2012

Imagine that you purchased $10,000 worth of product from one of your suppliers. When the invoice came, however, they incorrectly billed you $20,000 and your accounts payable department unknowing paid the full invoice. When you discovered the error 45 days later, you approached the vendor and they said, ‚ÄúSorry, read the fine print. If you don’t object to the billing within 30 days, we get to keep your money.‚ÄĚ

Would You Ever Do Business On These Terms? Guess What? You Might Be Doing It Right Now, And The Vendor Is Your Landlord.

The vast majority of commercial leases state that the landlord will provide a reconciliation of operating expenses at the end of each year. This is usually a one page summary of property expenses with categories listed such as Utilities, Maintenance, Repairs, and Miscellaneous. The tenant often has some set period to object if they think the numbers are incorrect (although are typically not given any support information to arrive at this conclusion) or they ‚Äúconclusively accept the amounts and waive any right to challenge or make claim‚ÄĚ or similar language against such costs in the future.

So even if the landlord fails to apply the caps you negotiated into the lease, or accidentally includes the cost of their holiday party, or added an extra zero to a charge, or includes capital items which should be excluded, or any other number of incorrect or inappropriate charges are included, your money is now in their hands and may be technically unrecoverable.

It is a very bad industry custom, and it is getting worse. Landlords are knowingly designing leases that may make challenging these expenses as difficult and expensive as possible for the tenant to audit a lease. We’re seeing language that includes wording like these:

  • Unreasonably short terms to challenge charges (hopes tenant will miss deadline, prevents recovery of prior year inappropriate charges)
  • No audits on a contingency basis (forces tenant to spend money as a deterrent)
  • Must be performed by a limited group of nationally recognized CPA firm (expensive, may force unfamiliar relationship, may prohibit firms that specialize in lease audits)
  • Must be conducted at landlord’s office (Refusal to provide electronic records forces expensive on-site visits and travel)
  • Confidentiality between CPA and tenant’s financial team only, prohibits disclosure even to other staff within tenant firm and tenant’s real estate advisors (Landlord wants to limit potential overcharge liability to their other tenants without having to correct unless discovered by each individual tenant, and do not want to alert others to their mistakes or propensity to overcharge)

What Incentive Would A Landlord Have To Make Such Unfair Restrictions?

Here’s How To Avoid The Pitfalls:

  • Get tough on your rights to audit leases in new documents and allow not less than 90 days to request a review, and up to 3 years to challenge if a wrongful charge is found (IRS requires them to keep records for at least 3 years. NOTE: it would be absolutely no additional burden on an honest and fair landlord to agree to such terms)
  • Don’t allow restrictions on contingency audits. If a landlord insists on a paid hourly audit, they should agree to pay your costs of the full audit which can cost as much as $50,000 per year under review depending on whether a national CPA firm performs the work versus a more efficient boutique firm like Commercial Tenant Services, Inc. (CTS).
  • No restrictions on your advisors or staff on requesting the information. With all due respect to your CPA, unless they specialize in commercial lease audits, they may not know what is appropriate or customary under your specific lease and, even if you do use a CPA, you or your tenant representative should be allowed to review charges prior to engaging the CPA.
  • Audit your leases regularly. You should perform an audit at least every other year on major leases in multi-tenant properties with common charges, and annually if charges are significantly higher over a prior year, ownership changes, classifications of expenses change, or there are major changes in occupancy in the property. Firms such as CTS with international coverage have seen it all and can very cost effectively and efficiently carry out a lease review/audit campaign for any size firm.

When It Comes To Restrictions In Your Right To Challenge Operating Expenses, Less Is More.