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"WHEN AND HOW TO HAVE A LEASE AUDIT PERFORMED"

Anthony F. Collura
Vice President, Lease Services
CRS Inc.

Any tenant who is charged additional rent, such as escalations for operating expenses, real estate taxes, common area maintenance (CAM) costs, which are customary in retail and office leases, is a candidate for lease auditing. Any tenant whose leased space is defined in square footage or a percentage of a building's total space should consider a lease audit. Any tenant who pays electricity charges other than directly to the utility service provider would benefit from a lease audit. Lease audits will verify or disprove the accuracy of a landlord's charges and measurements. Without a lease audit, the tenant generally relies on the accuracy of the landlord's calculations of such charges. Leases provide landlords with the responsibility to calculate the extent to which the tenant is liable for any increases in expenses. The prudent tenant will protect itself against overcharges with a lease audit.

The calculation and allocation of escalations often are complicated. The 1980's, in particular, heralded a new era in leasing that manifested itself in complex lease clauses previously unknown in the industry. Punished by recent inflation of expenses and buoyed by the high-flying lease market, landlords wrote lease provisions that were designed to protect them, but at the same time reached new levels of complexity. The interpretation of these clauses requires diligent analysis, and it is upon these interpretations that escalations are based.

It is not surprising then, that errors are made. It is predictable that such errors are made at the tenant's expense. The misinterpretations that are the most common cause of overcharges are varied. Misinterpretations of the permissible categories of expenses; differing views on the method of determining base year expenses are two common examples. In the latter example, occupants of a newly constructed or newly renovated building often are victimized by the establishment of an artificially low base year. The "grossing up" of first year expenses to fairly represent an appropriate base year is an area that warrants a professional review, as landlords commonly miscalculate what comprises an appropriate and equitable base year.

When should a lease audit be conducted?
Lease audits frequently reveal overcharges that have recurred over several years. The recovery process in such cases can be difficult — requiring the participation of only the most knowledgeable and experienced lease auditors. Not surprisingly, a landlord is reluctant to relinquish the benefits he has received from overcharges over several years. One hurdle to overcome in such situations is the possible expiration of audit deadlines contained within the lease. Many leases place time constraints on the period after bills are received when a tenant may contest the charges and conduct an audit of the landlord's books and records. In the same vein, statutes of limitations may have expired, denying the tenant legal recourse in the recovery of long-standing overcharges.  A tenant should not view these inhibitions as insurmountable obstacles in his pursuit of justifiable claims. A reasonable landlord is motivated to retain the goodwill of the substantial tenant. Supportable claims can be resolved even when the threat of legal action cannot be used in the negotiation process.

Situations arising from recurring billing errors can be avoided by auditing early in the term of the lease. Substantial leases should be audited immediately after the first escalation bill has been received. Erroneous charges identified at the outset can be resolved quickly, thereby possibly preempting recurrences of such errors. It should be noted that in drafting the lease, the tenant can incorporate safeguards that protect his interests and eliminate opportunities for misinterpretation that result in billing errors. Nevertheless, even when an audit is conducted after the first year of occupancy, future errors are not automatically precluded. Lease audits should be conducted annually so that errors are not allowed to compound over time.

Lease auditing should be viewed as an integral part of a company's internal procedures. They should be scheduled and performed regularly, and time constraints should be maintained in an automated data environment to provide a tickler-controlled compliance with lease terms.

What can you expect from a lease audit?
A lease audit is not like a financial accounting audit performed by an independent professional to provide comfort to a corporation and its stockholders that the company's financial statements reasonably reflect its financial status. A lease auditing firm singularly represents its Clients, and its mission is to ascertain whether a tenant has been materially overcharged and to actively pursue the recovery of any overcharges identified.

In many instances, lease audits reveal that a landlord has billed its tenant appropriately, and therefore, there are no overcharges to recover. In some cases, a lease audit may reveal that the landlord has erred to its own detriment; the tenant has been underbilled. The lease auditor will apprise his Client of his determination and take no further action. The lease auditor, being a representative of the Client, has no obligation to have the error made to his Client's benefit reversed.

Frequently, a lease audit will reveal that the tenant has been overcharged. The tenant will be presented with the findings and with an experienced lease audit firm, should be advised on the most appropriate recovery action to be taken. The experienced lease audit firm will undertake the recovery of the overcharges on behalf of its Client.

The benefits to a tenant from a lease audit are "win/win" by assurance that the tenant has not been overcharged or by the identification of errors and the recovery of overcharges, including the elimination of the likely continuation of overcharges. Since most lease audit firms will provide some form of contingent fee arrangement whereby no fee is paid unless the tenant receives a recovery, the situation is truly one of ultimate benefit.

Not all lease audit firms perform the actual recovery process, but it is generally beneficial to the tenant to be represented by a third party. The delicate relationship between a tenant and its landlord can be best preserved by utilizing the lease audit firm in negotiations of recoveries of overcharges. Further, the lease audit firm is most familiar with the intricacies of many claims and such depth of knowledge is required to convince the landlord of the justifiable nature of the claim. An experienced lease audit firm is also most knowledgeable of industry and local real estate practices and often will have key professionals with vast experience from the landlord/operational side of the real estate industry.

How is a lease audit organized?
The tenant's organization and participation in a lease audit is not demanding. A professional lease audit firm will undertake most of the organizational responsibilities. In fact, a lease audit firm is best equipped to plan an audit because it is fully aware of what is needed to scope and undertake the task. The first step is to select the leases to be audited. Some tenants assign a "test" audit to the firm they select. This is not necessarily a wise course, as delays in auditing the remainder of the leases can prove costly because of expiring deadlines, etc. Further, once the selection of the firm has been made, a tenant will benefit from the commitment it will make in response to being given a portfolio of leases to examine.

The lease audit firm should select for audit those leases that are most likely to produce returns to its Clients. It should recommend priorities for auditing and should provide its Clients with a plan for undertaking the full scope of the portfolio audit. The Client may have business reasons for revising the plan but, unless such considerations exist, the lease audit firm is the most experienced source for planning an audit program. The Client will have to provide or make available the documents needed to initiate an audit. These comprise leases, including amendments, and bills from landlords, including any supporting documentation provided.

The lease audit firm will then be in a position to start the audit process. It should maintain communications with its Client, keeping it informed of the progress of the entire program. The Client should retain the level of delegating the decision-making control over the audit, particularly in determining the method of resolution and negotiation of claims.

The experienced lease audit firm that can demonstrate a track record of success is an important tool for the corporation in fulfilling its overall financial control objectives.