Learn How SB 1103 Could Impact You

Although the parties to commercial leases in California have historically had the freedom to bargain over nearly all terms of a lease with little statutory restraint, a law that came into effect this year imposes novel requirements on California property owners renting commercial space to certain small businesses. California Senate Bill 1103, named the Commercial Tenant Protection Act (“CTPA”), imposes limits on a landlord’s ability to pass through certain building and common area operating expenses and expands some existing residential tenant protections to certain commercial tenants.

California commercial property owners, especially those who lease small retail spaces, professional offices or restaurant spaces, need to know what a “qualified commercial tenant” is and that new rules related to passing-through operating expenses to such tenants, which cannot be waived, require them to take proactive steps before a lease is signed.  Failing to comply with those rules could potentially lead to significant liability.

The new rules only apply to leases with “qualified commercial tenants,” which are:

1. Microenterprises, defined as companies with five or fewer employees (including the owner) that “generally lack sufficient access to loans, equity, or other financial capital” (this could potentially include, for instance, leases to solo professionals, such as therapists, chiropractors, artists and the like);
2. Restaurants with fewer than ten employees (“restaurant” is not defined, but landlords leasing space to coffee shops, bakeries, donut shops and similar businesses, which frequently have fewer than 10 employees, should assume they potentially qualify); or
3. Nonprofit organizations with 20 or fewer employees.

Additionally, to qualify for the CTPA protections, the otherwise qualifying tenant must provide a self-attestation of the number of its employees to the landlord upon or before execution of the lease and annually thereafter.

Expense Pass-Through Limitations

Many commercial leases, whether referred to as “triple net,” “modified gross” or otherwise, have terms requiring that the tenant pay all or some portion of the operating expenses incurred by the landlord in owning and managing the property, such as property taxes, insurance, maintenance and property management fees. For leases with qualified commercial tenants which are (1) entered into or renewed after January 1, 2025, (2) entered into or which commenced prior to January 1, 2025, and have no express expense pass-through provisions (this could be relevant for landlords with existing full-service leases which are amended after January 1, 2025, in order to pass through any expense), or (3) which are month-to-month or for a shorter term, the landlord cannot pass through operating expenses, unless the following requirements are met:

1. Operating expenses must be allocated proportionally among a property’s tenants, by square footage or another method substantiated through documentation;

Most commercial leases already allocate pass-through expenses based on proportionate square footage, but landlords with more complicated expense arrangements, such as “cost pools” or segregated expenses in mixed-use buildings, should consult with outside counsel as to how best to comply with this requirement.

2. The operating expenses must have been incurred by the landlord within the previous 18 months, or reasonably expected to be incurred in the next 12 months;

Some landlords will agree to similar limitations for the benefit of tenants with sufficient bargaining power, but the CTPA now makes these limitations mandatory for qualified commercial tenants, who would not ordinarily have the bargaining power to obtain this concession. Clauses of these type customarily exclude property taxes, because sometimes property owners will not receive a tax invoice from the County until long after the year to which the taxes apply, or because of a county’s ability to claw back prior years’ taxes in certain cases. Given that such a property tax circumstance is not an exception to this requirement, landlords anticipating supplemental tax bills or disputed assessments should consult with outside counsel.

3. Within 30 days of written request, the landlord must provide the tenant with “reasonable supporting documentation” of such expenses;

The scope of documentation this requires is not yet clear, but, while not a full audit right—a common term in many leases—this would likely require more than just a spreadsheet of expenses broken down by line-item.

4. The expenses cannot include expenses paid by a tenant directly to a third party or for which the landlord is reimbursed by a tenant, insurance company or other third-party; and

These types of expenses are already excluded in nearly all leases with expense pass-throughs, either expressly in the lease or by custom, so this requirement is not likely to have a major impact but is worth noting.

5. Before the execution of the lease, the landlord must provide the prospective tenant with a notice that the tenant may inspect documentation for such expenses.

While the landlord must provide a notice to a qualified commercial tenant “before execution of the lease,” a tenant need only provide an attestation that it is a qualified commercial tenant “before or upon execution” of the lease. As such, unless it is patently clear that a prospective tenant does not qualify, landlords should try to ascertain if a prospective tenant is a qualified commercial tenant well before execution of the lease. Landlords should also consider adding relevant representations from the tenant and the required disclosure to the lease itself.

Any purported waiver by a qualified commercial tenant of any of the above requirements of Section 1950.9 of the California Civil Code would be ineffective, as the provisions are non-waivable. If a landlord violates any of the provisions, the qualified commercial tenant has the right to sue the landlord for actual damages and attorneys’ fees, as well as treble (i.e. tripled actual damages) and punitive damages for willful violations. A violation could also give the tenant a defense to an eviction proceeding.

 New Notice Requirements

Existing law provides that tenants under month-to-month or shorter term residential leases must be given specified minimum advanced notice of the termination of the lease and of any rent increase. (SB 1103 also expands requirements for giving notice to tenants under leases with an unspecified lease term to qualified commercial tenants; however, commercial leases to tenants for an undefined period of time are rare.) The CTPA expands these protections to qualified commercial tenants under existing short-term leases or new leases entered into on or after January 1, 2025.

However, while Section 827(b)(1) of the California Civil Code, which contains the existing requirements for how, and the timeframe in which, a rent increase notice must be sent, expressly applies only to short-term leases, the new subsection (b)(5) added by the CTPA to Section 827 states that “[i]n all leases for a commercial real property by a qualified commercial tenant, a rent increase shall not be effective until the notice period required by [Section 827(b)(1)] has expired.”

The bottom line is that it is not clear whether a landlord must give a qualified commercial tenant advanced notice of a rent increase only for short-term leases or for all leases, including leases with years-long terms with rent escalation clauses already in the lease. If the latter, it is also not clear if the lease clauses themselves satisfy the notice requirement, if a separate notice must be sent in advance of each escalation, or whether a tenant could waive the requirement altogether. Landlords facing such ambiguity, as well as landlords entering into month-to-month or shorter-term leases with potentially qualified commercial tenants should consult with outside counsel.

New Translation Requirements

Existing law provides that persons “engaged in a trade or business who negotiate” in Spanish, Tagalog, Vietnamese, or Korean must be provided with a translation of most contracts, including residential leases, in that language, before execution of the contract in English. The CTPA also expands this protection to qualified commercial tenants. Of particular note, existing law makes an exception for persons who negotiate a contract through their own translator, including negotiations of residential leases, but that exception does not apply to leases with a qualified commercial tenant.

In general, if you are negotiating any contract with another person in any of the specified languages, or the other person negotiating the deal only speaks one of the specified languages, you should contact qualified outside counsel before executing a contract in English.

Procopio’s award-winning real estate team is here to help commercial landlords navigate these new requirements and is keeping on top of further legal and regulatory developments impacting California real estate. Feel free to reach out with any questions you may have.