Federal Government Leasing: Look Before You Leap

By Suzanne Reifman, partner at Vinson and Elkins

We are seeing an increase in cases in which building owners that have not previously leased space to the government find themselves landlords to federal government tenants, either by acquiring a foreclosure property with a government lease or by participating in a government procurement and securing a lease award. There are a host of advantages to housing a government tenant, especially in a “down” economy.

Notwithstanding recent debt ceiling negotiations, the government traditionally pays its bills on time, and even now, it is hard to find a more secure, creditworthy tenant. Also, once government tenants move into a location, they usually stay for many years and frequently acquire additional space in the building or in nearby locations. Furthermore, some government tenants attract businesses that also need office space and are often willing to pay whatever it takes to be near the government tenant. As a result, it is not surprising that more and more owners are actively marketing space to the government.

However, while securing a government lease can be rewarding, there are also risks that should be considered upfront.

Seven Factors to Consider Before Leasing

While not intended to be exhaustive, the issues identified below include key areas that owners need to be aware of at the earliest stages in the government leasing process. These risk areas primarily pertain to federal government leases (usually those entered into by the U.S. General Services Administration on behalf of other federal agencies). However, an owner can expect that many of these same issues will apply to leases with state and local governments as well.

Government leases can't be assigned to a new owner without the government's consent. The Anti-Assignment Act prevents all government contracts (including leases), from being transferred from one contractor to another without the government's written consent, which is provided through a formal “novation.” The government is under no obligation to novate the contract to the new owner, but it generally will do so unless there is a compelling reason to object to the new owner.

Under a novation, the new owner agrees to accept all the liabilities and responsibilities of the former owner. If the novation is not in place, the government will not recognize the new owner. This means that the government will continue to hold the prior owner responsible and the new owner will not receive rent (but, as a practical matter, be expected to perform).

As a result, prior to purchasing any property, an owner should determine upfront whether there are any government leases, conduct the appropriate due diligence relating to such leases (to ensure any problems are identified), and fulfill the necessary novation requirements. It should be noted that any due diligence should address the prior owner's compliance with various unique government requirements that exceed those expected of commercial landlords.

The government uses its own leasing documents. The government leasing process is very different from the commercial leasing process. Most significantly, the government uses its own standard lease documents and will not use an owner's lease form. As a result, although government leases frequently number in the hundreds of pages, it is critical that an owner thoroughly review and understand all of the provisions and their practical effect.

After submission of “Best and Final Offers,” no additional changes are permitted to government leases. In the commercial leasing process, virtually any issue can be subject to renegotiation at any time if both parties agree. That is definitely not the case in the government leasing process, in which there can be no changes after an owner submits its final offer to the government, except in rare situations.

In addition, the government's review and acceptance of the offer is subject to strict contract principles of offer and acceptance. If the government accepts the offer, it is binding (unless the owner was savvy enough to include language that will preserve certain rights). In addition, once the government has accepted the offer, the owner must enter into the lease (again, unless the appropriate caveats have been included in the offer), even if a more lucrative opportunity from a commercial tenant presents itself.

Many owners would prefer not to spend the time and effort reviewing a government lease in detail until after they receive a notice of award. However, because there are no “do overs” permitted in the government leasing process, this is a dangerous practice.

Government leases are based on a different pricing structure than commercial leases. And government definitions of key terms often differ from private sector interpretations. Owners need to ensure they understand what the government requires and what is included in their offer. Many owners think they know what the government means by “building shell” or what is included in the “full service rent,” only to find out later that they omitted key cost elements from their rental rate.

Government leases contain additional requirements not found in commercial leases. A government lease will include a number of provisions that are designed to protect the government's sovereign rights. One example is the “Changes” clause, which enables the government to make certain unilateral changes to the terms of the lease. Government leases generally will also include various socioeconomic requirements (such as small business subcontracting or labor requirements) and often will contain enhanced requirements relating to life safety and accessibility. The owner needs to consider at the time of initial offers how it intends to meet these requirements.

Failure to properly administer a government lease could lead to serious financial repercussions. Liquidated damages or other penalties can result from nonperformance of a government lease. In very rare cases, the government may self-perform work that an owner fails to perform or a lease could be terminated for default, among other things. A bad performance record can affect an owner's ability to win future government contracts. As a result, an owner should never ignore “lease administration” issues and should take seriously any government complaints about alleged performance problems.

Additionally, a failure to follow government procedures during the lease administration process, including proper invoicing requirements, could result in nonpayment. For example, an owner will not be compensated for a government modification to the lease under the Changes clause unless the owner can prove that the change was outside the scope of the original lease and resulted in increased costs.

The lease is a government contract in which statements or claims made to the government are subject to civil or criminal penalties. Throughout the life cycle of a government lease, from the submission of the original offer to the final invoice, an owner needs to be exceedingly careful about certifications and representations made, particularly where a request for payment is involved, to avoid any allegations of false statements or false claims, among other things.

Predictable, Consistent Process

Although it may seem daunting to enter into a federal government lease in light of these risks, it should also be considered that the federal government follows an extremely consistent process, using the same basic lease documents that contain virtually the same requirements for every lease. As a result, once the government's requirements are understood, in many ways working with the federal government can be quite predictable and offer significant opportunities.

Vinson and Elkins LLP is a full service international law firm with 760 lawyers across 15 offices worldwide. Its Real Estate practice group supports both commercial and government real estate transactions. For more information, please contact the author, Suzanne Reifman, at sreifman@velaw.com.