The Need for Exit Strategies in Your Commercial Lease
In good times and in not so good times, a well drafted and negotiated commercial lease will contain various exit strategies available to the landlord and tenant. These strategies will come in handy in situations where a tenant’s business is booming causing it to grow out of its current space (good times) or where the space is too big or expensive for the tenant to continue because business has dropped off considerably (not so good times).
Exit strategies can include the following:
- Contraction rights
- Right to go dark
- Right to expand
Below is a very brief overview of how each of the foregoing strategies operates.
Assignment: This approach effectuates a transfer of the tenant’s right, title and interest in the Premises to the assignee. However, the assignor remains liable on the lease to the landlord in the event of a default by the assignee. More importantly, in the event of a default by the assignee, the assignor tenant would be precluded from retaking possession for the purpose of mitigating any damages. A release, therefore, is critical. If no release is possible, a tenant should attempt to negotiate terms that the tenant-assignor’s liability only extends to the then existing obligations for the then existing term. If this is not possible, then the tenant may wish to consider a sublease.
Sublease: A sublease is a lease given by a lessee for a portion of the leasehold interest, while the lessee retains some reversionary interest. Both landlord and tenant will want a sublessee with good credit. The landlord may also wish to limit the tenant from soliciting tenants in the building, prospective tenants with whom the landlord is currently engaged in negotiations, and negotiating a sublease that is below market rents. The sublease may be for all or part of the premises, for the whole term or part of it, as long as the lessor retains some interest in the property. In this approach, the original tenant would remain liable to the landlord in the event the sublessee defaults. However, the original tenant-sublessor would have the right to go back into the property in an effort to mitigate any damages arising out of the sublessee’s default.
Contraction Rights: This right, allowing a tenant to shed space, is difficult to get unless the tenant has good leverage. This right could include the right to terminate the lease early. If a tenant has the good fortune to be able to negotiate this into a lease, the lease should be very clear about the date on which notice of the exercise of the right is to be given, as well as the effective date of the termination. The parties should also be explicit about whether the tenant’s right is a one time right, a right to be exercised at fixed intervals, or a right exercised on a rolling basis after a certain date.
Right to Go Dark: This type of clause can come in handy even if the lease does not allow a tenant to get out of its obligations. Retail and even office tenants can save on operating costs by “going dark.” It is important to ensure that the lease does not contain any continuing occupancy clauses or similar language. A potential compromise with the landlord who resists is to negotiate a clause that defines abandonment as the inability to pay rent and maintain the premises.
Right to Expand: This type of clause in a commercial lease will assist a landlord in retaining good creditworthy tenants from growing out of the building. The benefit to both parties is apparent. The landlord gets to keep a good tenant, and the tenant gets to save a bundle of cash by simply staying put and expanding out into its current building. Otherwise, a tenant will have lost the benefit of the funds it paid into the infrastructure of its current space and will have to undertake paying the costs of fitting out a new space. It is always cheaper to simply add on to existing space than it is to fit out a new building.
In practice, a commercial lease addressing these concerns will contain a “right of first offer” clause in which the landlord will come to the tenant first with any offer on the additional space within the building. Another approach is to include in a lease a “right of first refusal” in which the landlord will come to the tenant after it has a deal negotiated and request the tenant to accept the terms of this deal or forego the opportunity.
These are some of the more usual terms available in a commercial setting to assist tenants and landlords to deal with situations in which the tenant needs to expand its operations, or shrink them because of difficult economic times, or to assist a landlord in retaining good creditworthy tenants who need to grow their business.