By Lori DaCosse, JD (bio)
Problem:
A successful regional business (“Tenant”) executed a commercial office lease for Class A office space that contained a termination provision upon the Tenant occupying the real estate for a threshold period and upon the payment of a penalty. The monthly lease payment contributed to thirty percent (30%) of the Tenant’s monthly overhead. While the economy was booming (and business was outstanding) the Tenant desired to take down additional space and remodel. During the remodel, the Tenant incurred substantial expenses in tenant improvements that were added to the monthly lease as additional rent increasing the monthly lease payment from thirty percent (30%) to forty percent (40%) of Tenant’s monthly overhead. During this expansion phase (during which the Tenant achieved the threshold length of occupancy to entitle it to exercise the termination provision), the landlord offered a modestly attractive “buyout” of Tenant’s termination right under the lease. As such, the lease was amended and the termination provision stricken.
Then, 2008 happened. Business declined and the Tenant had to terminate employees. Only a fraction of the Tenant’s office space was actually in use and efforts to sublease were unsuccessful. When the Tenant began to review its lease in detail, it realized it was no longer able to terminate the lease.
Result:
The business defaulted on the lease, filed bankruptcy, and disbanded.
Lessons Learned:
A termination right in a commercial lease can be negotiated and usually requires occupancy for a minimum period of time and usually can be exercised only upon payment of a penalty. If there was a tenant build out, many of these “penalty” payments include a prorated reimbursement calculated factoring (i) length of tenancy; (ii) broker’s commission landlord paid to procure tenant and (iii) amount of tenant improvement costs to landlord that have not been reimbursed to landlord.
Especially in the context of a start-up business (but for any business), a lease termination right should be actively and aggressively negotiated. It could mean the difference between surviving lean times and folding.
