How to Give Small Tenants “Key Player” Disability or Death Termination Rights
Include 10 terms in your termination option clause.
Extraordinary individuals are the driving force behind many startups and small businesses. But leasing to tenants that depend so heavily on such individuals is risky. The business could suddenly come to a screeching halt should something happen to one of its “key players.”
Accordingly, these companies may be reluctant to enter into long-term leases without some assurance that they can get out of the deal if a key player dies or becomes permanently disabled. While granting tenants early termination rights isn’t something you want to do as a matter of course, it might be a worthwhile risk in certain situations.
When and if you do give a tenant a key player termination option, you need to ensure your lease affords you maximum protection. Without the right safeguards, tenants may abuse their early termination rights as a “get out of jail free” card. Here are the 10 crucial things to include in a key player early termination clause, along with a Model Lease Clause that you can adapt for your own use.
The Dynamics Behind “Key Player” Termination
Some small businesses can’t operate without a particular individual, like a professional practice made up of a single doctor, lawyer, accountant, etc. But under standard leases, these tenants remain liable for rent even if their key player gets killed or disabled, leaving behind only less consequential partners and support staff. And if the tenant can no longer continue to operate, the right to hold it responsible for continuing lease obligations won’t do the landlord much good.
So, keep an open mind. The key is to perform thorough due diligence to make an informed assessment of the risks. If you like the prospect’s business plan and are confident of its chances to succeed, granting key player termination rights might be a sensible price to pay to get it to sign a long-term lease.
INCLUDE 10 KEY TERMS IN KEY PLAYER TERMINATION OPTION CLAUSE
A key player early termination option can come back to bite you in the behind if you don’t draft it effectively. The lease must establish clear ground rules governing:
- When the option is triggered;
- What the tenant must do to exercise it; and
- How the early termination process will work.
Like our Model Lease Clause: Set Limits on Small Tenant’s “Key Player” Termination Rights, your key player termination provision should include 10 things.
1. Definition of “Key Player”
List the name(s) of the individual(s) who are deemed to be “key players” whose death or permanent disability would force the tenant to fold and trigger its right to terminate. Otherwise, tenants might use the death or disability of nonessential personnel without whom it can still operate as an excuse to get out of the lease [Clause, par. 1.]
2. Definition of “Permanent Disability”
Having identified the key players, describe the things that must happen to them to trigger the early termination option. Limit those things to death and “permanent disability.” Define the latter as a physical or mental illness or injury that makes it impossible for the named key players to continue to perform their normal business functions throughout the remainder of the lease term [Clause, par. 2(a).]
3. Tenant Duty to Close Permanently
The third point of clarification for the triggering mechanism is that the tenant must permanently shut down. This will safeguard you from the risk of the tenant’s using the early termination option to clear the way for relocating to a different property. Of course, this may be a moot issue when there’s just one key player who can’t be replaced. But it’s a crucial point when there are multiple key players who might decide to stay open after one of their number dies or becomes permanently disabled [Clause, pars. 1 and 2(b).]
4. Tenant Duty to Provide Notice of Election to Terminate
Describe what the tenant must do to exercise its early termination option. Specifically, require the tenant to give you written notice of its intent to terminate early no later than 30 days after it shutters the business. While the actual deadline for notification is subject to negotiation, you should seek to minimize how long the space stays dark. Note: If the dead or disabled key player is the “Tenant” under the lease, require its “authorized representative” to furnish the termination notice instead [Clause, par. 3(a).]
5. Continuation of Lease After Notice of Termination
Don’t let the tenant end the lease immediately by serving you written notice of termination. Give yourself as much time as possible to start looking for a replacement tenant by requiring the tenant to list a termination date in its written notice and specifying that this date must be at least a certain number of days. Our Model Lease Clause provides for 120 days, but tenants may seek to impose a shorter continuation period [Clause, par. 3(a).]
6. Tenant Duty to Verify Key Player’s Death or Disability
Require the tenant or its authorized representative to prove that the key player has died or become permanently disabled before it exercises the early termination option. State that verification must be to your “reasonable satisfaction.” Also consider listing the form of verification required, such as a death certificate or affidavit from an independent licensed physician who diagnosed the condition that caused the permanent disability [Clause, par. 3(b).]
7. Tenant Duty to Vacate by Termination Date
Require the tenant to vacate the space on or before the termination date so that you can begin the process of preparing it for the next tenant with minimal down time [Clause, par. 3(c).]
8. Tenant Can’t Be in Default
Bar the tenant from exercising its early termination option if it’s in default of the lease in any way. State that this condition applies both on the date it exercises the option and the date of termination. In other words, tenants who default on the lease after exercising the option can’t actually consummate the option by terminating the lease [Clause, par. 3(d).]
9. Tenant Duty to Pay Termination Fee
It costs money to get tenants to sign a lease and move into the space. The expectation is that you’ll recover these costs via the rent payments the tenant makes over the term of the lease. But those future rent payments you were counting on don’t come in when tenants terminate early. One way to reduce these financial losses is by charging the tenant a fee for terminating early. The termination fee should be payable when the tenant provides notice of its intent to terminate.
To calculate the fee amount, first add up your costs, including brokers’ commissions, legal fees, rent abatements, cash allowances and expenses incurred in making improvements to the space for the tenant.
Negotiating Strategy: In addition to these essential costs, propose including an amount, such as six-month’s rent, to cushion future rent losses in case you can’t find a replacement tenant.
The fee you’ll actually collect if the tenant chooses to terminate early is the unamortized portion of your total costs—that is, the portion of the costs for which you haven’t been reimbursed from the rent you’ve already collected from the tenant. To calculate unamortized costs, determine on a straight-line basis the portion of the costs you’ve already received from the tenant; then subtract that amount from total costs [Clause, par. 3(e).]
Example: A landlord has $20,000 of total costs on a 10-year lease. The tenant pays full rent and exercises its option to terminate at the end of year 4.
Step 1: Divide total costs by the term of the lease to get an annual cost figure. You recover $2,000 per year ($20,000 ÷ 10);
Step 2: Multiply the annual cost figure from Step 1 by the number of years that you’ve actually received rent payments from the tenant during the term of the lease so far. You’ve gotten back $8,000 of your costs ($2,000 x 4).
Step 3: Subtract the amount you calculated in Step 2 from total transaction costs to determine the early termination fee. The early termination fee would be $12,000 ($20,000 - $8,000).
10. Voiding of Early Termination Rights
Key player early termination rights should be reserved for special and limited cases and not passed along if the tenant assigns or subleases all or part of the premises to a third party. So, specify that any assignment or sublease by the tenant renders the early termination option null and void. Nullification should also result where the tenant:
- Loses the right to possession of the leased premises; or
- Fails to exercise the early termination option properly or timely in accordance with the provisions of the lease [Clause, par. 5.]
See The Model Tools For This Article
|Set Limits on Small Tenant's "Key Player" Termination Rights