How to Negotiate and Structure a Lease Buy-Out

The COVID-19 pandemic has illustrated the need for landlords and tenants to be flexible and work together to find solutions to leases that have become disadvantageous. One approach is to enter into a buy-out agreement allowing the tenant to end the lease early in exchange for an agreed-to sum of money. Maybe there’s already a clause in your current lease that provides for a buy-out, or maybe you’ll have to negotiate a new agreement with the tenant. Either way, here’s a look at the key issues to consider in negotiating and structuring a lease buy-out.

The Lease Buy-Out Price

The central issue in buy-out negotiations is how much the tenant should pay for the right to end the lease before the term expires. The stronger the market, the lower the buy-out price. Explanation: It’s easier to replace a tenant, often at a higher rent, when the market is strong. Replacing tenants is more challenging in a soft market; in addition, when the market is down, a current tenant’s rent is apt to be substantially less than what the landlord can realistically expect a replacement to pay. Other key factors influencing the buy-out price include:

• How much time is left on the lease;
• The tenant’s remaining rent obligations, for example, whether the lease provides for significant rent increases in the future;
• The value of any improvements that the tenant or landlord made to the space, such as whether tenant improvements are useable by future tenants;
• The unamortized portion of future commissions;
• The desirability of the tenant’s space; and
• The tenant’s financial stability.

PUT 11 PROTECTIONS IN YOUR BUY-OUT AGREEMENT

While price may be the key business term, there are also 11 legal protections that your buy-out agreement, like our Model Agreement, must include.

1. When Tenant Must Move Out

Specify the date (“surrender date”) that the tenant must move out and surrender the leased space [Agreement, sec. 1].

2. Ownership of Improvements

Be clear that surrender entitles you to possess not just the leased space but also the improvements. Otherwise, the tenant may claim ownership over the improvements, especially if that’s what the lease provides. However, the buy-out agreement is your opportunity to renegotiate that lease term and keep the improvements, even if they were made by the tenant at its own expense [Agreement, sec. 1].

3. Condition of the Leased Space

The condition of the space is a crucial issue, especially if you intend to re-lease it immediately. The default will be whatever the condition that’s specified in the lease. If that’s adequate, the buy-out agreement need only say that the tenant must return the space “in accordance with the Lease terms.” But if you want the tenant to leave the space in a better condition than the lease requires, the agreement needs to spell out what that condition is [Agreement, sec. 3(b)].

4. No Encumbrances on Property

Ensure that no one else has any legal claims to the leased space or any of the property the tenant leaves behind. This way, you’ll be able to do whatever you want with the property upon surrender without having to deal with third parties. As an additional precaution, consider having an attorney search the state records to determine if any liens have been filed against the property. If so, try to get the issues resolved before signing the buy-out agreement [Agreement, sec. 2].

5. Landlord’s Reentry Rights

After the surrender date, the tenant loses the right to possess the property and you can reenter. But what if the tenant moves out before the surrender date? You might want to get an early jump and start preparing the space for the next tenant. But if you reenter early, you run the risk that the tenant will return and demand that you undo the work so it can wind up its affairs. The buy-out agreement can take this risk out of play by giving you the right to reenter immediately upon the tenant’s early departure. The agreement should also state that your right to reenter early doesn’t affect the tenant’s duty to pay rent up to and through the surrender date [Agreement, sec. 8].

6. Tenant’s Written Acknowledgement of Surrender

Before signing a lease, the next tenant may want assurances of your absolute right to lease the space for its proposed use. So, require the buy-out tenant to deliver a written and recordable instrument acknowledging its surrender of all rights to possess and use the leased space on the surrender date [Agreement, sec. 9].

7. Payment of the Buy-Out Price

Specify how and when the buy-out payment will be made. Rather than requiring the tenant to pay the entire sum all at once, our model agreement provides for payment in two installments, an initial deposit due upon signing the buy-out agreement and a payment covering the balance due on the surrender date [Agreement, sec. 6].

8. Landlord’s Release from Lease Obligations

The buy-out agreement should specify which, if any, lease obligations continue after the surrender date. Typically, when the tenant buys out the landlord, the agreement provides for the latter’s release from “past, present and future” lease obligations. Our model agreement takes things a step further by requiring the tenant to also agree to release the landlord for any future claims it may have related to the lease. Stating that the tenant has no “defenses or offsets respecting the Lease” takes away the tenant’s right to keep a claim in its back pocket for assertion after the surrender date, such as for a rent refund due to landlord’s failure to repair a leaky roof [Agreement, secs. 3(a) and 10].

9. Tenant’s Partial Release from Lease Obligations

Buy-out agreements also release tenants from their lease obligations after the surrender date. The problem is that it may be difficult to definitively determine a tenant’s final liability on that date. Accordingly, landlords typically seek to keep tenants on the hook for certain obligations, including:

Liability for rent. Although the tenant doesn’t have to pay rent or additional charges accruing after surrender, it should remain liable for payments accrued up to and through the surrender date. Thus, for example, the landlord should retain the right to bill the tenant for its share of operating expenses (prorated for the time during the year in which it occupied the space) at the end of the year when total operating expenses are determined [Agreement, sec. 4(b)].

Liability for failure to vacate. The buy-out agreement should make the tenant responsible for expenses the landlord incurs as a result of the tenant’s failure to move out by the surrender date, including reasonable attorneys’ fees and “loss of bargain” if a better deal with a replacement tenant falls through or gets delayed [Agreement, sec. 4(a)].

Liability for third-party claims. The tenant should also remain liable for any claims against the landlord by third parties arising out of its use of the leased space, such as for failure to pay a contractor for work performed on the space [Agreement, sec. 4(c)].  

10. No Brokers Clause

Have the tenant represent and warrant that no brokers or real estate agents were involved with its surrender of the space and indemnify you against any such claims that are asserted [Agreement, sec. 5].

11. Tenant’s Duty to Pay Additional Rent for Failing to Surrender

It’s crucial to ensure the buy-out agreement protects you in case the tenant doesn’t keep its promise to move out by the surrender date. For starters, the tenant should have to pay additional rent for each day it remains in possession after the surrender date. Caveat: The tenant’s duty to pay additional rent may be unenforceable if a court thinks it constitutes a penalty. So, treat the additional rent obligation as a liquidated damages provision and make sure the amount is fair, reasonable, and tied to market rates [Agreement, sec. 7].