Let Tenants Who Can’t Get Bank Loans Terminate Lease

But set clear limits.

Prospective tenants who aren’t fully financed might be reluctant to sign a lease unless and until they know they’ll be able to secure an operating loan. If they can’t get the loan they need, they’ll want the right to terminate the lease. Of course, this leaves the landlord exposed to the risk of losing the transaction after a lease has been fully signed should the tenant exercise the early termination right.

The landlord could mitigate that risk, however, by seeking a backup deal during the period in which the tenant’s loan application is pending. In essence, the landlord allows the tenant to control the space until the tenant either gets the loan or is rejected and exercises the termination right.  

While less than ideal—most landlords don’t want to let tenants walk away after they sign a lease—there may be situations where it makes sense for landlords to share the risks of the tenant’s loan application being rejected when:

• There’s no broker involved and the landlord has no potential brokerage liability; and
• The tenant intends to take the premises as-is so that the landlord hasn’t incurred any construction or remodeling expenses to prepare the space.

However, you need to craft the right lease protections to ensure that tenants don’t take advantage of the clause by seeking to use it as a blank check to unilaterally terminate the lease at any time and for any reason, cautions a veteran New York City commercial leasing attorney with experience in negotiating these kinds of arrangements. Here’s a strategy for giving tenants the right to terminate if their financing falls through—and a Model Lease Clause you can use to implement it.

Get 7 Lease Protections

There are seven lease protections you need, according to the attorney.

1. Loan Must Be at a Predesignated Institution for Predesignated Amount. First, stipulate the name of the proposed lending bank to ensure that the tenant is dealing with a reputable institution that you recognize, trust, and know does business with individuals and entities in the tenant’s industry and financial situation. You should also place a cap on the amount of the proposed loan. Otherwise, tenants will be in a position to walk away from the lease any time they want simply by applying for an oversized or unrealistic loan that they know the bank will never approve. In essence, tenants get use of the space without a lease commitment and the loan application becomes nothing more than a charade that tenants go through to generate the rejection notice they need as their “get out of jail free” card [Clause, par. a].

2. Tenant Must Exercise Best Efforts to Secure Loan. Even if the proposed loan amount and lending institution are realistic, tenants may deliberately sabotage their own application by not submitting the proper paperwork and fees. Accordingly, spell out that tenants must exercise “best efforts” to seek the loan by applying in good faith, submitting all of the required documentation and paying all of the required fees [Clause, par. a].

3. Tenant Must Accept Loan If It’s Approved. The right to terminate the lease should trigger only if the bank rejects the tenant’s loan application. In other words, the lease should obligate the tenant to accept the loan if it’s approved and not give it a right to terminate if it decides it doesn’t really want the loan after all [Clause, par. b].

4. Tenant Must Provide Landlord Written Loan Rejection Notice. Establish a clear and fair procedure that the tenant must follow to exercise its termination right. To start, require the tenant to immediately provide you a copy of the rejection notice that it receives from the bank. This way you can verify that the tenant met its obligation to use its best efforts to seek the loan. The rejection should also have to be “absolute and unconditional” so that the tenant can’t terminate if it still has an opportunity to be approved for the loan [Clause, par. c].

5. Tenant Must Exercise Termination Option by Specific Deadline. You want tenants whose termination rights ripen to act fast and not just keep the loan rejection in their back pocket to use any time they wish. Set a deadline by which you must receive notice of the tenant’s decision to terminate the lease, which should be no more than five days after you receive the notice of rejection [Clause, par. d].

6. Landlord May Also Terminate Lease If Loan Doesn’t Come Through. The right to terminate the lease upon bank rejection should also be mutual. “The tenant may still want to make a go of the business even without the loan,” the New York City attorney explains. “The landlord should be able to end the lease if it doesn’t think the tenant will be able to succeed without the loan” [Clause, par. d].

7. Landlord May Void Termination Notice If Tenant Makes Material Misrepresentation. Last but not least, the clause should also give the landlord the sole option to void the tenant’s election to terminate if the tenant or its agents make or have made a material omission or misrepresentation about its business plan for the premises or financial condition.

“You may later discover that the tenant falsely cried poverty to get you to agree to give it the flexibility that comes with having the right to terminate,” the New York City attorney cautions. “You should then have the right to revoke the exercise of the termination right even if the tenant met all of the other conditions required for exercising that right” [Clause, par. e].