Make Termination Option Work in Your Favor
In a good economy, where commercial properties enjoy low vacancy rates, owners can more easily avoid giving termination rights to tenants. But in the past few years, more tenants have been negotiating to get them. Allowing a tenant to terminate its lease should be a last and final resort; generally, owners should reserve a termination right only for large or national tenants that have the leverage to demand it.
If you’re forced to give a tenant the right to terminate its lease under certain circumstances, don’t make the right unfettered. A termination option doesn’t have to be a huge risk for you—as long as your clause gives you the most protections available. We’ll give you Model Lease Language that you can use when drafting your termination provisions to make them owner-friendly. Show our Model Language to your attorney before using it in your clause.
Give One-Time Right to Terminate
Don’t assume that, to hook a desirable tenant that feels uneasy about committing to a relatively long lease, you have to immediately give in and offer the tenant an open-ended option to terminate at any time during the lease. Instead, negotiate with the tenant to limit it to a one-time opportunity to exercise the termination option. Keep in mind that the tenant will probably want this one opportunity scheduled sometime in the middle of the lease.
Model Lease Language
Notwithstanding anything to the contrary contained herein, Tenant shall have a one-time option to terminate this Lease (“Termination Option”) in accordance with and subject to each of the terms and conditions of this Lease.
A strong tenant with a long-term lease could argue that it should have two or three termination opportunities because of the length of the lease. Or it may insist on a “window period”—for example, from month 36 through month 40 of the lease term—during which it can exercise the termination option, says California attorney and Insider board member Tom Stewart. But no matter how many termination opportunities you give, make sure you’re specific about when the tenant can exercise its option.
Set Specific Time, Date for Termination
Set the termination date as a specific time and day in the lease—say, 11:59 p.m. on July 31, 2017. Setting a specific time and date avoids complications in calculating the exact termination date, advises Stewart. However, you may have trouble setting an exact termination date in the lease because you’re uncertain about when the lease will start—for example, if the lease commencement depends on certain improvements being finished. In that case you can say in the lease that the termination date will be a specific number of months after the lease begins and that the precise date will be included in a “commencement date agreement” to be signed and added to the lease when the lease term begins.
It’s a good idea to set the effective date of the termination on the last day of the month because it makes billing and reletting much easier for you. But try to avoid letting the lease terminate at an inconvenient time for you, such as at the end of the year when things are hectic or at the end of a month when several other leases are coming due.
Model Lease Language
Termination Date. If Landlord receives the timely Termination Notice and Tenant complies with all the provisions in this Clause, this Lease shall terminate at 11:59 p.m. on [insert date, e.g., July 31, 2017] (the “Termination Date”).
Set Notice Requirements
To ensure that you’re adequately notified that the tenant is exercising its termination right, require the notice to be in writing. And specify how you must get that notice—for example, by certified mail. Making the tenant give you as much advance notice as possible that it plans to exercise its termination option will make reletting the space easier for you. Remember that the amount of advance notice you should require will depend on the size of the tenant’s space and the anticipated time you’ll need to relet. Try for at least 12 months’ notice before the termination date, but keep in mind that you could have to agree to shorter notice if it’s a big box or large tenant or one with a lot of negotiating power.
After you’ve set the deadline for how late you must get the tenant’s termination notice, go one step further by setting a deadline for how early you can get that notice. For example, get the tenant’s written notice no later than 12 months before the termination date and no earlier than 14 months before the termination date. By limiting the time frame in which the tenant must give you its termination notice, you can lessen the period of uncertainty over whether the lease will terminate, and make any necessary arrangements for the space sooner.
Say in the termination clause that the tenant’s notice is “irrevocable”—that is, once the tenant exercises the option, it can’t change its mind and withdraw the termination, says Stewart. Without this protection, a tenant may think it can change its mind after you’ve spent time and money finding a new tenant for the space, he explains.
Model Lease Language
Tenant Gives Notice. If Tenant desires to exercise the Termination Option, Tenant shall give Landlord irrevocable written notice (“Termination Notice”) of Tenant’s exercise of this Termination Option, which shall be delivered by [insert method, e.g., certified mail]. The Termination Notice must be received by Landlord no later than the date that is [insert #, e.g., twelve (12)] full months prior to the Termination Date (as defined in paragraph [insert #]) and no earlier than the date that is [insert #, e.g., fourteen (14)] full months prior to the Termination Date. Time is of the essence with respect to Landlord’s receipt of the Termination Notice and all other deadlines in this Clause.
Collect Termination Fee
Require the tenant to pay you a termination fee. But don’t give a formula to calculate the termination fee; it’s better to set a dollar amount ahead of time as the termination fee in the lease, rather than rely on a formula. That’s because, with a set dollar amount, you won’t get into disputes with the tenant over whether you correctly used the formula.
The termination fee should reimburse you for your unamortized lease costs that you haven’t recovered as of the termination date, such as a tenant improvement allowance, broker’s fee, attorney’s fees, free rent, and any other rent abatement or other concessions you gave, says Stewart. You may not know the exact costs when you sign the lease, so it may be hard to give an exact termination fee, but generally you should have a good enough idea of these leasing costs so you can come up with a reasonable ballpark figure for the termination fee.
Don’t refer to the “termination fee” as a “penalty,” says Stewart. Many states won’t let you enforce a penalty, so you would have to give back the payment to the tenant, he explains. And have the tenant pay the termination fee as soon as possible. Ideally, you’ll want the entire fee to accompany the tenant’s termination notice. So state that without the termination fee, the termination notice won’t become effective, adds Stewart. But a tenant will probably want to pay the fee as late as possible—when the lease actually terminates. Compromise by requiring the tenant to pay half the fee when it exercises the option and the other half a few days before the lease terminates.
Also, ask that the tenant pay the termination fee in cash or certified funds, so that you won’t have to worry that its check will bounce, says Stewart. This is essential if you’re collecting any part of the fee at the end of the process, when the termination goes into effect. At that point, if the tenant gives you an uncertified check that bounces, you would be in the undesirable position of having to hunt the tenant down for the fee, Stewart warns.
Model Lease Language
Termination Fee Must Accompany Notice. In order for such Termination Notice to be effective, it must be accompanied by the entire termination fee in the amount of $[insert #], which shall be payable only in cash or certified funds.
State that Lease Obligations ‘Survive’ Termination
Make sure the tenant’s lease obligations, like paying rent, that accrue up to the termination date will “survive” the termination. That way, it must fulfill these obligations even after the lease has terminated and you’ll have a legal right to collect those payments.
Model Lease Language
Tenant’s Obligation Survives Termination. Tenant’s obligations to pay Base Rent, Additional Rent, and any other costs or charges under this Lease, and to perform all other Lease obligations for the period up to and including the Termination Date, shall survive the termination of this Lease.
Get Right to Cancel Termination if Tenant Defaults
Give yourself the right to cancel the termination if the tenant is in default on the day it exercises the termination option, on the termination date, or at any time in between. And note in the lease that if you cancel the termination, the tenant must continue to comply with the lease for the rest of the lease term—as if it had never exercised the termination option, Stewart emphasizes.
But leave yourself some flexibility—don’t obligate yourself to cancel the termination if the tenant defaults. Even if the tenant is in default, you may still want to let it terminate for one reason or another. But if you decide to let the tenant terminate, make sure the tenant is still required to cure—that is, correct—the default within the time frame set in the lease, even after termination.
Consider adding language that lets you keep the termination fee if you cancel the termination because of the tenant’s default. But expect a savvy tenant to demand that you offset the termination fee that you’re keeping against its rent then due, to prevent you from getting a “double recovery,” says Stewart.
Model Lease Language
Landlord May Cancel and Void Termination if Tenant in Default. Notwithstanding the foregoing, if at any time during the period on or after the date on which Tenant shall exercise its Termination Option, up to and including the Termination Date, Tenant shall be in default of this Lease, then Landlord may elect, but is not obligated, by written notice given to Tenant to cancel and declare null and void Tenant’s exercise of the Termination Option, and this Lease shall continue in full force and effect for the full Lease Term hereof unaffected by Tenant’s exercise of the Termination Option. If Landlord does not cancel Tenant’s exercise of the Termination Option after Tenant’s default, Tenant shall cure any default within the period of time specified in this Lease and this obligation shall survive the Termination Date.
Set Requirements for Surrender of Space
Require the tenant to move out of the space on or before the termination date. And require the space to be broom-clean, in good order, and in the condition that would be required by the lease if the lease term had simply expired. For example, the lease may require that the tenant remove tenant improvements like an internal staircase. You should also require the space to be free of any subtenants, other occupants, and their personal property by the termination date.
Model Lease Language
Tenant Shall Surrender Space by Termination Date. If Tenant exercises the Termination Option, Tenant covenants to surrender full and complete possession of the Premises to Landlord on or before the Termination Date vacant, broom-clean, devoid of Tenant’s or any third party’s personal property, and in good order and condition, in accordance with the provisions of this Lease, and thereafter the Premises shall be free and clear of all leases, tenancies, and rights of occupancy of any entity claiming by or through Tenant.
Give Termination Right Only to Tenant
Make it clear to the tenant that there will be no termination option after it sublets or assigns the space. In the lease, specify that the termination option is “personal” to the original tenant. By clarifying that the termination option is being given to the original tenant only, you can avoid having the right automatically given to a subtenant or assignee. After all, a termination option is a valuable concession that you gave to this specific tenant.
Model Lease Language
No Option After Sublet or Assignment. This Termination Option is personal to the named Tenant. If this Lease has been assigned or all or a portion of the Premises have been sublet, this Termination Option shall be deemed null and void and neither Tenant nor any assignee or subtenant shall have the right to exercise such option during the term of such assignment or sublease. This condition may be waived by Landlord at its sole discretion and may not be used by Tenant as a means to negate the effectiveness of Tenant’s exercise of this Termination Option.
Prepare for Pushback from Lender
Keep in mind when negotiating with a tenant that’s angling for a termination option that lenders dislike tenant termination options, which can create problems for you. Lenders usually will treat the proposed termination date as the end date of the entire lease.
For example, on a 10-year lease that gives the tenant a termination option at the end of year five, the lender will treat the lease as a five-year lease when it considers you for financing, notes Stewart. So when weighing whether a tenant is worth a termination right, remember that a termination option in a lease today may cause you problems when you try to finance or refinance in the future.
Additionally, many mortgages require the lender’s consent to all leases. Your lender may refuse to approve a lease with a termination option—in which case it’s not worth spending any time negotiating a termination option clause. Check your loan documents to see whether you need the lender’s approval.
Insider Source
Thomas F. Stewart, Esq.: Downey Brand, 621 Capitol Mall, 18th Fl., Sacramento, CA 95814; www.downeybrand.com.