Collect Rent from Small Tenant Without Giving up Search for Big Tenant

If your building is empty or near empty, you may be trying desperately to rent all the vacant space to one big tenant. But suppose that while you're searching for a big tenant, a small tenant asks to rent part of the vacant space. You've got a dilemma: Should you rent part of the vacant space to the small tenant? At least you'll collect some rent. Or should you keep the space vacant and wait for a big tenant? Then, you won't lose a big prospective tenant because some of the space that it wants is occupied.

Here's an innovative way to resolve this dilemma, says New Jersey attorney Marc L. Ripp: Sign the lease with the small tenant. But get the option to boot out the small tenant—that is, terminate its lease. That leaves you free to rent its space to a big tenant. Although tenants typically ask for a termination option, this type of termination option is something you should demand, he says. Without it, you may not be able to lure a big, desirable tenant to your building, Ripp warns.

With Ripp's help, we'll tell you about nine protections you should include in this type of termination option. Plus, there's a Model Lease Clause on p. 3 that you can adapt and use in your lease that includes these protections.

NINE PROTECTIONS FOR TERMINATION OPTION CLAUSE
* Make Tenant Acknowledge Your Termination Option

Make the tenant acknowledge in the lease that you've got an option to terminate the lease, says Ripp. That way, the tenant would have a hard time arguing that it didn't understand you could terminate the lease. The termination should take effect on the “termination date”—which is a day that you select to terminate the lease, he explains. The termination date can occur at any point before the lease expires. But Ripp recommends that you pick a termination date that occurs on the last day of a calendar month within the lease term or extension term so you'll get the full month's rent [Clause, pars. a(i) & a(ii)].

* Give Limited Advance Notice to Tenant

Say in the lease that once you've set a termination date, you'll alert the tenant to it by sending the tenant a written notice, says Ripp. You'll need to send this notice some time in advance of the termination date. You and the tenant may need to negotiate how far in advance. You may want to give the tenant as little advance notice as possible—say, 30 days—but expect a tenant to want more time. For example, the tenant may want 90 or more days' notice so that it has enough time to find new space and prepare to move, he says [Clause, par. a(iii)].

* Tie Tenant's Compensation to Month Option Is Exercised

A savvy tenant—even a small one—probably won't let you have the option to terminate without giving it something in return. So agree to compensate the tenant if you exercise the termination option. For example, the tenant may demand that you agree to make a “buyout” payment—that is, a fixed cash payment to buy out its lease, says Ripp. You might agree to a buyout payment equal to 12 times the tenant's monthly minimum rent, he says [Clause, par. c].

If you tie the compensation amount to a monthly minimum rent figure, say that you'll use the monthly minimum rent figure charged during the month that you send the notice exercising the termination option, advises Ripp [Clause, par. c(ii)]. That will help to keep the amount down—as rent typically escalates as the lease goes on. For example, if you send your termination notice in June 2004, you would multiply the June 2004 minimum rent by 12. But expect a savvy tenant to insist that the payment be calculated using the monthly minimum rent charged in the month in which the termination date occurs—the rent will often be higher at that later date, says Ripp.

* End Tenant's Lease Rights on Termination Date

Say in the lease that the tenant will have no further rights under the lease or interest in the space after the termination date other than those that the lease says will survive the end of the lease, says Ripp. The tenant should treat your termination of the lease as if the lease had expired naturally, he says [Clause, par. a(iv)].

* Keep Tenant on Hook for Outstanding Obligations

Make sure the tenant understands that even though you're ending the lease prematurely, it's still on the hook for its outstanding lease obligations—including those obligations that survive the lease, says Ripp. For example, it's still responsible for paying minimum rent, additional rent, and any other charges accruing up to the termination date, he explains. And if the lease has an indemnification clause, the tenant still must indemnify you—that is, defend and hold you harmless—after the lease ends [Clause, par. a(v)]. If you don't have this protection, the tenant could claim that once you terminate the lease, all of its outstanding lease obligations will immediately terminate, too, Ripp warns.

* Make Tenant Meet Three Conditions to Surrender Space

You'll want the tenant to surrender its space on or before the termination date so you can make the space available to the big tenant. When is the space actually “surrendered”? Set three conditions the tenant must meet for the space to be considered surrendered, says Ripp, and say that you alone determine whether they've been met: 1) The tenant has cured—that is, corrected—all outstanding lease violations; 2) It gives you possession of the space; and 3) It cleans the space and removes any remaining occupants and property from it [Clause, par. b(ii)].

* Charge Special Fee if Tenant Doesn't Surrender Space on Time

If the tenant hasn't surrendered the space on or before the termination date, require it to pay a special holdover fee, says Ripp. This special holdover fee is different from the holdover rent charged under your lease's standard holdover rent clause, he notes. And it replaces the holdover rent clause if the tenant holds over in the space after you've exercised your termination option, Ripp explains.

How much should the special holdover fee be? Set it high enough to give the tenant an incentive to surrender its space on time, advises Ripp. But don't set it so high that a court could call it an unenforceable penalty, he warns. You could charge a special holdover fee that's a multiple of the tenant's minimum rent then due (prorated for each day until the tenant surrenders the space), says Ripp [Clause, par. b(i)]. For example, Ripp has seen the special holdover fee set at double the tenant's minimum rent.

* Reaffirm that Tenant Must Leave by Termination Date

No matter how effective the special holdover fee may be at discouraging the tenant, you still want to make sure that the tenant doesn't think that it can stay in the space after the lease terminates, as long as it pays the holdover fee, says Ripp. So clarify in the lease that the tenant doesn't have your permission to stay in the space after the termination date, he says. And say that if the tenant refuses to surrender the space on or before the termination date, you can use any and all of your legal remedies against the tenant to regain possession of the space, he says [Clause, par. b(iv)].

Practical Pointer: Try to use the loss of compensation for the termination as another possible remedy against a tenant's remaining in the space, says Ripp. Say in the lease that the tenant won't get any termination compensation if it doesn't surrender the space on or before the termination date [Clause, par. c]. But expect the tenant to put up a lot of resistance to this remedy, Ripp adds. The tenant will most likely argue that it's unfair and onerous.

* Make Tenant Indemnify You for Third-Party Claims

Have the tenant agree that in addition to paying a holdover fee if it refuses to surrender the space on time, it will indemnify you from all damages, costs, claims, and expenses you incur from third parties as a result of the tenant's failure to surrender the space, says Ripp [Clause, par. b(iii)].

This protection becomes important if you sign a lease with a big tenant for the space. The small tenant's refusal to surrender the space could delay the big tenant's move into your building. And the big tenant could end up suing you for failing to deliver the space to it on time, Ripp explains.

Will Tenants Agree to Termination Option?

Ripp has worked on deals where the owner told the small tenant that it really wanted to rent the building to a much bigger tenant and it needed a termination option so it could get back the space if it found such a tenant. The small tenant typically agreed to give the owner a termination option in return for some form of compensation, he says.

The compensation package you negotiate with a small tenant will depend on your and the tenant's negotiating power. Since the tenant is small, you've probably got the upper hand in the negotiations—although the small tenant may realize that you need its rent payments to help pay your bills, Ripp says. But whatever the amount of compensation you and the tenant agree to, it will probably be well worth paying—especially if it frees the space for a big, desirable tenant, he points out.

CLLI Source

Marc L. Ripp, Esq.: Counsel, The Gale Company, 100 Campus Dr., Ste. 200, Florham Park, NJ 07932; (973) 301-8057; MRipp@thegalecompany.com.