Draft Narrow Termination Provision to Keep Tenant from Exiting Deal

If you own office building or retail space you’re probably very reluctant to give a termination right to your tenants in their leases. You run the risk of losing a large amount of money; allowing a tenant to get out of its lease early can render costly improvements and other expensive items associated with renting to it useless for reletting the space.

However, there are situations when you’ll have to concede and give a termination right. For instance, the tenant may be a large national tenant, or you need the tenant to fill a vacancy that’s threatening your bottom line, or the tenant has some other leverage. If you give a tenant a termination right, you should be very careful when drafting this provision so it doesn’t come back to bite you later.

Risks of Poorly Drafted Clause

Notice requirements and the circumstances under which the tenant can terminate its lease should be spelled out precisely; otherwise, the tenant could leave you in the lurch or exercise the right for an infraction that should have been negotiated as being able to be “cured”—that is, fixed without a further penalty. And be aware that if the clause is too broad and the tenant is entitled to exercise the right and does so properly, the chances are slim that you could argue that any of its post-termination actions—like expressing interest in your current or future properties instead of the one it’s terminating the lease for—are a waiver of the termination right or indicate that the deal is still alive despite the termination. This is especially true in situations where there’s a delay in construction of a center or office building and the tenant might want to exit the project before it’s done.

These were the issues that a California owner and tenant fought over in a recent case where a lease deal dragged on for years, with the owner ultimately arguing that the tenant hadn’t properly exercised its termination option. 

Case on Point

A national tenant that sold video games entered into a written lease agreement with the owner of a shopping center that wasn’t yet developed. Permits and approvals were required before constructing the shopping center that would contain the tenant’s proposed retail space. The lease was signed in 2005, with the owner estimating that it would take 18 months to get the permits and six months to build out the space.

The lease was later assigned to a new owner in 2006. However, delays in construction while attempting to obtain the permits were ongoing.

The lease’s “failure to complete” provision gave the tenant a one-time right to terminate the lease only if: (1) the owner hadn’t received its permits for the development on or before June 1, 2006; or (2) the owner was unable to deliver the space to the tenant on or before Sept. 30, 2006. The owner was required to provide written notice on or before June 1, 2006, indicating whether it was able to deliver the space by the deadline. The tenant would have until June 30, 2006, to provide written notice exercising its termination right—no later than 30 days from receipt of the owner’s notice. If the owner didn’t receive the termination notice during that time period, the tenant “shall be deemed to waive its termination right and the lease will continue and remain in full force and effect.”

The owner never provided the notice specified in the termination provision. Over the course of the next two years, the tenant sent several emails to the owner asking about a move-in date.

As of June 2, 2009, the owner still hadn’t delivered the retail space to the tenant. On June 2, 2009, the tenant sent written notice to terminate the lease. After receiving the letter, the owner offered alternative retail spaces at properties other than the delayed shopping center.

But the tenant told the owner that the other spaces wouldn’t work. It told the owner that it would like to wait for the new center, but if it waited it would need to update the terminated lease that had been negotiated years before. It also noted that it wanted a failure-to-deliver date if a new lease were signed, just in case the delayed project didn’t happen.

Five years later, the owner informed the tenant that it had obtained all necessary permits and had begun construction of the shopping center. The tenant stated that it wouldn’t be proceeding, and that “the deal is long forgotten.”

The owner later sent written notice to the tenant that pursuant to the terms of the 2006 lease, it was informing the tenant of “substantial completion of the Premises and delivery of possession to Tenant effective March 14, 2016.”

When the tenant informed the owner that it had exercised its right to terminate the lease on June 2, 2009, by letter, the owner asserted that the tenant had “waived” its right to terminate. The owner sued the tenant, which asked the trial court for a judgment in its favor on all three of the owner’s claims. The trial court ruled in favor of the tenant. The owner made two arguments that were unsuccessful. Here’s why the court didn’t agree with the owner. 

Argument #1: Proper Exercise of Termination Right

The owner contended that the deadline for the tenant to have exercised its right passed. It claimed that both events listed in the failure-to-deliver provision had to come to fruition in order for the tenant to cancel the lease. The tenant argued that the provision was worded so that only one of those events had to take place to trigger the right. That is, either the owner didn’t get the necessary permits by the stated date or the owner didn’t send a notice letting the tenant know that the space wouldn’t be ready.

The district court noted that, to prevail on a breach of contract claim, the owner must prove: (1) the existence of a contract; (2) the tenant’s performance of its obligations under the contract or excuse for nonperformance; (3) the tenant’s breach; and (4) the resulting damage to the owner. The district court determined that the tenant hadn’t failed to exercise its right under the provision because it had cited one of the two triggers in its decision to terminate. Both events didn’t have to happen.

The trial court said that the owner’s interpretation ignores the rest of the section, which provided two separate deadlines to exercise the termination right—demarcated by (a) and (b) in the language.

The first deadline was June 30, 2006, if the owner failed to meet the June 1 deadline to receive permits. The second deadline was no later than 30 days after receiving a written notice from the owner, which was required on or before June 1, 2006. There is no indication that only one deadline will apply, trumping the other.

The owner’s interpretation would require the court to read in the phrase “whichever comes first” at least once, as conditioning the separate deadlines for exercise of the termination right.

But, said the trial court, taken as a whole, “one time right” merely refers to the right to terminate in either circumstance. No language indicated that the two circumstances are mutually exclusive options.

The owner was unable to deliver the space on or before Sept. 30, 2006. Thus, the tenant had a termination right under at least one condition.

Argument #2: Waiver of Termination Right

The owner also argued that the tenant had waived its right to terminate. The district court pointed out that the intention to commit a waiver must be “clearly expressed.” The tenant’s later talk with the owner of updating or amending the lease meant signing a new lease entirely, said the court. A failure to mention the termination in phone or email conversations six years after termination didn’t qualify as an intentional relinquishment or clear expression of a waiver of the termination right, it concluded.

The district court also stressed that in the discussions about alternate locations the tenant hadn’t even committed to renting a new retail space [BDC Lodi III L.P. v. Gamestop, Inc., August 2018].