Get 18 Key Protections When Giving Tenant Termination Option

More and more tenants demand the flexibility to get out of their leases early for any reason—not only in response to financial difficulties or a casualty in the space. Ideally, you'd want to reject this demand. But to hook a desirable tenant that feels uneasy about committing to a relatively long lease, you may have to give in.

Fortunately, a termination option doesn't have to be a huge risk to you—as long as your clause gives you the most protections available. We've reviewed many termination option clauses and found that few had all the protections that the leasing experts told us were needed. So, with the help of New York City attorney A. Barry Levine, Toronto attorney Stephen J. Messinger, New Jersey attorney Marc L. Ripp, Denver attorney Mark A. Senn, and Sacramento, Calif., attorney Thomas F. Stewart, we've put together a checklist of 18 key protections that you should include in your tenant's termination option clause. We'll also give you a Model Lease Clause that covers all of the protections in the checklist (see pp. 3-4).

* Give One-Time Right to Terminate

Don't give the tenant an open-ended option to terminate at any time during the lease. Limit the tenant to a one-time opportunity to exercise the termination option, says Ripp [Clause, intro]. The tenant will probably want this one opportunity scheduled sometime in the middle of the lease.

If a strong tenant has a long-term lease, you may have to give two or three termination opportunities, or the tenant may insist on a “window period”—such as from month 36 through month 40 of the lease term—during which it can exercise the termination option, Stewart adds. 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 pm on June 30, 2007, advises Stewart [Clause, par. b]. Many leases we looked at didn't do this. Setting a specific time and date avoids complications in calculating the exact termination date.

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, Ripp says.

Practical Pointer: It's a good idea to set the effective date of the termination on the last day of the month, says Levine. It makes your billing and reletting much easier, he explains. But try to avoid letting the lease terminate at an inconvenient time for you—say, at the end of the year when things are hectic or at the end of a month when several other leases are coming due, advises Messinger.

* Require Notice in Writing

To ensure that you're adequately notified that the tenant is exercising its termination right, require the tenant's termination notice to be in writing, says Senn. And specify how you must get that notice—for example, by certified mail, adds Messinger [Clause, par. a].

* Get Ample Notice of Termination

Make the tenant give you as much advance notice as possible that it plans to exercise its termination option, says Messinger. This will make reletting easier.

How much advance notice should you get? That will depend on the size of the tenant's space and the anticipated time you'll need to relet, says Senn. Try for at least 12 months' notice before the termination date, he says, although you may have to agree to shorter notice if the tenant has lots of negotiating power [Clause, par. a].

* Limit Time that Tenant Can Send Notice

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, says Ripp. 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, Levine explains. For instance, if the termination date is June 30, 2007, you must get the termination notice no later than June 29, 2006, and no earlier than April 29, 2006, or else the tenant can't exercise its termination option, Ripp notes.

Be sure to say that you must actually get the notice within that two-month period, not that the notice must be sent during that period, suggests Ripp [Clause, par. a].

* Make Notice Irrevocable

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 [Clause, par. a]. 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.

* Say “Time Is of the Essence” for Deadlines

Say that “time is of the essence” for all of the deadlines in the clause—but especially for the tenant's termination notice, says Levine [Clause, par. a]. Most of the termination option clauses we looked at didn't have this legal phrase. This phrase means that it's crucial for you and the tenant to fulfill your obligations under the clause by the deadlines set out in the clause. Using this phrase will help you if a tenant exercises its termination option—that is, gives its notice—after the deadline, explains Levine. If you get into a court battle over the late notice, the court may rule that the late notice is invalid because “time is of the essence.” Without this phrase, a court might rule that the termination is valid even with the late notice, he warns.

* Collect a Termination Fee

Require the tenant to pay you a termination fee. Several of the termination clauses we looked at gave a formula to calculate the termination fee. But most experts we spoke to agree that it's better to set a dollar amount ahead of time as the termination fee in the lease, rather than rely on a formula. With a set dollar amount, you won't get into disputes with the tenant over whether you plugged the right numbers into the formula, Senn explains [Clause, par. c].

The termination fee should—at a minimum—reimburse you for your unamortized lease costs as of the termination date, says Messinger. These are lease costs that you haven't recovered as of the lease's termination date.

Example: You sign a 10-year lease with a termination option at the end of the sixth year. Your lease costs—broker's fee, tenant improvement allowance, and attorney's fee—total $100,000. If you amortize these costs on a straight-line basis over the lease, that's $10,000 per year ($100,000 ÷ 10). So if the tenant terminates the lease at the end of the sixth year, your unamortized costs for the remaining four years will be $40,000.

It's reasonable to include the unamortized amount of these lease costs in the termination fee. These might include a tenant improvement allowance, broker's fee, attorney's fees, free rent, costs you incur if you “take over” the tenant's old lease, and any other rent abatement or other concessions you gave, say Senn and Stewart. You may want to add an interest factor to reflect your borrowing cost for these funds, Ripp says. You may also want to add several months' rent to the fee—based on your estimate of the time it will take to relet the space, adds Senn. This can range anywhere from one month to 12 months.

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, says Levine.

Practical Pointer: 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.

* Make Tenant Pay Termination Fee as Soon as Possible

Have the tenant pay the termination fee as soon as possible, says Ripp. Ideally, you'll want the entire fee to accompany the tenant's termination notice. Without the termination fee, the termination notice won't become effective, adds Stewart [Clause, par. c]. But a tenant will likely want to pay the fee as late as possible—when the lease actually terminates. As a compromise, require the tenant to pay half the fee when it exercises the option and the other half a few days before the lease terminates.

* Get Termination Fee in Cash or Certified Funds

Demand that the tenant pay you the termination fee in cash or certified funds, so that you won't have to worry that the tenant's check will bounce, says Stewart [Clause, par. c]. 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.

* Make Tenant's Lease Obligations “Survive” Termination

Make sure the tenant's lease obligations—such as its obligation to pay rent and other lease costs—that accrue up to the termination date will “survive” the termination of the lease, says Ripp. That means the tenant must fulfill these obligations even after the lease has terminated [Clause, par. d]. For example, if you must bill the tenant after the termination date for an expense—say, electricity, that accrued before the termination date—you'll have a legal right to collect it, explains Messinger.

Practical Pointer: If the tenant is a percentage rent tenant, make sure that the tenant's lease obligation to give you gross sales reports survives the termination of the lease, too, says Senn. You won't be able to calculate the percentage rent the tenant owes up to the termination date unless the tenant gives you these reports after the termination date, he explains.

* 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, says Levine. 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 explains.

Be sure that you're not obligated to cancel the termination if the tenant defaults. You'll want flexibility in this situation. Even if the tenant is in default, you may still want to let it terminate, Senn explains. 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, says Ripp. Also, say that this obligation to cure the default will survive the termination of the lease, he adds [Clause, par. e].

Example: The tenant damages the space after it has exercised its termination option. You decide to let the tenant terminate. But the tenant is still responsible for repairing the damage—even if this obligation runs past the termination date.

You may want to go one step further and get the right to cancel the termination if the tenant isn't in default when it exercises the termination option or afterward but has been a chronic lease violator or defaulter throughout the lease, add Messinger and Ripp.

Practical Pointer: Expect the tenant to let you cancel the termination only if it has caused a major—that is, important—default or monetary default, says Senn. That way, you can't cancel the termination for an unimportant, minor default. And consider adding language that lets you keep the termination fee if you cancel the termination because of the tenant's default, says Messinger. But to prevent your getting a “double recovery,” expect the tenant to demand that you offset the termination fee that you're keeping against its rent then due, adds Stewart.

* Set Requirements for Surrender of Space

Require the tenant to surrender the space—that is, move out—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, says Messinger. For example, if the lease requires the tenant to remove an internal staircase, this must be done, he explains. You should also require the space to be free of any subtenants, other occupants, and their personal property by the termination date, says Ripp [Clause, par. f].

* Treat Tenant as Holdover

If the tenant doesn't comply with all the surrender requirements, get the right to treat it as a holdover tenant. That means you can charge it whatever holdover rent you set in the lease's holdover clause [Clause, par. g].

* Make Tenant Liable for Holdover Damages

Make the tenant liable for all damages you incur, including “consequential” damages—that is, losses that you suffer as a result of the tenant's violation that aren't direct or immediate—because the tenant is holding over in the space. Examples are the expenses of a holdover proceeding against the tenant and the cost of losing a new tenant, say Levine and Ripp. Also make the tenant liable for losses the new tenant suffers because the holdover tenant is preventing it from moving into the space, adds Levine [Clause, par. g].

* Say Lease Not in Effect After Termination

Say that after the tenant has properly surrendered the space and the lease terminates, you and the tenant will have no further lease obligations, says Ripp [Clause, par. h]. This doesn't apply to the obligations that the clause says will survive the termination. But it will stop the tenant from demanding that you fulfill a lease obligation after the termination date. A tenant will want an exception: that you must reimburse it after the lease terminates for overpaid CAM costs or operating expense, Senn adds. That's reasonable, he says.

* Require Release from Tenant

In return for giving the tenant such a powerful, special perk as a termination option, make it agree to give you something in return. For example, require the tenant to release you, as of the termination date, from any and all actions, claims, damages, liabilities, obligations, and causes of action arising in connection with the lease, says Ripp [Clause, par. i].

* No Termination Option for Subtenant or Assignee

Clarify that the termination option is being given to the original tenant only, says Ripp. To do that, say in the lease that the termination option is “personal” to the original tenant, say Levine and Ripp. And the tenant must occupy its entire space by itself. It mustn't have transferred its lease to an assignee or any part of its space to a subtenant. After all, a termination option is a valuable concession that you gave to this specific tenant. There's no reason that you should automatically give this option to anyone else or that the tenant should keep it if it has assigned or sublet, Ripp explains.

Expect the tenant to balk at this limitation, arguing that it could interfere with the tenant's ability to assign or sublet. But try not to back down on this limitation, says Ripp.

Also, give yourself the right to waive the requirement that the tenant must occupy the entire space, because the tenant might propose an assignee or subtenant that's more desirable than the tenant, notes Ripp. But make it clear to the tenant that after it has sent you its termination notice, it can't assign or sublet as a way to negate the exercise of its termination option, he adds [Clause, par. j].

CLLI Sources

A. Barry Levine, Esq.: 320 E. 23rd St., New York, NY 10010-4713; (212) 477-5118; blevine2@nyc.rr.com.

Stephen J. Messinger, Esq.: Partner, Minden Gross Grafstein & Greenstein LLP, 111 Richmond St., Ste. 700, West Toronto, ON M5H 2H5, Canada; (416) 362-3711; smessinger@mindengross.com.

Marc L. Ripp, Esq.: Counsel, The Gale Co., 100 Campus Dr., Ste. 200, Florham Park, NJ 07932-1007; (973) 301-9500; MRipp@thegalecompany.com.

Mark A. Senn, Esq.: Member, Senn Visciano Kirschenbaum Merrick P.C., 1801 California St., Ste. 4300, Denver, CO 80202; (303) 298-1122; MSenn@SennLaw.com.

Thomas F. Stewart, Esq.: Member, Downey Brand LLP, 555 Capitol Mall, 10th Fl., Sacramento, CA 95814; (916) 444-1000; tstewart@ downeybrand.com.

Sidebar

Prepare for Flak from Lender on Termination Option

Lenders dislike tenant termination options. This can lead to two particular problems for you.

First, lenders usually will treat the proposed termination date as the end date of the 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 Sacramento, Calif., attorney Thomas F. Stewart. So a termination option in a lease today may cause you problems when you try to finance or refinance in the future.

Second, many mortgages require the lender's consent to all leases. Check your loan documents to see whether you need the lender's okay, suggests New Jersey attorney Marc L. Ripp. 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.