Get 6 Lease Protections When Giving Tenants Expansion Options

In this era of post-COVID-19 uncertainty, commercial tenants are increasingly reluctant to lock themselves into spaces of fixed dimensions over the entire lease term. Their driving imperative is flexibility. In the early days of the pandemic, as telecommuting shrank the need for space, flexibility largely meant the ability to contract. Now that employees are returning to work, many tenants are now seeking to expand their space. In addition, tenants that signed long-term leases before the pandemic now need extra space to meet social distancing requirements under public health orders.

Landlords can accommodate these needs by granting tenants the option to expand their space during the lease term. Expansion options are especially attractive in shopping centers, office buildings, and other multi-tenant settings experiencing high vacancy rates. However, giving tenants carte blanche to expand may be a recipe for chaos to the extent it forces you to shuffle other tenants around and/or re-engineer on the fly. That’s why landlords must establish clear limitations and ground rules. Here’s how to draft an expansion option that protects your interests.

How Expansion Options Work

Expansion option clauses give tenants the right to lease extra space in the premises, like the remainder of an entire office building floor, at a future date in the event they need more space than they originally leased. While there’s no such thing as a one-size-fits-all expansion option, our Model Clause: Let Tenants Expand Leased Space in a Way that Protects Your Interests, which comes from New York City attorney Trevor Adler, partner with Stroock & Stroock & Lavan LLP, includes the six protections you need.

1. Set conditions for tenant to exercise option. First, specify that the tenant may exercise the contraction option only if it’s in full occupancy of the original demised space and not in default of any lease terms [Clause, Sec. 1.01].

2. Establish time frame for option exercise. Require tenants to provide written notice (the “Expansion Acceptance Notice”) of their intent to lease the designated space (the “Expansion Space”) within a time frame (the “Expansion Notice Date”) that begins no earlier than after a specific anniversary of the lease commencement date and no later than after a date a fixed number of years after that date. In other words, require tenants to be in their lease a fixed number of years before exercising the option. Specify that time is of the essence in the tenant’s providing the Expansion Acceptance Notice and that failure to provide timely notice extinguishes the option and allows you to lease the Expansion Space to another tenant without any encumbrance [Clause, Secs. 1.01 and 1.02].

3. Require tenant to accept space “as is” and “where is.” One key question to negotiate is the condition in which the Expansion Space must be when the landlord delivers it. Tenants will typically want the space to be delivered in the same condition as the original space. However, our clause requires the tenant to accept the space in “as is” and “where is” condition. Result: You’re not obligated to furnish it or perform construction or alterations [Clause, Sec. 1.01].

4. Establish lease terms for expansion space. Adler notes that, “while expansion options are frequently negotiated in leases, they’re infrequently exercised without any re-negotiation.” Rather, expansion options are often used as a baseline for future negotiations, with agreed-upon terms that tend to diverge from the original lease. “The greater the time between the date of lease signing and date of expansion negotiation, the more likely the expansion terms are to diverge from the terms stated in the lease’s expansion right,” according to Adler. To provide you a degree of certainty going forward, our Model Clause stipulates that the original lease terms will apply to the Expansion Space, except that:

• The fixed rent will be increased to reflect the market value rent of the Expansion Space (the “Expansion Space Market Value Rent”) (Section 1.04 of our Model Clause sets out an elaborate process for establishing the Expansion Space Market Value Rent, either via negotiation or arbitration if the parties can’t agree);
• The tenant’s share of CAM or other proportionate share of costs based on rentable space occupied will be proportionately recalculated based on the number of rentable square feet in the Expansion Space;
• All recurring additional rent will be recalculated to reflect the incorporation of the Expansion Space into the demised premises [Clause, Sec. 1.03].

In addition, if the tenant’s space is expanding from a partial to a full floor, add provisions modifying the lease requiring the tenant to pay all utilities for the floor and include core bathrooms within the demised premises for purposes of repair, insurance, and indemnity responsibilities.

5. Rule out liability for failure to deliver expansion space. It may be difficult to deliver timely possession of the Expansion Space, especially if that space is currently occupied or in possession of other tenants, assignees, or sublessees. So, state that you won’t be liable—and the lease won’t be considered impaired—if, after making reasonable efforts, you can’t deliver on time due to a holdover, retention of possession, or any other reason beyond your control. Also specify that in these circumstances, the Expansion Space commencement date will be pushed back until the date you deliver possession (provided that the tenant doesn’t cause or contribute to the problem making you unable to deliver possession) [Clause, Sec. 1.06].

6. Stipulate that expansion option is tenant’s personal right. Clarify that the expansion option is personal to, and may be exercised by, only the initially named tenant and can’t be transferred or assigned to anybody else [Clause, Sec. 1.07].

Insider Source

Trevor T. Adler, Esq.: Partner, Stroock & Stroock & Lavan LLP, 180 Maiden Lane, New York, NY 10038-4982; (212) 806-5945; tadler@stroock.com.