Include Six Key Points in ‘Fair' Rent Acceleration Clause

If you're like most owners, you want to give tenants an incentive not to default under their leases. One strong, popular incentive is a “rent acceleration” clause. This clause lets you “accelerate” the rent of a defaulting tenant, so that it must pay the rent for the rest of the lease term immediately upon default. This compensates you for the losses you could suffer by not having a tenant in that space.

Because a rent acceleration clause is such a tough remedy, a tenant will try hard to keep it out of its lease. But you should fight to put at least some version of the clause in the lease, because it gives you vital financial protections. For instance, you could negotiate a fair rent acceleration clause instead of a tough one, advises New York City attorney Nancy Ann Connery. A fair rent acceleration clause reduces the amount of accelerated rent the tenant must pay. So, for example, instead of owing the entire rent amount due for the rest of the lease term, you'll let the tenant deduct the rent amount you could get if you relet the space. A fair rent acceleration clause will still adequately compensate you for losses if the tenant defaults—as long as it's drafted properly, she says.

To make sure that your fair rent acceleration clause is drafted properly, we'll give you a checklist of six key points to include in the clause. And we'll give you a Model Lease Clause, on p. 3, that you can adapt for your leases to include those key points.

Six Key Points to Include in Clause

Make sure that your rent acceleration clause, like our Model Lease Clause, includes the following six key points:

* Allow for Acceleration of Rent at Discounted Value

The clause should give you the right to collect an accelerated rent if the tenant defaults, says Connery. But it should also say that the rent amount will be “discounted to present value.” Money paid up front is worth more than the same sum over a period of time. So you can agree in the lease that if the tenant must pay accelerated rent, the amount should be “discounted”—that is, reduced to reflect the present value of the future accelerated rent payments, says Connery. We'll discuss the discounted value formula later [Clause, par. a].

* Make Accelerated Rent Include Both Base Rent and Additional Rent

Leases traditionally permit acceleration of both base rent and additional rent. So have your rent acceleration clause say that the tenant will pay accelerated rent consisting of both annual base rent and annual additional rent that would have been payable over the balance of the lease term from the default date to the lease's original expiration date, advises Connery [Clause, par. b].

* Indicate Amount You're Willing to Deduct from Accelerated Rent

Because this is a fair rent acceleration clause, you'll let the tenant deduct a certain amount from the accelerated rent due. Your lease clause will take into account the fact that you can relet the space after a defaulting tenant has moved out. So your clause should state that you'll deduct the “fair and reasonable rental value” of the space for the balance of the lease term from the accelerated rent, says Connery. Deducting that amount gives the tenant a credit for what you should get if the space is relet at fair rental value, she explains. This way, the accelerated rent amount more accurately reflects the damages you'll suffer as a result of the tenant's default.

The tenant will want to define “fair and reasonable rental value” so that the amount is both predictable and as high as possible. For example, the tenant may want the clause to say that the fair and reasonable rental value is to be determined on the basis of rents for comparable space nearby and on the assumption that the value will be determined with reference to the “maximum economic utilization of the space.”

But you'll want to keep that rental value down, says Connery. To do that, get the right to determine, on your own, the fair and reasonable rental value, she says. Base that value solely on rents payable under leases for comparable space in your building—rather than in buildings nearby, which may charge much higher rents than yours—during the 12-month period immediately preceding the rent acceleration date, she says. If you determine that there aren't any such leases, then you should have the right to determine, by yourself, the fair and reasonable rental value in good faith.

Connery suggests that the rent acceleration clause also say that if the space is relet before the accelerated rent is finally determined (by a court or otherwise), the rent under the new lease will be considered the fair and reasonable rental value for the defaulting tenant's purposes. This provides not only a definite rent amount but also a number that will be, in large part, under your control. But because the new lease's rent may be less than the going rate, a tenant may resist letting you use it as a measuring stick for fair and reasonable rental value, she warns [Clause, par. b].

* Specify Discount Rate to Reduce Accelerated Rent to ‘Present Value'

Because, as we noted above, you should agree to discount the accelerated rent to its present value, the lease clause must specify how you'll calculate that discount. To make that calculation, you need an appropriate interest rate, or “discount rate,” says Connery. The lease clause should specify the discount rate or at least how you'll determine it, to avoid uncertainty and confusion. While the tenant will negotiate for a high discount rate, you should demand a low rate. A high rate will reduce the amount of accelerated rent far more than a low rate, Connery explains. She suggests using one of two alternatives:

• A fixed rate agreed upon by you and the tenant; or

• A rate tied to an index, such as the yield of actively traded U.S. Treasury bonds with 10-year maturities. This index is a conservative, safe investment with a relatively low rate of return, Connery explains [Clause, par. c].

Practical Pointer: Because a rate that's agreed upon and fixed when the lease is signed may be out of line with interest rates at the time of the tenant's default, Connery prefers a rate that's pegged to an index. But expect the tenant to negotiate for a discount rate tied to an index that measures commercial rates of return (such as a designated bank's prime rate), she notes. That's a higher discount rate than what you'll propose.

* Release Tenant from Liability, But Not Reletting Costs

The tenant won't want any further liability under the lease after it has paid accelerated rent and whatever it owed before the rent was accelerated, notes Connery. So it will demand a release from further liability under the lease. But you should still insist that the tenant pay any costs you incurred because of its default, she says. So make clear in the rent acceleration clause that the tenant will still be responsible for your default-related costs after paying the accelerated rent. Then refer the tenant to a separate lease clause (one that's not part of the rent acceleration clause) that deals with reimbursement of your costs, says Connery [Clause, par. d]. For more details on what this separate clause should say, see box above.

* Specify How to Calculate Additional Rent

Unlike annual base rent, which is typically set out in the lease, annual additional rent is an unknown amount. You typically have to estimate a tenant's share of annual additional rent at the beginning of a year because you won't know actual costs until the end of the year.

How can you calculate future annual additional rent for the rent acceleration clause? Use past additional rent to estimate the annual additional rent to be accelerated, suggests Connery. For instance, compute the annual additional rent paid in the 12-month period preceding the lease's termination. If fewer than 12 months have passed since the lease started, take the average monthly additional rent that was payable since the start of the lease and multiply that number by 12, she suggests [Clause, par. e].

Once you've calculated that annual figure, you can use it to calculate how much additional rent would have been payable from the default date to the lease's original expiration date, Connery explains. Note that the tenant may try to exclude the additional rent from the accelerated rent calculation. If you're dealing with a strong shopping center tenant, you may have to give in on this point and exclude additional rent from the rent acceleration clause, says Connery. So it appears as “optional” in the Model Lease Clause.

* If Tenant Tries to Limit Clause to Defaults in Rent Payments

The tenant may try to weaken the usefulness of the rent acceleration clause by limiting your right to accelerate its rent only if the tenant defaults by not paying the monthly rent. It will argue that you shouldn't have the right to accelerate rent for any other type of lease default—whether monetary or nonmonetary—because the result will be too harsh. Respond to that argument by telling the tenant that any default serious enough to let you terminate its lease should also let you accelerate the rent, says Connery.

Practical Pointer: Courts around the country have adopted different rules on whether owners can enforce rent acceleration clauses against tenants, notes Connery. That's why, if you're considering adding a rent acceleration clause to your lease, you should first ask an attorney in the state where your building or center is located whether your state's laws will let you enforce the clause against your tenants, she says.

CLLI Source

Nancy Ann Connery, Esq.: Partner, Schoeman, Updike & Kaufman, LLP, 60 E. 42nd St., New York, NY 10165; (212) 661-5030; nconnery@schoeman.com.

Sidebar

Keep Tenant Responsible for Default-Related Costs

Don't let the tenant off the hook completely after it pays the accelerated rent, says New York City attorney Nancy Ann Connery. Rather, insist that the tenant pay any costs you incur because of its default, she says. For instance, you should get the tenant to pay your legal fees and reletting costs. Generally, reimbursement of your costs is dealt with separately from the rent acceleration clause, she notes. Your lease should say that if the lease terminates because of a tenant default, the tenant will reimburse you for any default-related expenses you incur, says Connery.

For example, your lease should say:

Model Lease Language

Tenant shall reimburse Landlord for any expenses incurred by Landlord in connection with reletting the Premises, including, but not limited to, attorney's fees and disbursements, brokerage commissions, advertising costs, costs incurred to secure the Premises, and the cost of preparing the Premises for reletting, including, but not limited to, the cost of making such repairs, alterations, replacements, and decorations to the Premises as Landlord may consider desirable or necessary.

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