Negotiate 8 Key Items in Lease's Default Clause

In a recent survey by the Institute of Real Estate Management members, more respondents cited debt collection as the number-one dispute between managers and tenants, proving that careful drafting of default clauses is as important as ever.

While some of the provisions that owners' attorneys include in leases' default clauses these days have become standard, others are emerging in response to changing market conditions and other contemporary issues facing the commercial real estate sector.

Friendlier Negotiations

When it comes to lease negotiations, owners and tenants probably will be more willing to compromise on their default clauses' terms, some experts say.

“I think that one of the fallouts from the liquidity crunch, the subprime market slowdown, will be that tenants that had aggressively expanded because they were betting on excessively strong markets are going to find that they have more space than they need,” says Irene Hosford, a partner in the Dallas office of Brown McCarroll, L.L.P.

That means tenants are likely to ask for more time to cure their defaults. And owners aren't as likely to resist those requests as readily as you might think, according to Hosford.

“Tenants are going to find themselves negotiating with owners with more debt in the market than they should have,” she says. “So both sides are going to need to find ways to keep leases alive.”

“Consumers don't want to shop at a shopping center where half the stores are dark,” agrees M. Rosie Rees, a partner in the Chicago office of Pircher, Nichols & Meeks.

In an effort to keep their tenants afloat, some owners may temporarily reduce their tenants' rents, or enter into agreements whereby the tenant has until the owner finds a new tenant before the original tenant must vacate the owner's space.

That's not to say that owners shouldn't continue make sure the default provision in their leases gives them as much leeway as possible.

Put 8 Key Protections in Default Clause

Here are some of the more traditional protections Rees suggests you include:

1) List what qualifies as a “default” and specify when default occurs. For purposes of the lease, a default may occur when it actually happens or within a certain amount of time after the owner tells the tenant it has defaulted.

2) Make sure rights are “cumulative.” “That ensures that you'll be able to exercise one right after the other,” Rees explains.

3) Get right to collect rent, terminate lease after tenant vacates premises. If the tenant is no longer using the premises, that shouldn't mean you can't collect rent any longer. You should also try to get the tenant to agree that you can accelerate the rent if it defaults. In other words, you should try to secure the right to immediately collect all of the rent the tenant would be required to pay during the lease's complete term. This acceleration provision is a common subject of contention, according to Rees. “Tenants often won't agree to that,” she says.

4) Get right to collect damages caused by tenant's default. The owner should be entitled to recover the costs it incurs to re-let the premises to another tenant. For example, the owner may have to hire a broker and pay commissions, hire an attorney to negotiate a new lease, or repair the premises if the tenant left them in bad condition. “Owners also try to get additional costs so that if it's necessary to build out the premises to suit the new tenant's needs, those costs are covered as well,” Rees says.

5) Include a self-help right. A self-help right is useful when the tenant defaults while it has occupancy of the premises—for example, when the tenant fails to maintain the premises as the lease requires.

“Let's say the pipes in a big shopping center's sprinkler system are interconnected throughout all the center's stores,” says Rees. “If the tenant mucks up the whole system while working on its own portion, the owner wants the ability to go onto the tenant's premises and fix the sprinkler right away.”

Editor's Note: For tips on negotiating a self-help eviction right, as well as a Model Lease Clause, see “Make Sure Lease Clearly Spells Out Your Self-Help Eviction Right,” Insider, July 2007, p. 6.

6) Try to limit your responsibility to mitigate damages. The responsibility to mitigate damages requires the owner to do what it can to limit the harm caused by the tenant's default.

“Different states have different standards for mitigation of damages,” Rees says. “For example, the owner doesn't want to be forced to take the first tenant that comes along, just to mitigate its damages. There should be standards in the lease regarding the quality of the tenant that the owner would be forced to accept.” She adds that the owner shouldn't be forced to accept a tenant in any space other than the one the defaulting tenant occupied. For Model Lease Language, see box above.

7) Have tenant waive its rights to regain possession of the property. “Under state law, tenants that are evicted or whose possessory rights are terminated may have some rights to get the premises back,” Rees says. “The problem with that from the owner's perspective is that, if you've evicted a tenant and you've gotten another tenant to move into that space, the last thing you need is for the first tenant to have 90 days to try to come back in and recover the premises,” she says.

8) Get right to late charges and interest when tenant pays late. Sometimes leases even charge tenants for bounced rent checks. While this late-charges provision is sometimes included in a lease's default clause, it's sometimes included elsewhere, Rees notes.

Insider Sources

Irene Hosford, Esq.: Partner, McCarroll, LLP; Dallas, TX

M. Rosie Rees, Esq.: Partner, Pircher, Nichols & Meeks; Chicago, ILFeatur