Protecting Against Lost Rent for Tenant's Changed Circumstances

Q: I own a mixed-use building that has retail stores on the ground floor and residential units on the floors above. The ground floor is specifically zoned for retail use. Should I factor in the potential for zoning changes in my leases, and if so, how?

A: Yes. Zoning laws, which are subject to change, present challenges. This will be part of negotiations with tenants and will affect the way that you draft leases.

Tenants are likely to be concerned that if zoning laws change, they won’t be able to operate their businesses. They’ll be worried that they’ll still be on the hook for a multi-year lease. Termination rights will be implicated here. But you can protect your interests in such a situation, so that you won’t lose out on rent if a tenant can no longer use the space.

‘Partial Invalidity’ Protects Owners

A boilerplate clause that’s often overlooked by tenants and owners is a “partial invalidity” clause. This type of clause says that if a court invalidates any provision of the lease, the rest of the lease still remains in effect. That means that, if something happens that prevents the tenant from using the space as it intended—that is, according to the uses stated in the lease’s use clause—there’s nothing stopping you from forcing the tenant to still meet all of its lease obligations. How does this work?

Let’s say a tenant signs the lease for retail space on the first floor of a residential building, but a change to the zoning laws later bars retail stores from operating in the building. Under the typical partial invalidity clause, even though the tenant’s use clause is invalid, it would still have to pay rent and perform its other lease obligations.

While a small tenant or one without much leverage might agree to a partial invalidity clause without much negotiation, a savvy tenant will want to avoid this situation by getting the option to terminate the lease in that event.

Limit Termination Right

If you must give in and grant the tenant an option to terminate if it can’t use the space as intended, limit this termination option by demanding that the tenant make its decision to terminate by a certain deadline or loses its right to terminate the lease.

A major point to win is that the tenant will still be responsible for meeting any obligations that arose before the termination. This protects you if, for example, the tenant was behind on its rent at the time of termination. Also, it’s not uncommon for an owner to ask that the tenant pay any back rent before it can terminate the lease. And make sure that the tenant is responsible for damage to the space that occurred while it was still doing business there.