Use Disincentives to Discourage Month-to-Month Tenancy

When a commercial tenant stays in its space after its lease term expires, it becomes a “holdover” tenant. The most common reason for a holdover is the tenant's inability to move because its new space isn't ready yet. As a result of a tenant's mismanaging its relocation, a lengthy holdover situation can become a very complicated and costly trap for the owner. Avoid this trap by discouraging tenants from holding over: Include a costly and inconvenient holdover clause in the lease agreement.

Protect Yourself Against Holdover Damage

In the case of a holdover tenant with an original lease term of more than one month, the owner has two choices: (1) evict the tenant; or (2) accept the tenant and create a periodic tenancy known as a “month-to-month” tenancy. Remember that the regular eviction process can be time-consuming, so you may want to take your chances and allow a holdover to turn into a month-to-month tenancy; depending on how cooperative your tenant is, a holdover may come to an end before an eviction proceeding would.

Although some tenants negotiate special provisions with their owners for additional time if they need it at the end of their lease terms, many tenants stay where they are if they still are looking for outside properties when their leases are over. You should be concerned in this case because your tenant: (1) is looking for property elsewhere, so the holdover doesn't have any true benefit for you because it is leaving after that period; (2) is hindering your ability to effectively market the space; and (3) may threaten your ability to deliver possession to your new tenant.

However, a holdover clause that converts the tenancy under the lease term to a month-to-month tenancy, imposes substantial costs and penalties, and includes broad indemnification provisions for you is the best way for you to protect yourself against your holdover tenant.

Use Costs and Penalties as Leverage

The first opportunity to avoid a holdover problem is during the initial lease negotiations. Make negotiating a holdover clause, like our Model Lease Clause: Add Holdover Clause to Lease Agreement, a priority. It's true that a holdover cannot fully be prevented because—despite any provisions in the lease agreement—a tenant can refuse to pack up and leave. However, if you address the holdover issue with your tenant upfront, letting it know that there will be serious financial consequences if it continues to occupy your space after its term is up, it may not rely on a month-to-month tenancy as a back-up plan if it cannot find a new space outside of your building.

The holdover clause in your lease should be framed in a month-to-month tenancy and should provide that, during every month of that tenancy, your tenant will pay to you the greater of the fair market rental value for the space or 200 percent of the fixed annual rent and all additional rent payable by the tenant for the last month of the term, advises Alan M. Di Sciullo, Esq., director of Global Real Estate at Shearman and Sterling LLP and co-author with John B. Wood, Esq. of Negotiating and Drafting Office Leases. (Most likely, your tenant will try to negotiate for a lower percentage, but be aware that higher numbers are more of a deterrent). The higher rent that a tenant would owe as a result of a holdover clause for occupancy past its lease term is designed to be a disincentive for the tenant to stay there for a length of time, not a windfall for the owner, although it might collect more money than under the original lease, notes Di Sciullo.

Don't Forget Supporting Provisions

Equally important in a holdover clause is an indemnification provision in which the owner looks to its tenant to indemnify and hold it harmless for any costs or inconveniences due to the holdover, such as letting new tenants into the premises, says Di Sciullo. He recommends also agreeing in a new tenant's lease to only a “tender of possession” on its move-in date rather than “actual possession” on that date. This puts the burden on the new tenant to evict the holdover tenant if it is in the space on the tender date.

You can't really avoid a holdover, concludes Di Sciullo, but requiring a long period of notice from the tenant, setting holdover rent very high, insisting on indemnification in case the holdover materially affects the next tenant, and including a tender of possession clause in the new lease are precautions that, together, are another disincentive for holding over besides costs and penalties.

Month-to-Month Tenancies Motivated by Market

Month-to-month tenancies resulting from a holdover are a headache for owners, and purposeful month-to-month tenancies are rare. “The same incentives for a traditional lease are not there,” says Di Sciullo. “It's beneficial to have longer-term rent, as long as you can get a creditworthy tenant.”

However, the current economy has revived some interest in month-to-month tenancies, he adds, because owners who are not able to get long-term tenants for their space may resort to short-term tenants to fill spots for now. “It may be good for an owner in a market like this to try to accommodate a short-term tenant until it gets the long-term tenant it wants,” Di Sciullo observes. “It is a placeholder, not a relationship.” But don't put a lot of work into the premises, because when the tenant leaves in 30 days, you are left with a set of improvements that you will have to write off over someone else's term.

Insider Source

Alan M. Di Sciullo, Esq.: Director of Global Real Estate, Shearman and Sterling LLP, 850 3rd Ave., E 446, New York, NY 10022; (212) 848-4137; alan.disciullo@shearman.com.

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