What is a Commercial Lease Termination Agreement?
A Commercial Lease Termination Agreement is an agreement between landlords and tenants of commercial property that sets forth the terms and conditions of ending a lease. Such agreements provide both landlords and tenants with certainty about how the lease will come to an end, as well as setting forth the terms of the parties’ relationship after the termination of the lease. A Commercial Lease Termination Agreement will generally provide clauses regarding the obligations of the landlord and tenant, as well as how the lease will be terminated. For instance, a Commercial Lease Termination Agreement will set forth when the lease will end, whether and how rent will be paid between the time of agreeing to the Commercial Lease Termination Agreement and the time of the termination, and the obligations of the landlord and tenant after the termination of the lease, such as agreeing that no further damages will be pursued after the termination .
Such agreements provide clarity and protection for both the landlord and the tenant. Terminating a lease early without a written Commercial Lease Termination Agreement can expose both parties to liability, because there is ambiguity in what rights each party may have after the termination of the lease. A dispute between landlord and tenant after the termination of the lease with respect to a lease termination is a possibility that can be avoided if the parties enter into a Commercial Lease Termination Agreement that preserves their rights before the lease actually ends.
Commercial Lease Termination Agreements for commercial property are similar to a residential lease termination agreement; however, a commercial lease termination agreement should be more concise and should focus on the rights of the parties, after the lease is terminated, with respect to ongoing rights.
Essential Elements of a Lease Termination Agreement
Generally, in any commercial lease termination agreement, the components should include the following:
Parties
Of course, you need to specify the parties to the agreement. This will be the landlord and the tenant to the lease.
Termination Date
The date upon which the lease term will be terminated will be set forth. This date could be prior to the actual termination date of the lease term.
Termination Payment
Are there any payments to be made upon termination? Will the tenant have to pay a lump sum payment or will they receive a payment from the landlord? How are common area expenses handled?
Post Termination Payment
If a termination payment or a post termination payment is required, then the landlord will need to agree to deliver the payment within a certain time frame following the termination date. The parties may also agree upon a time frame following the lease termination for the tenant to remove personal property from the premises.
Grounds for Terminating a Commercial Lease Agreement
Commercial tenants may find themselves in need of space outside of the one they are leasing. Various forces may drive this, such as downsizing, relocating the business or changes in strategy and direction. The tenant, therefore, may seek to terminate their original lease prior to its expiration prior to continuing to search for new space.
One obvious reason for terminating an existing commercial lease is the desire to downsize or expand operations. Whether due to a downturn in the economy, a poorly received product or service, or any variety of reasons, a company’s business strategy may lead to downsizing. Conversely, robust growth and success may create a need for more space to house the personnel, equipment, and inventory that accompany a newly thriving company. Instead of breaking their lease, which would entail costly legal fees and possibly court awards to their landlord, tenants may be able to renegotiate with their landlord. Depending on the goodwill a tenant has built up with their landlord over the years, a good faith request to renegotiate the terms of the lease may very well result in the landlord’s consent. Perhaps the landlord will agree to simply adjust the monthly rental terms and allow the current lease to continue, with the understanding that the tenant is seeking additional space with a different landlord. Alternatively, a company may be operating successfully, but simply wish to move the location of their business and access a different market. The landlord may agree to terminate the lease early, either in order to keep their current tenant, or simply to obtain the benefit of a renegotiation of terms with another tenant.
Another reason to consider a termination agreement is the possibility of being forced to close the business as a result of litigation or other setbacks. If this were to happen, the tenant may not have the monetary resources or ability to show the landlord good faith in the event the tenant sought to pay out the remainder of the terms of the lease. A termination agreement, again, would be helpful in most situations. For example, a plaintiff in a lawsuit may prevail and obtain both a judgment for damages as well as injunctive relief (equitable relief) that forces the defendant out of its location. Such business closing legal scenarios may be rare, however, and hopefully would not be necessary. Nevertheless, if a tenant is forced to leave a premises as a result of problems caused by the landlord, or if the tenant itself is struggling in a down economy while its landlord prices out the rent terms for the lease, the tenant may have an option available under which they and the landlord can both save money and time by entering into a commercial lease termination agreement.
Legal Risks and Considerations
The legal aspects of commercial lease termination agreements require careful consideration. Parties must give significant forethought to the allocation of risk, how to distribute costs, and who will bear the burden if problems arise after the termination agreement is executed. Unless the terms are clear, future disputes may arise and go to litigation. This section will explain some common post-termination issues and how parties can avoid them.
For example, when a tenant goes out of business, he may lose the sale or other items of tangible personal property (TPP) left on the premises. The TPP could be used as collateral for debt that was used to finance his business, or otherwise have enough value to justify some type of enforcement action. If the tenant fails to remove all his personal property, will landlord be liable for the payment of rent and other charges after he vacated? If the tenant abandons his TPP, who bears liability for loss or damage to the items by landlord or by others? A commercial lease termination agreement could address these issues and provide the parties with a clear understanding about how to avoid problems.
More common issues arise from undisclosed or assumed liabilities. In the first case, the problem is simplicity – is the new owner of the business (i.e., the landlord who purchased a tenant’s assets) really aware of all the risks associated with the prior operations? In the second instance, it is the free lunch syndrome – assuming some liability or responsibility without obtaining compensation (does the buyer (i.e., the landlord) understand the full extent of the liabilities that the seller (i.e., the tenant) had, and does the buyer intend to assume these risks without compensation?) In terminating a lease, parties should consider whether the tenant has complied fully with his environmental obligations under federal or state law. The landlord may be held responsible for violations of such laws even after the tenant vacates the premises.
Negotiating a Commercial Lease Termination Agreement
Negotiating a commercial lease termination agreement can involve sensitive discussions between landlord and tenant, but they are essential if you are to minimize any legal liability for either party. What this means for the tenant is that if you give the landlord everything it demands without question, you will probably face real legal liability for breach of contract by defaulting on the lease and you may not even get out of some of the lease obligations. It also means that you should not simply give the landlord its request if you think it is being unreasonable.
The other main issue in negotiating the termination agreement is timing. It is often necessary to approach the landlord before the lease is set to expire, anticipating being in default and possibly having to deal with a breach of contract claim. The landlord will expect you to compensate it for its loss of rental income after breaking the lease , but you should be able to negotiate a lower rent than what is actually due, especially if the landlord is able to recover a new tenant quickly.
Another important issue is whether the landlord will waive its right to collect interest or other charges owed at the time the lease is broken or ended. Such an agreement can provide you with significant savings if there are outstanding invoices for repairs or disputes about payments under the lease.
Credit of the deposit can also be negotiated, and it is important because the landlord will likely look to the tenant for other damages related to damage to the property. Specifically, "ordinary wear and tear" will have occurred, but the owner may have the responsibility for repairs necessary to return the premises to its original condition.
Options Other than Lease Termination
While a lease termination may be the immediate concern of the parties, it is important to consider whether the parties might prefer to continue doing business together. If so, it is important to explore options short of terminating the lease.
Traditionally this would include a sublease by the tenant to a third party of the balance of the term. The rental under the sublease must represent fair market rent, and the terms of the sublease should not be contrary to the terms of the original lease. In this case, while the tenant remains liable to the landlord under the original lease, the tenant is collecting rent from the subtenant and will be making a profit during the subterm. While this approach can do much to make the tenant whole should the balance of the lease term be substantial, this may not be a legal option under the current laws of the jurisdiction. For example, the California Civil Code requires that, as a default matter, any lease to an entity other than an individual for leasing of space for use as a hotel or similar establishment is terminable on 30 days notice.
If a sublease is not an option under state law, or if both parties wish to relieve the tenant of its obligations to the landlord entirely, a lease assignment may be appropriate. An assignment transfers all rights and obligations of the tenant under the lease to the assignee, or, as it is sometimes phrased, "an assignee’s assumption of the tenant’s liabilities and obligations under the lease for the benefit of the landlord." After such assignment, the tenant is released from performance under the lease, unless there is a prohibited third party transfer clause. Once assigned, however, the original lessor and new lessee are free to negotiate the terms of the relationship.
In California, absent contrary contract language, once a lease is assigned, the original parties are free to renegotiate the terms of the relationship. In this case the original parties could agree to reduce or eliminate the rent, provide a rent credit, assign a portion of the rent to the assignee or provide a one-time cash payment in exchange for an assumed lease obligation. The new arrangement could even be for consideration in the form of an extension of the term or an agreement to forego a legal claim against the original party.
Where a lease termination agreement simply cannot be reached, the parties may also choose to explore whether a lease modification might meet both their needs.
Procedures of Commercial Lease Termination
It is vital to ensure that all parties are in agreement with regard to the terms of the termination. Once this is done, a legal meeting of the minds exists and the parties can move forward to actually executing the termination. This will involve preparing a lease termination agreement from the aforementioned outline. A few options exist in terms of how to prepare such an agreement.
In some cases only the names and signatures will be needed. I have witnessed some agreements where all that was required was a few sentences on the letterhead of the landlord that stated that the respective parties agreed to terminate the lease as of a certain date. The parties each signed the letter, and that was all that was required. However, the one with the least required information is enshrined in law (the Agricultural Land Act and Vastgoed v. Davey) only for short term leases of less than ten years. General legal agreements are required for long term leases.
In most cases, for long term leases, it is best to have a legal agreement that outlines everything pertaining to the termination. This will include, but is not limited to, details such as the names of the parties, location of the property, the dates of both the original lease agreement and the termination of the same, as well as signatures. In addition, any financial reparations or amendments pertaining to the termination should be included in this agreement as well. Parties may want to have the document signed by a notary public for additional reassurance or in instances where this is a requirement.
A helpful checklist that has been useful, albeit in a more informal manner, is:
• What are the names of the parties?
• What was the duration of the lease?
• What were the commencement and termination dates of the lease?
• What was the date of termination?
• What was the rental amount per month?
• What were the amounts payable in the event of breach of contract?
Once there has been confirmation that the lease has been ended by both parties, it is generally a good procedure, although not necessarily a requirement of law, to draft a legal document that records this and then send copies to the parties. It is acceptable for both to sign this – either a few words on a letterhead as mentioned above or a general legal form. At the point of signing, copies are distributed and upon receipt of these copies they become binding upon the parties, who can refer to and prove that the termination has been properly executed should this situation arise.
The less formal short term leases usually afford less risk and accordingly fewer requirements of law. In these instances, it is, however, still advisable to obtain confirmation of the cancellation and the amount to be paid in the event of default in order to avoid future dispute. Obtaining confirmation from the tenant regarding whether the property has been handed back to the owner can also save some aggravation.
Case Studies and Practical Examples
Periodic instances arise in the life cycle of a business during which it becomes necessary or desirable for the business to terminate all or portions of its commercial leasing portfolio. A variety of reasons exist for such terminations, including, for instance, in connection with a merger or acquisition, further geographical expansion, or following the closing (or significant downsizing) of a division or facility.
Barker Pacific Group (BPG), a West Coast national office services provider operating in multiple markets, undertook such an exercise in recent years when it needed to rationalize its operations and reduce its leasing commitments as part of a company-wide realignment. In this connection, BPG approached us for assistance in this undertaking as its real estate counsel. We assisted BPG’s management team in the termination of nine (9) of its existing leases over a ten (10) month period. The majority of these were classified as "office" leases, however, the terminated leases covered a wide-range of properties, including coworking spaces, warehouse/distribution facilities, and retail-type locations. Each lease had an average remaining term of 5 – 10 years. The leases ranged in size from approximately 1,500 square feet to about 8,000 square feet.
The BPG transaction exemplified a type of commercial lease termination arrangement variously termed a "termination agreement", an early termination agreement, or a lease buyout. What is common to each of these arrangements is the mutually agreed termination of the remaining term and obligations of a commercial lease on an early basis (i.e., prior to the scheduled expiration date). A termination agreement may include the payment of termination fees—usually on a per-square-foot basis—and/or the surrender of other security (such as , by way of an obvious example, in the context of a retail operation, the net present value of the payments that would have been due under the leases in lieu of exiting the leased premises). Apart from the foregoing, the terms of such agreements are customarily subject to some measure of negotiation by the parties. A termination agreement may or may not require the consent of the landlord as a condition precedent to the early exit of the tenant. However, where it is necessary (or even advisable) to obtain such consent, the landlord’s concurrence is customarily part of the termination agreement.
In each case, we assisted BPG to avoid future lease commitments and the associated costs in return for a cash payment to the landlord, which typically reflected the removated rent and other obligations potentially due over the last months of the lease term. We assisted BPG in negotiating and drafting the lease termination agreements, revised form documents were utilized, taking into account each landlord’s request. The transaction was successful for BPG and its applicable landlords, terminating each of the nine leases and freeing BPG in an equitable fashion from future lease obligations.
The BPG transaction provides another good example of how a systematized process facilitated by seasoned real estate counsel, and a professional real estate team (such as BPG utilized here), can help to manage the transaction in a cost effective and efficient manner. Whether consistent with a particular company’s organizational processes or goals, the ability to form a workable template that can be applied in similar situations, as we did in the BPG situation (somewhat similar to the statistics of a "template deal"), can assist in improving the bottom-line benefit of such business transactions.
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