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Commercial Lease Workouts – Issues to Consider During Initial Lease Negotiations and During the Leas

Author: Michael A. Faerber Date: 11/03/2009

Categories: Commercial Leasing, Corporate and Business Law

Given the effect of the economy, many companies find themselves struggling to make rent payments. Companies may want to consider discussing rent abatement, rent deferrals and/or other concessions with their Landlords. The types of relief that may be available to a Tenant will differ depending upon a number of circumstances and each Landlord may react differently to such requests depending upon the local market conditions coupled with the vacancy rate for the property in question.

There are numerous approaches and suggestions to initial lease negotiations that, given certain concessions are granted, may benefit the Tenant in future negotiations. Additionally, should issues need to be addressed in the future there are tactful methods of how to commence lease negotiations at that point.

Initial Lease Negotiations – Foresight:

While no one enters into lease negotiations with the thoughts of potential financial problems, there are provisions to be included that could go a long way to assist a company out of potential financial failure.

  1. Early Termination. At the time of initial lease negotiations, if a company believes they may have a need to terminate their lease earlier than the stated period (i.e. – expected growth, concerns about the business of the company being tied to one large contract or client), the Tenant may want to consider negotiating for an earlier termination right in their lease. Landlords may be reluctant to agree to such provisions since their goal is not to enter into a lease for a period of time only to end up with empty space earlier than anticipated. Often a Landlord’s loan on their property is based upon the lender’s comfort level with guaranteed rent rolls through long term leases. Also, any costs incurred by the Landlord in entering into a new lease, such as brokerage commissions and build out expenses, are part of the calculation made by the Landlord when negotiating the amount of rent and the length of the term. Additionally, such costs are depreciable by the Landlord over certain periods of time.
    If a Landlord is willing to consider early termination, it may do so in exchange for an agreement by the Tenant to pay a termination fee, usually based upon the undepreciated amounts of brokerage commissions and build out expenses incurred by the Landlord. This would allow the Landlord to recoup some of its costs while giving the Tenant the option to terminate the lease early. Depending upon market conditions at the time, if the Tenant is looking for replacement space in a new building, the new Landlord may be willing to pay some or the entire termination fee as an incentive to help move the Tenant.
  2. Guarantees. When entering into a lease, if the Landlord requests guarantees, a Tenant should consider negotiating limitations on the guarantee, such as limiting maximum liability of the guarantor to one year’s worth of base and additional rent, having a diminishing liability over several years during the lease term and/or having the guaranty terminate earlier than the lease term, provided the Tenant is not in default under the lease at the time.

Negotiating During The Term:

  1. Early Termination Clause As Incentive For Landlord and Tenant to Renegotiate. If a company is lucky enough to have had the foresight to request an early termination clause, the Tenant may be able to use this provision as leverage to obtain relief for the Tenant. The Tenant may be willing to offer the Landlord a waiver of the termination right, in exchange for reduced or temporary abatement of the rent. This will help the Landlord avoid dealing with empty space for which they will need to advertise and spend additional costs on brokerage fees, repairs and improvements. Landlords may consider requiring that the lease term be extended in exchange for lower or abated rent.
  2. Percentage Rent Relief. Tenants who pay Percentage Rent may want to request a change in the percentages or annual breakpoint dollar limits that make up the calculation of Percentage Rent to lessen the likelihood that the Tenant will have to make such payments during these difficult times and/or ask the Landlord to agree to an abatement of Percentage Rent for a period of time, to allow the Tenant to stabilize its business and costs. Tenant may also consider negotiating that the Landlord waive its right terminate the lease if the Tenant fails to generate Percentage Rent, if such a provision exists in the lease.
  3. Rent Reduction. Other Tenants may want to approach their Landlord with a request for rent reduction and/or abatement based solely on the argument that without such relief the business may fail and the Tenant could find itself seeking bankruptcy relief, which may not be in the best interest of either party.
  4. Common Area Maintenance Payments. If a Tenant is paying common area maintenance costs or operating expenses to the Landlord based upon a Base Year calculation, the Tenant may want to request that the Base Year be adjusted to the current year to lower the monthly amounts they are paying toward these costs.
  5. Landlord Goals. Landlords will want to be careful not to lose quality Tenants they can otherwise keep by making deals but at the same time Landlords need to consider the economic effect of giving concessions. While the Landlord may agree to rent reductions, abatements or changing Base Years on payment of operating expenses or common area maintenance costs, they will still need to make certain they are able to cover their expenses and not end up with a short fall when it comes time to pay taxes, insurance, loan payments and operating expenses. The Landlord will want to make certain that the payments received from the Tenant will allow it to keep current on these payments.
  6. Effect of Guarantees during the Term. The existence of personal and other guarantees on a lease will need to be considered in the equation when a Tenant asks for relief. Some Landlords may not be willing to consider rent reductions or abatements, and if a Tenant finds itself in that position and considers going out of business and/or filing bankruptcy, the existence of personal or other guarantees may still be enforceable by the Landlord. If the Tenant was able to negotiate limits on the guarantees, then the Tenant may not be as negatively affected by such concerns. It is not likely that a Landlord would consider termination of guarantees as part of requests for relief by a Tenant, since the guarantees are specifically requested by Landlords for protection in these types of circumstances.

Should you have any questions or concerns about a lease related to the issues raised in this article, or any other Lease questions, you can contact Michael Faerber directly at (240) 778-2305 or by e-mail.