Tenant's Exit Strategy
March 1, 2017
As a broker negotiating a term sheet on behalf of a tenant, you often seek to include a one-time option to terminate the lease early upon payment of a termination fee, typically calculated at a certain number of month's rent plus landlord's amortized costs for brokerage, leasehold improvements and free rent. The early termination option provides tenant with some flexibility, if, at that time, tenant will need to move to larger space or where circumstances force tenant to cease business at the leased premises.
However, the lease itself may be negotiated to contain other key provisions so as to further enhance tenant's flexibility whenever it needs to exit the space. Among these exit strategies are:
1. Ability to Assign or Sublet. Under New York law, unless the lease has added a provision that the landlord be reasonable in withholding consent to assignment and subletting, a landlord may arbitrarily withhold consent and thus entirely prevent tenant from employing its exit strategy, or extract lease modifications or a monetary fee in exchange for granting consent. Also, other added lease terms can greatly facilitate the disposition process by, for example, requiring only a term sheet rather than the fully signed document be presented to the landlord for consent, specifying a short time period in which landlord must respond (and, perhaps, even including a provision in which landlord’s consent would be deemed approved if landlord fails to respond), and limiting the carve outs from the reasonableness requirement, such as cutting back on restrictions on use of the space, permitting subletting rentals which are less than landlord's asking rents, and allowing marketing to occupants of the building when landlord has no available appropriate space. Obviously, the tenant's exit from the space would be most meaningful if there was a full release from future liability, but this is rarely achieved.
2. Recapture Exit. If the lease permits landlord to recapture in the event tenant wants to assign or sublease, landlord should be required by the lease to make this decision before having to go to market, so as to facilitate the marketing if landlord does not intend to recapture and to avoid wasting time and the expense of marketing if it does. If landlord did recapture, this situation does present an opportunity for tenant to be relieved of its obligation to pay rent to the extent that the assignment or sublease covers the rent under the main lease, ideally by adding a provision to the lease that recapture be in the form of lease termination, rather than an assignment or sublease back to the landlord.
3. Lingering Liabilities. After an assignment or subletting, tenant will (most likely) remain liable under the lease, as will its guarantor. In the case of an assignment, if the assignee goes into default because of financial difficulties, an indemnity given by the assignee to tenant in the assignment document may not be worth much, and the tenant would then remain exposed to liability to the landlord. There is typically no mechanism for the tenant to regain possession of the space if the assignee defaults, so the tenant would be without any ability to mitigate those damages by finding another party to take over the lease, unless, in the lease, tenant had negotiated an agreement with the landlord that would allow tenant to regain possession of the space in that situation. On the other hand, in the case of a default under a sublease, the tenant has the ability to terminate the sublease, cure the default and re-sublet the space to a better credit subtenant.
4. Default Scenario. If tenant is in default, leases typically allow landlord to continue to collect the rent every month as and when it comes due, but under New York law landlord is not required to seek another tenant for the space or otherwise mitigate its damages. Therefore, a landlord could allow the space to stay vacant and accrue a large damage claim against a defaulting tenant which has been unable to assign or sublet (a landlord could deny consent for the default alone). While tenant may or may not have assets sufficient to pay such damage claim, a clause requiring landlord to mitigate such damages would be beneficial to the tenant and should be negotiated into the lease, as such a provision is normal in most every other commercial transaction (but is strongly resisted by New York landlords). Such a clause could, in effect, require landlord to do the subletting for tenant, and the rents collected from that subletting (or deemed collected by the mitigation requirement) would reduce the amount tenant is liable for under its lease as if it had sublet.
So it takes both a knowledgeable broker and a diligent lawyer to help their tenant client achieve maximum lease exit flexibility.