An Overview of Commercial Lease Agreements
A commercial lease agreement is a contract under which one party agrees to allow another the use of real property ( "the lease") in exchange for consideration (usually rent). The lease can either be written or oral. Most leases in Michigan must be in writing. Once the lessee takes possession of the property and the terms of the lease are agreed-to or fulfilled (usually by payment of rent), the lessee is entitled to exclusive possession of the property for the duration of the lease .
Commercial lease agreements vary as to how much detail is included in the lease, how long the lease is for, what uses the property may be put to, what kind of structures the tenant can build or improvements the tenant can make, and whether or not the tenant can assign its interest in the lease to a third party.
The landlord has a vested interest in the success of the business. Both the landlord and tenant have a vested interest in the business operating without interruption. The purpose of the lease is to define the terms of the legal relationship between the landlord and tenant so that both parties understand their rights and obligations.
Triggers for Early Termination
Several of the most common reasons an organization may want to terminate a lease early include:
Business Downsizing
As businesses grow and change, organizations frequently need to downsize. Whether you’ve lost key employees or your market share has changed, downsizing enables you to reduce expenses by downsizing your footprint.
Relocation
Business relocation is another reason why an organization may choose to terminate a commercial lease. In many cases, companies move to a larger location due to expanding their workforce. However, sometimes companies relocate due to financial challenges or significant environmental changes in the area.
Financial Challenges
If relocation is too cost-prohibitive or downsizing is not a possibility, some organizations will fall on financial challenges and choose to terminate the lease as a last resort. While this option may damage your organization’s credit reputation, it’s still better than continuing to pay for a space that’s beyond your budget, especially when the other alternative is bankruptcy.
Legal Considerations for Early Termination
Breaking a lease early can subject the breaching party to a claim for damages by the non-breaching party. The damages may include (a) the expected rental value of the balance of the term of the lease, (b) any additional costs or obligations which the non-breaching party must incur in order to mitigate his/her/its damages, and/or (c) all expenses incurred by the non-breaching party resulting from the breach.
As a result of a leasehold breach, in some circumstances, a party may be entitled to damages, including: consequential damages, punitive damages, and damages for mental anguish. Although some courts allow estoppel to prevent a party from breaking a lease early, others do not. If a party has breached a lease, a Court may or may not allow rescission (termination or cancellation) of a lease. In any event, an action for damages may lie.
A lease governs the potential liability of the parties in all circumstances and therefore, it is very important that you diligently review the lease agreement for any terms that deal with early termination of the lease. The lease agreement should provide for any penalties in the event that a lease is terminated early, and whether there are any provisions that allow either party to avoid paying a penalty.
The Negotiation Process for Early Termination
Successful negotiation of an early termination is, in many instances, the least expensive alternative for the parties. The process should start as early as possible. After all, the sooner that the landlord is in possession of the premises, the sooner it can identify a new tenant who may be willing to pay the current market rent. The amount of the re-letting expenses that must be incurred by the landlord should not be underestimated. They might be equal to two full months of rent. In addition, the landlord will have lost the benefit of the original term of the lease, which is an additional loss of two months of rental income.
It is too often the case that the lease broker is an obstacle to amicable negotiations. While the broker’s duties are contractual in nature, whether they arise from the listing agreement or a commission contract, the broker’s insistence on demanding a commission from the landlord despite a favorable termination of the lease sets off a vicious cycle of disagreements between the landlord and its broker. All too often, the broker demands payment of its commission before it will agree to a termination fee. Not only does this threaten a landlords’ income, but it may inhibit amicable discussions directed toward a new lease to a replacement tenant.
A landlord may want a replacement tenant because of its financial strength or holding over rents, a tenant who will make tenant improvements, or a tenant that is already in possession of part of the premises. A tenant with an out clause with a six-month notice requirement is advantageous to a landlord from the viewpoint of time. By starting negotiations with open hands rather than open wallets, the landlord may avoid the rigors of negotiation with the tenant.
The landlord might suggest that the tenant extend its term at the higher rent, and terminate the existing lease with a compromise on the security deposit. Or the landlord may agree to break the lease upon a specified date, and then negotiate an extension or renewal.
A short-term renewal is an attractive alternative to the re-letting exercise. If the new lease calls for the same rent, the landlord will not be disadvantaged financially by a shorter term. A tenant will be able to allow extra time for the changes to its business model to take hold. It is a viable alternative that may avoid litigation.
Alternatives to Termination
Early termination of a commercial lease agreement does not have to be the only option. Landlords have invested too much time and money into building out the space and leasing it with the hope of long-term tenants. Remember, a longer lease equates to more tennant/landlord relationship for the landlord, as well as a larger obligation.
In fact, landlords are often willing to negotiate their way out of the lease to prevent the costly measures of new tenant improvements. Moreover, a vacant space is a huge financial burden to a landlord.
One way to ensure you can get out of your lease and have your landlord come out on the other side smiling a little more is to opt for a sublease agreement.
A sublease agreement is a short-term arrangement between your landlord and one of your subtenants. That is, as the individual leasing the premises initially, you then lease the space you occupy to one of your subtenants, and the duration for the sublease is short, generally less than the term of your lease with the landlord. In many cases, your lease will even require you obtain the landlord’s consent before subleasing.
Note, however, that in most cases, subleases require the subtenant you lease to fulfill the same obligations and duties that you owe to the landlord under the initial lease agreement you signed when you began occupying the space.
But what if a sublease isn’t possible? An assignment – essentially a purchase and sale agreement for a lease – may be the solution. On the other hand , a sub-lease allows you to remain legally liable for the lease agreement while an assignment removes you entirely from the lease. However, the assignment will often increase the cost, as rent tends to increase with the assignment.
Another option followed by many landlords is to sell the remaining term to another interested party in exchange for a lump-sum payment. A lump-sum payment is an amount agreed upon by the landlord and tenant to determine the remaining term as the fixed basis for the buyout.
The two options, subleasing and selling, set the landlord up to gain a little after the tenant walks away. However, both of these solutions equate to profits made during a tough time and can add to the overall value of the property and ensure that the landlord quickly finds a better-suited tenant.
Landlords may also be willing to renegotiate the terms of the lease agreement, settling on a periodic rent of an agreed upon sum over a certain period of time. The renegotiation brings the rent price down for the tenant, yet allows the landlord to recover some of the losses suffered from a vacant property.
The terms of the agreement are often flexible and depend on the parties involved. The best way to find an agreement is to approach the landlord and renegotiate the terms again, as found in the original lease document.
Essential Steps if Termination Cannot be Avoided
If early termination is unavoidable, the most important thing to remember is that you must give your landlord the amount of notice required under your lease agreement. If you do not provide sufficient notice—and in the required format—you could be liable for paying even more rent while your early termination request is getting worked out. The basic rule is that no matter how bad the situation gets, you want to avoid a protracted legal fight. So if you are sure you need to get out of your lease early, start preparing to terminate it in the manner (and on the schedule) detailed in your lease.
Depending on the landlord you are dealing with and your situation, the terms of the lease agreement, and the laws in your area, you may have some negotiating leverage that can minimize your costs. There are good reasons your landlord will understand—if you’re moving out of state or out of business, or any number of other legitimate reasons. Some leases let you off the hook, at least in part, if you can find a suitable replacement tenant. Sometimes landlords are willing to work out a short-term extension that allows you extra time to locate your replacement.
Remember that even if you’re stuck in a lease, you can usually avoid most of the damage by getting out early. Whether that means paying rent with a new tenant or paying up a little more for the remaining months, your goal is damage control—not winning a battle. Depending on the laws in your jurisdiction, you may also want to consider what constitutes proper notice, because specific notice terms in your lease may not be enforceable.
Legal Assistance and Resources
The law surrounding early termination of a commercial lease agreement in Ontario can be complex. Tenants and landlords alike must consider the legal implications of terminating a lease before the expiry date. In many cases, it is advisable to seek legal advice prior to deciding on a course of action. Without the right advice, a tenant may find themselves on the hook for the remainder of the term if they try to get out of a lease without following the correct process . A landlord may inadvertently waive their rights if they provide oral assurances or otherwise act in a way that suggests they are willing to let the tenant out of the lease without following the process set out in the agreement.
Real estate and business lawyers can help both landlords and tenants to understand their rights and obligations under the agreement, as well as the process involved with terminating the contract. The Law Society of Ontario has a public registry of lawyers and paralegals, which can be found here. This registry can help businesses find legal support suitable for their needs.