April 24 2009
Given the weak economy, many tenants may find themselves with premises that they no longer require or which they need to dispose of in order to cut costs. This update explores some of the more common exit strategies employed by tenants.
Each exit strategy is fraught with business and legal issues. Accordingly, just as the tenant should retain a leasing broker and lawyer before leasing any new space, it should do the same when looking to unload excess premises. A leasing broker can provide invaluable information relating to the local market, such as the likelihood of finding another user for the space and what that user might be willing to pay. Similarly, a lawyer can assist in understanding the tenant's rights and obligations under the lease, as well as the risks associated with each possible exit strategy.
As a general rule of thumb, it is also a good idea for the tenant to meet with the landlord early on while it is still considering all its options. The tenant should use the meeting as an opportunity to explore how receptive the landlord will be to the various strategies available to the tenant.
Finally, for tenants seeking to shed multiple locations, each location should be considered separately. The optimal strategy for one location may be unworkable or unrealistic in another.
Assignment or sub-letting is the most common exit strategy employed. The advantage to this strategy is that it is relatively simple to carry out and the lease usually affords the tenant the contractual right to assign or sub-let with the landlord's consent, which may not be unreasonably withheld. One significant disadvantage of this strategy is that in almost all circumstances the tenant will likely be unable to secure a transferee that is willing to pay the full rent payable under the lease (thereby leaving the tenant to pay the shortfall). Moreover, even if the tenant secures a transferee that is willing to pay the same rent as is payable under the lease, the tenant will remain liable to the landlord in the event that the transferee defaults on its payments.
In assessing whether an assignment or sub-let is a plausible exit strategy, the tenant needs to determine the rent which an assignee or sub-tenant would realistically be willing to pay, as well as the cost of any alterations and inducements that the tenant would likely have to perform or provide in order to secure the deal. The tenant would also need to determine how long the premises would likely need to be on the market before a transferee was secured. Armed with this information, as well as an estimate of brokerage, legal and landlord consent costs, the tenant can calculate its rental cost savings. If the savings are negligible, the tenant may determine that this is not a viable exit strategy.
Where the tenant can achieve worthwhile cost savings through an assignment or sub-let, it must still consider how cooperative the landlord will be in connection with the tenant's assignment and sub-letting efforts and whether it will consent to the transfer. The right to 'act reasonably' provides the landlord with broad discretion. Moreover, many leases permit a landlord to withhold its consent if it has space in the building which can accommodate the transferee. Where the landlord has a significant amount of vacant space in the building, it will be loath to consent to the transfer as it will want to enter into its own direct deal with the prospective occupant.
A lease buy-out involves the negotiation of an early termination of the lease with the landlord. While the landlord will undoubtedly want a lump-sum payment in exchange for the early termination, it may be advantageous for the tenant to pursue a buy-out for a number of reasons. In a best-case scenario the lump-sum payment will be significantly less than the rent payable for the balance of term (even if the tenant can secure an assignee or sub-tenant to assume some of the rent obligation). A tenant may be able to negotiate a relatively small termination payment where the premises are likely to be re-leased by the landlord in a short period of time (a leasing broker can assist in gathering this market intelligence). In any event, where the tenant is required to pay all or nearly all of the balance of the term rent, the early termination still allows the tenant to shed its overhead costs associated with the premises. A negotiated early termination will also end the tenant's liability under the lease. The opportunity for a 'clean break' is not available under any of the other strategies described in this update.
There are several reasons why a landlord might be inclined to negotiate a buy-out of the tenant's lease. For example, the landlord may have concerns about the tenant's ongoing solvency, with the result that it views cash in hand as preferable to dealing with a bankrupt tenant. Also, the landlord may view the termination as an opportunity to rid itself of an undesirable tenant or to give the space to another tenant in the building that is looking to expand. In cases where the tenant has broad assignment and sub-letting or use rights, the landlord may accept an early termination in order to avoid ending up with an undesirable transferee or use.
The 'going dark' strategy involves the tenant shutting down its operations in the premises but continuing to honour its rent payment and other lease obligations. This strategy allows the tenant to reduce its overhead costs associated with the premises due to the fact that it is no longer actively carrying on business in the premises. By ceasing its business activities the tenant will save on employee, inventory and utility costs. The primary downside to going dark is of course the fact that the tenant remains obliged to pay full rent. While going dark may not be a viable long-term solution, a tenant may choose to do so on an interim basis while it attempts to secure a lease assignee or sub-tenant, or while it tries to negotiate a lease buy-out with its landlord. The negative factors associated with vacant premises may place added pressure on the landlord to accept a buy-out.
A failure to carry on business actively from the premises may constitute a tenant default under the lease. If the lease requires the tenant to carry on its business actively, then before going dark it should discuss with its legal advisers the risks associated with doing so. These risks need to be weighed against the advantages of going dark. In some cases it may be that the landlord will not exercise its remedies with respect to the default as it is content simply to continue collecting rent. By meeting with the landlord beforehand, the tenant may be able to ascertain whether the landlord would terminate the lease or exercise its other remedies if the tenant sought to go dark.
The exit strategy employed by some tenants is simply to abandon the premises, stop paying rent and repudiate all lease obligations. This course of action will render the tenant in default and almost certainly expose it to liability, but it may be one of few viable options where the tenant is in financial distress. In addition, as a result of provisions contained in the Commercial Tenancies Act (Ontario), individuals assisting in removing the tenant's property from the premises (ie, the midnight movers) may find themselves personally liable for double the value of the property removed. This is obviously a high-risk strategy that must be approached with extreme caution and with a full understanding of the risks being assumed by the tenant. Nevertheless, in certain cases it may prove to be effective as it may motivate the landlord to come to the negotiating table. A landlord faced with a tenant bankruptcy or vacant premises and the prospect of spending the next several years litigating in court may be pressured into accepting a settlement which still allows the tenant to achieve an overall cost saving.
For further information on this topic please contact Joseph Grignano at Blake Cassels & Graydon LLP by telephone (+1 416 863 2400) or by fax (+1 416 863 2653) or by email (email@example.com).
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