Lease Flexibility for a Tenant's Changing Needs - International Law Office

International Law Office

Commercial Property - USA

Lease Flexibility for a Tenant's Changing Needs

June 30 2000

Introduction
Option to Renew
Short Term Extension Options
Holdover
Expansion Option
Right of First Offer to Lease
Right of First Refusal to Lease
Purchase Option
Right of First Offer to Purchase
Right of First Refusal to Purchase
Assignment Rights
Subletting Rights
Termination Option
Contraction Option


Introduction

A commercial lease will often have an initial term of 10 years or more, and a series of renewal terms that may aggregate 20 years or more. During the lease term the space needs of the tenant are likely to change, perhaps several times and in ways which are not foreseeable at the time that the lease is being negotiated. These changes may be caused by many varying factors, including:

  • the unforeseen growth of the tenant's business;

  • the downsizing of a particular area;

  • the sale of a subsidiary or division;

  • a merger with a competitor; or

  • a change in strategic planning.

A tenant's ability to respond to changing space needs is often dependent upon how much flexibility is built into the lease as part of the initial lease negotiations.

This article will discuss ways in which a tenant can create flexibility in a lease agreement.

Option to Renew

Number and length of renewal terms
The more renewal options that can be built into the lease, the better for the tenant. Maximum flexibility can be achieved if the tenant can specify the length of the renewal term (eg, between two and five years) when the tenant notifies the landlord of his or her interest in renewing the lease.

Renewal term rent
The rental rate for the renewal term may be:

  • a fixed amount per year;

  • a percentage of the last year's rent;

  • tied to a fair market value formula; or

  • a combination thereof.

For example, the renewal term rent might be equal to the lesser of the rent for the last year of the lease term and a stated percentage of fair market rent for the space.

Renewal rent may be a percentage of the fair market rent for the leased premises (eg, 80% or 90% of fair market rent). Fair market rent is generally determined by comparing the leased premises to other comparable space in the building and in other comparable buildings in a specifically designated area. If the parties cannot agree upon the renewal term fair market base rent and the renewal rent within a specified time period, then the renewal term fair market base rent may be determined by an appraisal process.

The appraisal procedure which often works best involves a process whereby each party submits its proposed fair market base rent amount to an independent third party (who may be an appraiser or a leasing broker), considered satisfactory to both the landlord and the tenant. The third party is instructed to select one of the two proposals, and is not permitted to modify the submissions. This process (often called 'baseball arbitration' in the United States, because it was first used in resolving salary disputes between baseball players and owners) is intended to keep both the landlord and the tenant honest. If one party submits an unreasonably high proposal, the independent arbiter is likely to pick the other party's proposal as the fair market rent.

If the renewal term rent is tied to a fair market valuation, it is important that the lease provide for current base years for taxes and operating expenses.

Exercising the renewal option
Timing for exercising the renewal option is crucial. The landlord would like the tenant to commit (or waive its option to renew) as early as possible. If the tenant does not renew, the landlord needs time to market the leased premises and to find a new tenant. The tenant, however, would like the time for exercising the renewal option to be as late as possible. Often, the time to renew is a function of the size of the space being renewed, because the landlord needs more time to market and lease a large block of space. The date for the tenant to exercise its renewal option is often 'of the essence'. In many jurisdictions in the United States, this means that if the tenant is late by even one day in exercising its renewal option, the tenant has no further right to renew.

Ideally, the tenant would like to know the renewal rent (including going through a renewal rent appraisal procedure, if necessary) before committing to exercising the renewal option. This not only facilitates budgeting and planning for the tenant or its user group, but also may be essential for obtaining management approval for the lease renewal.

Renewal term premises
The premises to be leased during the renewal term may be all, or a part, of the premises leased during the initial term. Ideally, the tenant should have the flexibility to designate the portion of the initially leased premises that is to be renewed. For example, if the initially demised premises included all of floors one through five in a building, the tenant may want the flexibility to lease one or more of such floors during the renewal term. The floors which the tenant elects to continue leasing should, of course, be contiguous.

Refurbishment allowances
The tenant should consider, as part of its initial lease negotiations, requiring the landlord to provide a refurbishment allowance if the tenant exercises its renewal option. Any such refurbishment allowance should be determined on a 'per rentable square foot' basis if the tenant (i) has the option to lease less than all of the initially leased premises, or (ii) has expanded the leased premises during the initial term. A refurbishment allowance will usually result in an increase in the renewal term rent.

Short Term Extension Options

If the tenant does not renew the lease, the tenant should have the right to exercise one or two short term extension options (eg, three to six months for each extension period). The rent payable during each short term extension period is usually a fixed amount per rentable square foot, often based on a percentage of the base rent payable during the last year of the lease term; such rent is not generally tied to a fair market rent valuation process. For example, during the first six months of the extension period, the base rent could be 100% of the base rent payable during the last year of the term. During the second six months, the base rent could be 125% of the base rent, payable during the last year of the term. If the tenant exercises its first six-month extension option, then the tenant usually waives any further renewal right, but may still have the right to exercise a second six-month extension option. This short term extension right provides the tenant with short term flexibility to facilitate an orderly move from its existing leased premises into new space.

Holdover

If the tenant 'holds over' beyond the expiration of the lease term, the tenant can be evicted from the leased premises. The holdover provisions of the lease do not give the tenant the right to remain in the leased premises beyond the stated expiration date.

If the tenant does remain in the leased premises, the tenant's holdover rent should be expressly quantified. This is usually a stated percentage of the base rent payable during the last year of the lease term, and may increase over time (eg, 125% of base rent for the first three months, 150% for the next 3 months and 200% thereafter).

The lease should expressly provide that if the tenant holds over beyond the expiration date, the tenant will not be responsible for consequential damages to the landlord resulting from such holdover, such as the loss of a new tenant because the initial tenant is still occupying the space.

Expansion Option

An expansion option provides the tenant with the unilateral right, at its election, to lease certain specifically identified space (often identified by one or more floor plans attached to the lease), at a specified time and on specified terms.

Exercise of expansion option
The lease will provide that the tenant must exercise its option, if at all, by a certain date (eg, on or before the third anniversary of the commencement date). If the tenant misses that date, then the option is usually forfeited. If the tenant exercises the expansion option, then on the expansion space commencement date the following will occur:

  • the expansion space is added to the leased premises;

  • the expiration date for the expansion space must be coterminus with the expiration date for the balance of the premises;

  • the rent is adjusted accordingly;

  • the tenant's proportionate share for operating expenses and taxes is increased by the amount of the expansion space added to the premises; and

  • the number of parking spaces to which the tenant is entitled may be increased.

Expansion space rent
The rent may be a fixed amount, or it may be tied to a fair market value procedure. If the rent is a percentage of fair market value, then there should be a separate base year and a separate tenant's proportionate share for each expansion space. If an appraisal process is to be used, it is always preferable for the lease to provide that the proposed rent for the expansion space is determined before the tenant has to exercise its expansion option. If the parties are unable to agree on the applicable rent amount, a 'baseball arbitration' process (as discussed above) can be used to determine the expansion space rent.

Expansion space improvement allowance/free rent period
As part of the initial lease negotiations, the tenant should consider including a tenant improvement allowance and a free rent period for the expansion space. If the rent is the same as the initially leased premises, then this could include a pro-rata share of the improvement allowance (per rentable square foot) included for the initial premises, together with a pro rata share of the free rent period allocable to the initial premises.

For example, if the tenant receives $20 per rentable square foot and six months free rent for the initial premises for 10 years, and the expansion option is exercisable on the fifth anniversary of the lease commencement date, then the tenant would be entitled to an allowance of $10 per rentable square foot for the expansion space and a three-month free rent period.

Commencement date for the expansion space
If the tenant is responsible for building out the expansion space, then the landlord is generally required only to deliver possession of the expansion space vacant, clean and with the building systems working. If the landlord is responsible for building out the expansion space for the tenant, then the lease must set forth the mechanics of coordinating the delivery, review and approval of the tenant's construction documents, and a fair method of determining when the commencement date for the expansion space should occur.

The lease may provide for a per day penalty paid to the tenant if the landlord is unable to deliver possession of the expansion space by the required date.

The tenant should have the right to rescind its exercise of the expansion option if the landlord fails to deliver possession of the expansion space by a specified date. The landlord will probably insist on a much more lenient rescission date where the landlord is building out the expansion space according to the tenant's plans and specifications.

'Must-take' space
Unlike expansion space (which the tenant can unilaterally elect to lease or not lease), 'must-take' space refers to space which automatically becomes a part of the leased premises on a certain date, provided that the landlord (i) can deliver possession of this space vacant, and (ii) with the agreed upon tenant improvement work in place. No exercise notice is necessary.

Must-take space usually has a fixed rent tied to the rent then payable under the lease for the balance of the leased premises. The lease could, for example, provide for penalties to the landlord if the landlord is unable to deliver possession of the must-take space by a specified date (eg, if an existing tenant holds over in this space). Alternatively, the tenant may have the right to terminate the lease with respect to the must-take space if the landlord fails to deliver vacant possession of the space by a specified date.

Right of First Offer to Lease

Thr right of first offer to lease gives the tenant the first opportunity to lease space in the building, if the landlord wants to offer the space for lease (the Offer Space). Landlords frequently insist that a tenant's right of first offer with respect to any space must be subordinate to the landlord's ability to lease (or re-lease) that space to the existing tenant of that space.

Offer notice
If the landlord desires to lease the Offer Space, the landlord must first offer the Offer Space to the tenant. The offer notice should set forth the following:

  • the exact location (though the use of a floor plan) of the Offer Space and the landlord's determination of the number of rentable square feet contained within it:

  • the date that the landlord anticipates being able to deliver vacant possession of the Offer Space to the tenant; and

  • the landlord's determination of the fair market rent for such space.

The lease should set forth the formula (including loss or add-on factors for full and partial floors) by which the rentable area of various spaces in the building are to be determined, and the landlord's determination of the area of the Offer Space should be based upon that formula. The tenant has a right to accept or reject the offer. If the tenant accepts the offer, but disputes the rent, then the rent will be determined by a baseball arbitration process (as discussed above).

As an alternative to the fair market rent valuation process, the lease can provide that the tenant must accept or reject the rent amount established by the landlord (with no option to determine the fair market rent by an appraisal process). If the tenant rejects the offer, the landlord is free to lease the space to a third party within a designated time period (eg, 12 months), at a rent that is not less than the rent offered to the tenant.

Acceptance of offer
If the tenant accepts the offer to lease the Offer Space, then on the requisite delivery date the Offer Space becomes part of the leased premises upon all of the terms of the lease. The base rent is adjusted to include the agreed upon rent for the Offer Space. The lease should provide for a new separate base year for the Offer Space, and a separate proportionate share, if the rent for the Offer Space is tied to fair market value.

Rejection of offer
If the tenant rejects the offer, then the landlord may lease the space (in its entirety) to a single third party, for a specified period of time, on such terms as the landlord may desire. If the landlord fails to lease the space to a single third party within the prescribed time period, the landlord must again re-offer the space to the tenant at the rental rates being offered by the landlord to other prospective tenants. The landlord should not be permitted to lease the offered space in parts to various parties, as this would be a materially different deal than the deal initially offered to the tenant.

If the offer is for a fixed rental rate (as opposed to a fair market value rental rate), then the landlord should be permitted to lease the offered space at a rate that is not less than the rate initially offered to the tenant (or at a certain percentage of the rate offered to the tenant). If the landlord wants to lease the space at a substantially lower rental rate, the landlord would again have to first offer the space to the tenant at the new lower rental rate.

Right of First Refusal to Lease

Right of first refusal to lease
The right of first refusal to lease differs from a right of first offer, in that the space is not offered for rent to the tenant until the landlord has an offer (which the landlord wants to accept) from a proposed tenant to lease identified space on specified terms (eg, rental rate, term, free rent period, improvement allowance). Before the landlord can accept the offer from the proposed tenant, the landlord must first offer to lease the space to the tenant on the same terms.

The tenant usually has a relatively short time to accept or reject the offer to lease the space on the proposed terms. This short response period is necessary in order that the landlord will not lose the deal with the prospective new tenant if the existing tenant declines.

A right of first refusal may materially constrain the landlord's ability to effectively market the space. As such, landlords do not favor rights of first refusal. A proposed tenant may not enter into serious negotiations if the space can be taken away under an existing tenant's right of first refusal.

Difficulties may arise in accepting the offer to lease the space on first refusal terms, if the tenant seeks to lease the first refusal space for a term which is coterminus with the tenant's existing lease. The economic terms offered by the landlord may have to be adjusted to provide the landlord with a comparable net effective rental rate for the term of the first refusal space, including pro-rata adjustments to the free rent period, the tenant work allowance, etc.

Rejection of first refusal space
If the tenant rejects the offer to lease the first refusal space, then the landlord can lease the space to the specifically identified prospective tenant, within an enumerated time period and only on the offered terms (or on other terms that are no more favorable to the identified tenant than the terms offered to the tenant). If the landlord proposes to lease the space on terms which are more advantageous to the prospective tenant, the landlord must again re-offer the space to the tenant on the new terms.

Purchase Option

A purchase option is most often granted by a landlord when the tenant leases all, or a substantial portion, of a building. The purchase option provides the tenant with the unilateral right to acquire the building at a specified time and at a specified price. The purchase price may be:

  • a fixed price;

  • a fair market based price; or

  • a fair market based price which is subject to a minimum fixed price.

If the purchase price is based upon a fair market valuation, and if the parties are unable to agree upon the sales price, a baseball arbitration process should be used to determine the fair market price. In addition, if the purchase price is based upon a fair market valuation, the tenant must carefully define the fair market value, so as to limit or prevent the landlord's attempt to seek a price which reflects the highest and best use of the property, rather than the use currently in effect.

If possible, the tenant should have the option to withdraw its purchase option notice if the purchase price, as ultimately determined between the parties or by an appraisal process, is unsatisfactory to the tenant. If the tenant has this ability, then the time period for the tenant to exercise the option must be sufficiently in advance of the lease expiration date to allow the landlord sufficient time to re-let the space if the tenant does not elect to purchase the building. For example, the tenant should have to exercise its purchase option not later than 18 months to one year prior to the lease expiration date.

Right of First Offer to Purchase

Unlike a purchase option, the right of first offer to purchase is triggered only if and when the landlord elects to sell the building. If the landlord wants to sell the building, he or she is required to deliver an offer notice to the tenant setting forth the offered sales price, the desired closing date, and all other material terms and conditions on which the property is offered for sale.

Along with the offer notice, the landlord is required to deliver copies of the following documents to the tenant:

  • title materials;

  • environmental reports;

  • leases;

  • management agreements;

  • service contracts; and

  • other due diligence materials in the landlord's possession.

The tenant should have a reasonable due diligence period (eg, 30 days) to inspect the building before having to accept or reject the offer.

If the tenant accepts the offer, the acceptance forms a binding contract for the sale and purchase of the building. If the tenant is leasing the entire building under a net lease (whereby the tenant is responsible for paying all real estate taxes, service contracts and the like), the only adjustment to the purchase price would be for rent for the month of the closing.

When negotiating a right of first offer, consideration should be given as to whether the right applies only once - when the then current landlord seeks to sell - or whether the right is revived for any (or all) subsequent sales that may occur during the lease term.

Rejection of offer
If the tenant rejects the offer (or fails to accept it within a specified period), then the landlord may sell the building for not less than the price offered to the tenant (or possibly within 95% of the offered price). If the landlord wants to sell the building for a lower price, then the landlord must first re-offer the building for sale to the tenant. If possible, the tenant's right of first offer should continue throughout the lease term, thereby applying to successive transfers.

Exempt transactions
The tenant's right of first offer should not apply to mortgage foreclosures or deeds in lieu of foreclosure. Often, the lease may provide that the landlord (and its affiliates) may market several properties as a package (eg, a portfolio sale) without triggering the right of first offer. Finally, the lease should provide that a sale of the ownership interests by the landlord may trigger the right of first offer, if the landlord does not own any other assets.

If the lease does not provide an exclusion for multi-property sales, then the lease needs to address the ability to allocate the total offered sales price among the respective properties, to arrive at a true offer price for the subject property.

Right of First Refusal to Purchase

This is similar to a right of first offer, except that the landlord has a prospective buyer who has made an offer for the building, which the landlord wants to accept. The tenant has a right to purchase the building on the same terms that the landlord is willing to accept from the prospective buyer. If the tenant rejects the first refusal offer (or fails to accept the first refusal offer within the prescribed time period), then the landlord may sell the building to the specific buyer on the offered terms. The exempt transactions that apply to the right of first offer to purchase (discussed above) would also apply here.

Assignment Rights

An assignment is a transfer of all of the tenant's rights under the lease to a new party (the assignee). The tenant has no further right to occupy or use the leased premises.

Unless the lease expressly provides otherwise, the assigning tenant continues to be liable to the landlord for all of the lease obligations of the assignee, including the obligation to pay rent (ie, the original tenant is not released from its lease obligations). In essence, the original tenant (the assignor) is guaranteeing to the landlord the obligations of the new tenant (and successors, if any) under the lease. This continuing liability would apply not only during the original term, but also during any express renewal terms under the lease.

Unlike a sublease, if the assignee defaults under the lease, often the assignor is unable to cure the default of the assignee or to recover possession of the leased premises.

Right to assign
The tenant should always have the right, without the landlord's consent, to assign the lease to:

  • its affiliates or subsidiaries;

  • entities with which the tenant is merged or consolidated; and

  • entities that purchase substantially all of the tenant's assets.

A credit tenant should, under most circumstances, also have the right to assign the lease to an unrelated third party without the consent of the landlord.

Under certain circumstances, it may be possible to provide that the original tenant will be released from ongoing liability, if the assignee meets a certain net worth test. Landlords are, however, reluctant to agree to this. If the tenant cannot be released upon assignment, then the tenant should consider subletting the premises, rather than assigning the lease.

In a multi-tenant building (as distinguished from a building where the tenant is the sole occupant), the landlord may be reluctant to allow a blanket right of assignment. The landlord wants to control the tenant make-up of the building, and may not want the tenant competing with the landlord, in the future, for leasing space in the building.

Subletting Rights

A sublease creates a direct landlord-tenant relationship between the original tenant (the sublandlord) and the new tenant (the subtenant). The subtenant pays its rent to the sublandlord, who continues to pay rent directly to the original landlord (the overlandlord). The sublease does not affect or modify the contractual relationship between the original landlord and the original tenant created by the lease.

If the subtenant defaults under the sublease, the sublandlord has the same rights against the subtenant as the rights that are available to a landlord against a defaulting tenant (ie, the right to terminate the sublease and to recover possession of the subleased premises). This allows the sublandlord to re-enter possession of the subleased premises, cure any nonmonetary defaults, and thereby protect its original lease from being put into default by the overlandlord.

All subleases should expire not later than one day prior to the expiration date of the main lease. Otherwise, in many jurisdictions the sublease may be construed as an assignment.

A sublease arrangement (as opposed to an assignment) enables the tenant to re-occupy the space upon the expiration of the sublease term if the tenant so desires, provided that the term of the sublease is significantly shorter than the remaining term of the lease. In certain circumstances, this flexibility allows the tenant to 'warehouse' the space for future expansion needs.

Right to sublease
The tenant should always have the right to sublease to affiliates and subsidiaries. Ideally, the tenant should also have the right to sublease all or any portion of the space to unrelated third parties without the consent of the landlord.

Certain restrictions may apply to the tenant's subletting rights, including:

  • a limitation on the amount of space that may be sublet without the landlord's consent (eg, the tenant cannot sublet more than 50% of the space without the landlord's consent);

  • a prohibition on subletting to certain types of tenants (eg, the landlord may be concerned about violating any exclusive use clauses in other tenants' leases executed before the tenant's lease); and

  • the tenant cannot sublet to existing tenants in the building, unless the landlord has no other space available in the building.

The tenant should never agree that it will not sublet at a rental rate that is less than the rental rate per rentable square foot being offered by the landlord in the market for comparable space in the building. This is because subleases will generally command lower rental rates than direct leases.

Consent rights of landlord
If the landlord's consent is required to sublease all or a part of the leased premises, then such consent should not be unreasonably withheld and the landlord should be required to respond within a short time period, time being "of the essence". The failure of the landlord to respond within the requisite response period should be deemed approval.

The landlord's consent should be limited to certain express factors, such as the use of the sublease space. Because the original tenant continues to be directly liable to the landlord for rent and all other lease obligations, and provided that the original tenant is a substantially creditworthy entity, then creditworthiness of the subtenant should not be a reason for the overlandlord to deny consent.

The notice requesting consent should be accompanied by a basic term sheet, and not a proposed sublease. Subtenants are often reluctant to spend the time and resources necessary to fully negotiate a sublease agreement if the subtenant has no assurance that the overlandlord will consent to the sublease arrangement.

Landlord's recapture rights
Landlords may seek a 'right of recapture' if the tenant wants to sublet the space or assign the lease. This is analogous to a right of first offer by the tenant to the landlord to take back the space proposed to be sublet (or the entire space if the lease is proposed to be assigned).

The tenant must first offer the space to the landlord on the same terms that the tenant wants from a subtenant. Recapture rights should, if possible, be avoided by a tenant. These rights can substantially complicate the lease. In addition, a recapture right may substantially hinder a tenant's ability to effectively assign the lease or sublet the premises.

If the landlord insists upon a recapture right, a variety of issues may have to be addressed in the lease, including:

  • When does the landlord's recapture right arise: before the tenant goes to the market? after the tenant has a term sheet or letter of intent? after the tenant has a signed assignment or sublease agreement?

  • What types of transactions give rise to the landlord's right of recapture: an assignment of the lease? a sublease of all of the leased premises, for the remaining lease term? a sublease of any portion of the leased premises for the remaining lease term? a sublease that, when combined with all other subleases, results in a sublease of substantially all of the leased premises?

  • What method of recapture will the landlord use to recover the subject premises: by assignment (in case of a proposed assignment of the lease)? by sublease (in case of a proposed sublease, regardless of the term of the proposed sublease)? by partial lease termination (in cases of a proposed sublease for the balance of the lease term)? by total lease termination?

Determining the amount of rent to be paid on recapture must be considered. If the recapture is by sublease, the possibilities include:

  • the rent under the tenant's lease;

  • the rent to be paid by the subtenant (where an actual deal triggers the recapture right); or

  • fair market rent (where the recapture right is triggered by the tenant's notice before the tenant goes to the market).

Profit sharing
The effect of profit sharing provisions of the lease must also be taken into account. Often, a landlord will require that the tenant remit to the landlord all or a portion (eg, 50%) of any profits received by the tenant in connection with an assignment or subletting.

Profits determined on a true 'net basis'
Assignment profits should be the net of any fees or costs paid by the tenant in connection with the assignment, including:

  • brokerage fees;

  • attorneys' fees;

  • advertising costs;

  • tenant improvement contributions paid by the assignor to the assignee; and

  • costs of any alterations made by the assignor for the benefit of the assignee.

Sublease profits should be based on the aggregate rent actually received by the sublandlord during a specified period, over the aggregate rent actually paid by the sublandlord to the overlandlord for the same period. The sublandlord's costs of subletting should be recouped first, before any net profits are remitted to the overlandlord. Costs include:

  • tenant improvement contributions;

  • alteration costs;

  • brokerage fees;

  • advertising costs;

  • free rent; and

  • rent paid by the sublandlord during any period while the sublet space was vacant.

Nondisturbance
If the sublandlord defaults under the main lease, and the main lease is terminated by the overlandlord, in the absence of a nondisturbance agreement between the overlandlord and the subtenant, the sublease will automatically terminate. Ideally, the lease can provide that if the tenant enters into a sublease that the overlandlord has approved, the overlandlord will agree to enter into a nondisturbance agreement with the subtenant.

This nondisturbance agreement will provide that if the main lease is terminated, the overlandlord will recognize the subtenant as the direct tenant of the overlandlord, and will not disturb the possession of the subtenant in the premises. This would, in effect, result in the sublease becoming a direct lease between the overlandlord and the subtenant under the terms (including the rent) of the sublease. This arrangement alleviates a subtenant's concern that its sublease could be terminated if the sublandlord were to default under its lease with the overlandlord.

Landlords are often reluctant to grant nondisturbance rights for a variety of reasons, not least of which is that the landlord may be bound to a rental rate that is lower than the rental rate being paid by the initial tenant under the main lease.

Additional rights to facilitate assignment and subleasing ability
Certain other rights in a lease may enhance the ability of a tenant to assign the lease and/or sublet the premises. Additional rights may include the following.

Alteration rights. Broad alteration rights are essential to facilitate the ability of a tenant to sublet portions of its leased premises. The tenant needs to be able to separate the leased premises, and to improve the sublet space to suit the needs of its subtenant. If the consent of the landlord is necessary to make the required alteration, flexibility may be impaired. The lease should also allow the tenant to separately submeter the sublet premises for purposes of measuring electricity and other utilities.

Signage rights. If the tenant has any signage rights in the building, the lease should allow the tenant to include the names and logos of its subtenants on any building or monument signs, where the tenant is permitted to put its own name or logo. Even if the initial tenant may not elect to erect a sign at the building, a subtenant or assignee may have different signage policies, requirements or desires. Similar rights to list the names of the subtenant's employees on the building directory should also be addressed.

Rooftop rights. If the tenant is leasing all or a substantial portion of the building, the tenant should consider negotiating for the right to erect satellite dishes and other telecommunications equipment on the roof of the building. Access to the building's risers and conduits should also be addressed. Even if the initial tenant has no plans to utilize rooftop rights, these rights might be essential to a future subtenant or assignee. These rights become more important as the telecommunications needs of tenants continue to grow.

Permitted Uses. Every lease has a permitted use clause. Use may be limited to "general and executive office use", or may be as broad as "any uses permitted by applicable law". The use clause should be as broad as possible, and should not limited to the intended use of the initial tenant. For example, the use clause might permit the installation of a cafeteria and dining facilities, or other specified amenities, even if the initial tenant has no immediate intention of installing such facilities in the leased premises. The next tenant (or an affiliate, subsidiary or division of the initial tenant) or a subtenant may have different needs and requirements.

Termination Option

A termination option affords the tenant the right to terminate the lease in its entirety prior to the stated expiration date. Generally, the termination option cannot be exercised prior to a specified date. For example, if the lease has a 10-year initial term, the termination option cannot be exercised prior to the fifth anniversary of the commencement date.

The tenant usually has to provide a termination notice well in advance of the termination date, in order to afford the landlord ample time to re-let the premises. If the tenant fails to vacate the premises by the termination date, the tenant will be deemed to be a holdover tenant under the lease.

No restoration obligation
The tenant should not be obliged to restore the premises to their original condition as of the termination date. Ideally, alterations made by the tenant during the lease term may remain in place after the termination date, unless the tenant elects to remove the alterations at its expense, and repair any resulting damage to the premises.

Termination payment
Often, the tenant will be required to make a termination payment to the landlord as consideration for the right to terminate the lease prior to the expiration date. This payment may be:

  • a specified amount;

  • a percentage of the base rent that would have been payable by the tenant during the remainder of the lease term if the tenant had not elected to terminate the lease;

  • the unamortized portion of any tenant improvement allowance paid by the landlord to the tenant; or

  • some other agreed sum.

Contraction Option

A contraction option permits the tenant to terminate a portion, but not all, of the leased premises. Like the termination option, the contraction option is generally exercisable only after a specified date. This contraction option exercise date is often tied to an anniversary of the commencement date of the lease. On the effective date, the lease will terminate with respect to the specified portion of the premises affected by the contraction option.

The tenant's proportionate share for taxes and operating expenses must decrease in proportion to the number of rentable square feet being deleted from the premises.

A lease may contain successive contraction options, allowing the tenant to continue 'dropping space' over the lease term. It is difficult to implement a contraction option under a triple net lease, where the tenant is maintaining the entire building and providing its own building-related services.

Identifying the contraction space
It is important that the portion of the leased premises that is subject to the contraction option be clearly identified (eg, by floor, half-floors or quarter-floors). Often, a floor plan can be used to identify the contraction space.

The contraction space should be configured to allow the landlord the ability to re-lease the contraction space. For example, if the tenant is leasing a block of floors, the contraction space should not be in the middle of the block of floors, but should start from either the top or bottom of the block of leased floors. As an alternative, the floor plates can be divided into halves or quarters to facilitate identifying the possible contraction space configurations.

Contraction work
If the contraction space can be less than a full floor, the lease should identify who is responsible (ie, the landlord or the tenant) for separating the contraction space, including the building systems, from the remainder of the leased premises on the applicable floor. Access to public corridors, core bathrooms, and elevators and fire exits must be considered in configuring the contraction space and identifying any work necessary to separate the contraction space from the rest of the leased premises.

Contraction payments
Similar to the termination payment, the tenant often will be required to make a contraction payment to the landlord as consideration for the partial termination of the lease. Often, the landlord will seek to recoup the unamortized tenant improvement allowance allocable to the number of rentable square feet contained in the contraction space.


This article was written by Sandor A Green, Esq.

For further information on this topic please contact Sandor A Green or Barry C Ross at Robinson Silverman Pearce Aronsohn & Berman LLP by telephone (+1 212 541 2000) or by fax (+1 212 541 4630) or by e-mail (green@rspab.com or ross@rspab.com).

The materials contained on this web site are for general information purposes only and are subject to the disclaimer.


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