Strategies to Exit an Existing Lease
Six Ways to Break Your Lease with Minimal Repercussions
There are many reasons a company or individual would want to end their office lease before the expiration date. Perhaps you've outgrown the space, need to downsize, have merged, or been acquired by an out-of-market company.
Can one simply terminate their lease? The short answer is "no." A lease is essentially an agreement to make periodic payments for the exclusive right to use a space, and the payments include the unamortized portions of legal expenses, brokerage commissions, and design and construction costs that a landlord incurs, therefore you can’t simply walk away from that debt. There are however strategies that are sometimes available that can help. It's important that you appoint a real estate advisor that will zealously represent your interests, but while also identifying the landlord's needs so that both sides can arrive at a solution.
The best approach to getting out of your lease early is a preemptive approach. Address it in the original lease agreement before it is signed and while it can still be negotiated. A forward-thinking real estate advisor and attorney can provide crucial support with this.
This is a unilateral right in favor of the tenant that allows a tenant to terminate a lease if certain conditions are met. For example, the clause may state the right to terminate after the 24th month with 6 months' advance written notice and a termination fee equal to unamortized leasing costs plus a 3-month termination penalty.
Favorable Sublease Rights
Since this is typically a tenant's best exit strategy, ensuring tenant-friendly sublease terms in the original lease is of paramount importance. Prevent the landlord's right to "reasonably withhold their consent" by removing restrictions such as not being able to sublease to a tenant that has previously toured the building. Stipulate that the landlord must provide their consent, recapture or disapproval within a short time period, such as 14 days from tenant's request.
Also, ensure the tenant is allowed to make reasonable deductions from sublease proceeds (tenant improvements, marketing, brokerage commissions, legal, etc.) before sharing any potential profits with landlord.
Should a situation arise where the lease needs to be broken and you do not have provisions for it in the lease agreement, there are still several options to discuss with the landlord.
The tenant and landlord negotiate a dollar amount that is typically less than the remaining lease obligation but recognizes unamortized transaction costs, and the lease is terminated. This is the easiest, but not the least expensive option.
The tenant identifies a replacement tenant to take over the existing lease for the duration of the term. If the subtenant's financial strength is superior to the tenant's, this could also create an opportunity for a termination, as the landlord may prefer to sign a new direct lease with the subtenant. This is typically referred to as "recapture."
If the landlord is in breach of the lease, the tenant may terminate if that is one of their available legal remedies.
If your company is going out of business, give your landlord as much notice as possible and keep them informed of your bankruptcy proceedings. Note that a cash security deposit will not be returned. Also, if the lease has been securitized by a personal guarantee, that entity or individual could still be liable for the remaining obligation.
Unlawful detainer and eviction proceedings are ugly and expensive – neither side wants to go down that path. Most landlords are reasonable and willing to work with their tenants, but it's important to start those conversations early. Respect their economic considerations and end goals so that a win-win solution can be negotiated for both parties.
About the Author: Benjamin Osgood
Benjamin Osgood is Managing Director at San Francisco-based Recreate Commercial Real Estate. He specializes in helping international, regional and local, well-established and young high-growth companies navigate the sophisticated and fast-paced commercial real estate landscape by identifying high-quality office space as well as helping to plan strategically for the future.