Lease Terminations in a Soft Leasing Market: Issues for Landlords to Consider

By Jesse Sharf and Kamyar David Shabani

Commercial tenants who leased space at the peak of the leasing market several years ago were generally more anxious to get into their space, and to negotiate expansion rights, than they were concerned about maximizing their options in the event of a downturn. As a result, many of these tenants, whose need for space has diminished rather than increased, regret having signed their lease without a provision that gives them the ultimate flexibility - a right of termination. Short of subleasing their space (most likely for substantially less than their rent obligation under the lease), assigning their interest in the lease (if they are even able to find an assignee and secure the landlord's consent), negotiating a workout of the lease terms with their landlord (though landlords - and their lenders - typically will not entertain such discussions unless the tenant is in financial trouble) or defaulting under the lease (and risk damage to their credit), tenants are resigned to ride out the lease term at painful above-market rental rates.

Tenants who are in the market to lease space today are leveraging the continuing softness in the leasing market to act on their renewed awareness of the importance of a termination right, and many tenants are now insisting, and frequently getting from their landlords, the right to terminate their lease. Of course, this is not to suggest that such termination rights are commonplace in any market - in fact, in some markets, they are not even considered by landlords; however, it is safe to say that such rights are far more common today than they were five years ago. The appeal of a termination right is self-evident, particularly since obtaining the termination right costs the tenant nothing, even if exercising the termination right would not be cost-free. Unless a landlord enjoys above-market occupancy in its building, agreeing to a termination right may be necessary to get the tenant into its building. Landlords who are presented with a credit-worthy tenant in particular have a difficult time refusing such a tenant's request for a termination right.

There are, however, protections that a landlord can and should negotiate in the context of a termination right in an office or R&D lease. The most important protection a landlord can obtain (and which is common) is a lockout period before which the tenant cannot exercise the termination right. Typical lockout periods extend...