Navigating a commercial lease can be challenging, particularly in times of economic uncertainty. Fluctuating interest rates, inflation, product demand, tariffs, consumer confidence and debt tolerance all continue to create a complex landscape. Now more than ever, commercial tenants must ensure their lease terms provide both flexibility and protection against unforeseen circumstances. Fortunately, tenants can proactively guard against such uncertainties by first identifying their particular risks and goals. From there, they can utilize negotiating leverage to obtain the best possible outcome. Below are five key provisions that tenants should focus on when negotiating a commercial lease to safeguard their interests.
1. Rent Abatement and Force Majeure Protections
Many businesses have experienced firsthand how economic downturns, pandemics, and other unexpected events can disrupt both short and long-term operations. To combat unanticipated financial shortfalls, the tenant should consider negotiating:
- Rent abatement or deferral clause; this provision can offer temporary relief if they are unable to operate due to government-mandated closures or other force majeure events.
- Force majeure clauses that explicitly include pandemics, supply chain disruptions, and economic crises. This ensures that the tenant is not penalized for circumstances beyond their control and can access appropriate relief.
2. Flexible Term and Early Termination Options
Sometimes, a business lease can become an unnecessary drain on precious company resources. For this reason, addressing term lengths and early-exit options can be valuable tools in the tenant's leasing strategy. For instance, the tenant can negotiate for:
- Shorter lease terms with renewal options rather than long-term commitments. Renewal options should clearly state rental increases to avoid negotiating fair market value in five to ten years. This way the tenant has a predictable potential increase.
- Early termination rights, which allow the tenant to exit the lease with reasonable notice and a predetermined penalty. In a retail lease, the tenant can negotiate for a sales-based kickout, permitting them to terminate if sales are below a certain amount for a given period of time. In office leases, the tenant can negotiate for an early termination. In both instances, early termination typically involves costs such as unamortized building costs, broker fees, and a termination fee based on the remaining rent obligation. Nevertheless, this option may still offer the most practical solution during an economic downturn.
- Co-tenancy provisions, particularly where the tenant's business is dependent on anchor tenants. If specified key tenants cease operations or vacate the premises, the tenant shall have the right to pay reduced rent (e.g., alternate rent) or to terminate the lease after a defined cure or notice period.
3. Rent Structure and Operating Expense Caps
In a similar vein, the tenant should avoid aggressive rent escalations and unpredictable operating costs by:
- Negotiating fixed or capped rent increases, rather than relying on fair market value or percentage-based increases tied to inflation.
- Placing limits on Common Area Maintenance (CAM) expenses, to prevent landlords from passing on excessive or unexpected costs.
- Considering percentage rent structures where rent is tied to revenue, providing greater flexibility during slower economic periods. These deals are often structured with a low base rent and a percent rent component. This approach can be mutually beneficial: it offers predictable income for landlords while giving the tenant a lower cost of entry.
4. Subleasing and Assignment Rights
If the Tenant's business struggles, downsizes or reorganizes, the ability to sublease, assign, or transfer the lease can be crucial. To preserve flexibility, the tenant should:
- Ensure the lease permits subletting with landlord approval, which should not be unreasonably withheld, conditioned or delayed.
- Secure the right to assign the lease to another business without excessive fees or landlord restrictions.
- Negotiate the right to sublease part of the premises, not just the entire space, subject to landlord approval that cannot be unreasonably withheld, conditioned or delayed.
- Obtain landlord's pre-approval to assign or sublet to affiliates or other related entities without triggering termination or recapture rights by landlord.
- Limit continuing liability after assignment, so the original tenant is not responsible for the assignee's obligations. If the landlord resists, the tenant can negotiate a burn off period, releasing the assignor if the assignee does not default within a specified time frame.
- Include the right to transfer the lease in the event of the tenant's corporate reorganization, merger, or sale.
5. Tenant Improvement Allowances and Maintenance Responsibilities
Securing favorable terms for tenant improvements (TI) can significantly reduce upfront costs and provide additional financial flexibility. To achieve this end, the tenant can negotiate:
- A landlord-funded TI allowance, rather than bearing the full cost of improvements.
- An amortized TI repayment structure, allowing improvement costs to be spread over the lease term.
- Clearly defined maintenance responsibilities, ensuring the landlord remains responsible for structural repairs, roofing, HVAC systems, and other major expenses.
Conclusion
In an uncertain economy, tenants must be proactive in lease negotiations to protect their financial stability and maintain operational flexibility. While the above is not an exhaustive list, focusing on rent relief, flexible lease terms, predictable expenses, assignment and subleasing rights, and tenant improvement allowances can help tenants better navigate economic fluctuations and sustain their business through unforeseen challenges.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
