Originally published as an Op-Ed by the Oregon Daily Journal of Commerce on March 4, 2022.
Like in any long-term relationship, by the time a landlord and tenant have decided to terminate a commercial lease, both parties are usually in a rush to go their separate ways. Regardless why a landlord and tenant decide to terminate a lease before its natural end date, early termination raises many common business and legal issues that each party should consider, negotiate, and then memorialize in a written agreement. Parties that give proper attention to these key issues will help protect themselves and accomplish the breakup efficiently and with as little pain as possible.
The most common business issue to resolve is whether either party must make a special payment to the other party in exchange for the early termination. While it is usually the tenant that pays the early termination fee, sometimes circumstances arise in which it is the landlord that wants to “buy its way out” of the lease early. Unless the lease provides for an agreed-upon termination fee, the determination of the proper early termination fee expected from a tenant will typically reflect a number of considerations, including the remaining term of the lease, whether the tenant still owes any back rent, the amount and status of any remaining security deposit or prepaid rent, the unamortized costs the landlord originally incurred for any tenant build-out, broker commissions, rent concessions, and costs the landlord anticipates incurring as a result of getting the space back early. If a tenant is paying a lease termination fee, the parties should explicitly state in the lease termination agreement when it must pay such a fee (i.e., when the early termination fee is executed, on the date the tenant vacates, or at some later date), and whether, upon receipt of the fee, the landlord otherwise waives all other payments that the tenant may owe under the lease.
The lease termination agreement should also cover the timing and manner of the tenant’s departure. Both parties should carefully review the applicable provisions in the underlying lease that describe the tenant’s obligations before surrendering the space to the landlord. Regardless what the lease explicitly requires, the parties should consider whether they want to change their approach. For example, following the closure of a failed business, the landlord may be in a better position than the tenant to remove any trade fixtures or abandoned property from the vacated space, and those considerations should be factored in the cost of any required repairs the landlord may have to incur when negotiating the early termination fee. Addressing the disposition of the tenant’s personal property is more complicated if any of that property is leased or is subjected to tax liens or a lender’s UCC filings.
As another example, it may be beneficial for both parties to allow a tenant to continue operating its business in the leased space for a time period following the signing of a lease termination agreement in order to sell inventory or wrap up operations. In such a scenario, a landlord will typically want to negotiate the right to actively market the space (and allow prospective tenants to visit) before the date when the tenant is obligated to surrender the space, and the landlord may even want the right to force the tenant out even earlier in order to accommodate the timing requirements of the replacement tenant. If the early termination is being sought by the landlord to accommodate site redevelopment, the landlord should consider whether it has any effective remedies should the tenant not depart in a timely manner.
In the event a tenant does not meet its obligations for surrendering the space or otherwise defaults under the terms of the lease termination agreement, the landlord should ensure that the lease termination agreement expressly provides the landlord with the right to exercise all legal and equitable remedies against the tenant (or against the guarantor). In addition, if the parties agree that the landlord will return a security deposit to the tenant in connection with the termination of the lease, the landlord should specify in the lease termination agreement that the landlord has the right to use some or all of the security deposit to cover the cost of removing the tenant’s personal property from the space or repairing any damage to the space.
Another key legal issue that can complicate early termination discussions is whether and the extent to which each party will release the other from any existing or future claims and liabilities arising from the terminated lease. In considering whether to give such releases, the parties should remember that typically no additional releases would have been given by either party had the lease expired in the normal course. For example, unless there are special circumstances, the landlord should release the tenant from any existing or future claims resulting from any tenant defaults. Similarly, the tenant should usually release a landlord from any claims resulting from an alleged default on the part of the landlord (including any claims relating to tenant improvements that the landlord may have been obligated to complete).
However, certain categories of claims should be excluded from the waiver and release provisions. First, neither party should agree to release the other from a claim resulting from a breach of an obligation by either party under the terms of the lease termination agreement itself. Second, to the extent the underlying lease includes indemnity obligations that expressly survive the expiration of the lease term, such as an agreement by the tenant to indemnify the landlord for environmental liabilities, those specific indemnifications should remain in effect following lease termination. In addition, if the landlord is holding a guaranty, and the intent is to terminate the guaranty and the lease simultaneously, then that intention should be reflected in the termination agreement.
In sum, while the time required to address and negotiate the foregoing points in a lease termination agreement may briefly delay the breakup, doing so will ensure that both parties avoid common headaches that can result from overlooking these important issues.