A business owner may want “out” of their commercial lease agreement for a host of reasons. Perhaps the overhead is too high and the business needs to downsize. Or perhaps the business is expanding rapidly and requires a larger premises.
Whatever the reason, how easy (or hard) it is to exit your lease early will depend on two factors: the transfer provisions in the lease, and whether there is demand for your space at the time you intend to exit. If the stars don’t align, you may be forced to pay the rent and comply with your tenancy obligations until the lease expires – even if you have vacated the property.
Fortunately, there are some things you can do to minimise your potential losses if you do choose to vacate the premises early.
Option One: Assign the Lease
Assignment involves finding another tenant to take over the lease. An agent can usually market the property and assist with finding another suitable tenant. However, your pool of potential assignees may be smaller than you might like. The incoming tenant typically will have to demonstrate that they have the financial standing and trading record to take on the lease obligations. Not every business will pass the financial tests set out in the lease.
Invariably, the landlord will have the right to approve the identity of the assignee and the terms of the assignment. But once the transaction is approved, the incoming tenant takes on the lease agreement and all the obligations attached to it – they literally step into your shoes. You fall out of the picture completely, and have no further responsibilities under the lease.
Occasionally, we come across an assignment clause that seeks to keep the original tenant on the hook even after they’ve assigned the lease, as guarantor for the incoming tenant. We advise our clients to reject these clauses since they defeat the purpose of assigning the lease.
Option Two: Grant a Sub-lease
Sub-leasing also involves finding another tenant. But instead of taking over the existing lease, the sub-tenant signs a separate sub-lease agreement with you to occupy part or whole of the premises. The sub-tenant agrees to pay the rent you have agreed with them and comply with both the sub-lease and the head lease obligations. But crucially, your original agreement with the landlord is still in play. You still have to pay the rent under your lease, even if the sub-tenant doesn’t pay the rent under the sub-lease.
As with an assignment, the landlord needs to approve the sub-lease transaction and either you, or the sub tenant, will be responsible for the landlord’s legal fees to review and consent to the sub-lease documentation. The financial tests may be less stringent than for an assignment, however, since you are still on the hook for the lease rent.
If you’re thinking about granting a sub-lease, take care that the sub-lease term doesn’t run too close to the end of the head lease term. You’ll need time to comply with any “make good” obligations before you hand the property back to the landlord. Be careful also with any options to extend the head lease. The sub-lease should make it clear that you are not under any obligation to exercise the option on behalf of the sub tenant. If the sub-tenant wants to extend the term, they can negotiate a new lease directly with the landlord – and you can drop out of the picture.
Option Three: Surrender the Lease
If you can’t find anyone to take over the premises or you need to exit quickly, it may be possible to negotiate a payout figure with the landlord to get out of the lease early. This is known as a lease surrender. How much or how little you pay depends on the landlord’s willingness to help you and your bargaining strength. At the very least, you can expect to have to compensate the landlord for lost rent, an amount that represents the make good liability at the end of the lease, and the landlord’s expenses in re-leasing the property. Surrender payments can be substantial.
Legally, the landlord does not have negotiate a surrender. If he refuses to play ball, then you will remain bound by the lease obligations for the remainder of the term, unless you can find another avenue of exit.
No exit strategy is straightforward, and we always include clauses to make the assignment and sub-leasing process as streamlined as possible. For example, we refuse to include onerous financial tests on an incoming tenant, such as a requirement that they provide a 6-month bank guarantee. Clauses of this nature cut off your exit routes, since they make it more difficult to find a potential tenant who satisfies the strict financial tests.
It’s also worth including language that obliges the landlord to act reasonably. The usual wording is that a landlord “must not unreasonably withhold consent” to an assignment or sub-lease. In some nasty clauses, the landlord is permitted to withhold consent at their absolute discretion. They can say “no” simply because they got out of bed on the wrong side that morning. If your lease contains this clause, you’re essentially screwed … if you’ve got a difficult landlord.
The moral of the story is simple: get the lease right from the very beginning. If you negotiate a fair and reasonable transfer-of-lease clause before you sign, you can adapt and not be penalised if your business changes direction at some point in the future.
If you need assistance with exiting your lease early, please contact us to discuss how we can help.