Most tenants focus on finding exactly the right premises and carefully negotiating their lease to protect their interests for years to come. Time passes and occasionally tenants decide to reverse the process – negotiating out of, instead of into, their lease. For example, a tenant may decide to partner or amalgamate with another practice in a different location, relocate to more appropriate premises, or close an operation that is not economically viable. This article explores exit strategies associated with ending the tenancy without lease expiration.There are four approaches to getting out of a tenancy before the end of the term. Which approach is correct is based on probability of success, timeline, and cost.
Assigning the lease to a third party. Typically, the smoothest and least costly approach to ending a tenancy early is to find a third party who wants to lease the premises by taking assignment of the existing lease, or entering into a new replacement lease. A suitable replacement tenant may be identified by asking the landlord, or advertising the space on the open market. Occasionally, an incoming tenant will actually pay the exiting tenant for the opportunity to take over the premises and the existing leasehold improvements, but typically the exiting tenant does not want to leave behind leasehold improvements to help their own competition. The landlord is often entitled to any rent premium between that which has been agreed to and the amount the successor agrees to pay. This approach is clean; the exiting tenant often has no remaining liability for any lease terms or conditions. The landlords consent and cooperation is required. The cost is often minimal. Occasionally an exiting tenant actually makes money on the transfer. Problems include finding the replacement tenant, and negotiating the “deal” because both the incoming tenant and the landlord have negotiating advantage.
Subleasing the premises to a third party. A “second best” approach to exiting a premises early is to find and sublease the premises to a third party. The landlords consent and cooperation is required. Parties may be looking for an opportunity to lease space, especially in high profile developments. Subleasing is an alternative if the landlord will not agree to outright assignment. Again, the incoming party may actually pay for the leasehold improvements and the opportunity, and again the landlord may share some or all of the premium or upside realized in the rent and leasehold improvement sale. A strong downside to the sublease approach is that the existing tenant is still firmly “on the hook” – if the subtenant falters, the primary tenant will be responsible. The probability of finding a suitable subtenant is low, the time line for success is unpredictable, and the exiting tenants negotiation leverage position weak.
Closing. Some tenancies actually close and continue to pay the rent for a period of time, usually the remainder of the current term. This can be an expensive proposition, and most landlords will not agree because they want the day-to-day activity in their development. This approach requires the landlords consent and cooperation. The time line is definite.
Breaking the lease. This is a game of hardball. We call these files “extractions” as they are bloody, painful, messy and leave a hole. There are two primary approaches:
1. Open negotiation – In this approach, we call the landlord, explain the situation, and ask for cooperation to cut a “deal”. The leverage position is negative. Why would a landlord agree to release a tenant who has promised to pay rent for an extended period of time for no reason in the landlords favour? Minimizing the expense of an extraction can be accomplished by: 1) identifying and administering a “buy out” or other form of early termination provision, 2) identifying and exploiting a technical flaw in the lease such as an error by the landlord in the tenants favour, or 3) maximizing the weight of perceived or real leverage tools such as “the tenant has no assets”, or “the tenant is bankrupt”, or “the landlord has a moral or legal obligation to minimize tenants pain”. This approach has the advantage that it is unlikely to end up in litigation, the timeline is certain, and the probability of success is high. Even with little or no leverage, landlords will often consider an early exit in return for a lump sum payment of rent, especially in markets with a low vacancy rate.
2. “Midnight run” – In this approach, the tenant attempts to break the lease by grabbing the premises assets and running, often during the night, which is why it’s called a “midnight run”. This approach can and will lead to litigation. Most leases prohibit the tenant from removing the assets, leaving before the end of the term, and not being continuously open and operating. However, the approach does create an immediate and certain solution, and creates a leverage position in which the landlord has to sue the tenant and chase the assets, which many landlords are reluctant to do. Some tenants prefer to ask for forgiveness rather than permission.
Each of these approaches requires a thorough understanding of lease terms and conditions, and the implications of the chosen approach.PA