Tenant Leasing Illustrated
August 2014
Issue #31



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Madison Park
Hello,

When leasing new space, a tenant should remain focused on the possible need to eventually reduce such space. Maintaining the flexibility to do so can be extremely valuable, not only over the course of a long lease term, but also up front at the beginning of a transaction.

In this issue, we discuss nine areas to focus upon when negotiating a lease contraction option.

Sincerely,
Alan
Alan Katz
Mintz & Gold LLP 

 

When Space Contraction Is Your GOOOAAAAAAAAL!!!

 

Alright, I admit it. I became hooked.

I marked up my leases with my red, white and blue pen. I hooked up my computer to ESPN to watch games in the office while pretending to read leases. During negotiations, I would, on occasion, fake an injury for delaying purposes or bite an opposing counsel on the shoulder.

World Cup fever had struck!

I credit my soccer education to my three travel soccer playing sons, in particular my youngest, Noah, a high school "futbul" hot-shot (and his coach Barry, who marvels that even the ignorant like me can learn to appreciate "the beautiful game").

Not that it all makes sense to me. I mean, why can't they use their hands? And is there anybody who actually understands offsides? Best of all, the U.S. loses to Germany but, no matter, we all celebrate as we advance to the next round.

In commercial leasing (you knew I would get around to it somehow), a tenant can also win by losing. Losing space that is.

A tenant with sufficient leverage can negotiate for pre-commencement or post-commencement contraction options.

Essentially, the tenant is given the option upon notice to the landlord to reduce its space and to adjust fixed rent, proportionate shares, etc. accordingly.

Such an option provides flexibility. Most tenants cannot predict their space needs over a long lease term, particularly one for ten or fifteen years (post-commencement option).

Some tenants need time to determine their initial needs, which may change during the lease negotiation and build-out phases, especially when downsizing or upsizing from their current space, or if contemplating a major corporate acquisition or sale while negotiating their lease (pre-commencement option).

A tenant that takes a relatively large amount of space (or has other leverage) will try to negotiate a number of other rights to address this need for future flexibility, such as expansion options, rights of first refusal and rights of first offer, and even termination rights. Contraction options can be an important piece of this program.

If you are able to obtain a contraction option in your lease, make sure to address the following nine concerns:
  • Make the notice requirement reasonable. Your landlord will require that you provide ample notice of your exercise of the contraction option. While certainly a reasonable request, you will want to make sure that you provide yourself with ample time as well. Such notice can be at specific times during the lease (e.g. after the 5th and/or 10th anniversary of the commencement date) or at any time during the term upon notice (e.g., notice of 12 months, 18 months, etc.).

    A pre-commencement option will require much shorter notice periods for both you and your landlord, but the timing has to make sense in light of your particular needs. You should note that a pre-commencement option will likely change your existing economics (e.g. tenant improvement allowance, free rent, etc.)
  • Be careful not to forfeit your contraction right for immaterial defaults. Your landlord will not grant you contraction rights while a default has occurred and is continuing. But be sure to limit this restriction to "monetary and material non-monetary defaults" so that an unsavory landlord cannot play games based on an immaterial (or fictitious) default.
  • Be mindful of the configuration of your remaining space. You and your landlord will both want certainty as to the space that can be terminated (your landlord will want the surrendered space to be in a configuration that allows for leasing) and if the surrendered space is to be less than a full floor, include a diagram as an exhibit to the lease. Sometimes you may be able to negotiate for flexibility as to the amount of the surrendered space, in which event delineate some "must take space" that provides your landlord with a minimum rentable area and both parties with sufficient elevator and restroom access, but at the same time allows you to vary the size of the retained space.
  • Location of space in stacking plan. If you are leasing multiple floors, your landlord will not want you surrendering space in the middle of a stack of floors. It is a reasonable request that your contraction starts with the highest or lowest floors in your stack (and your landlord may insist that you start with the more valuable highest floors, although this is negotiable). Just be careful when space planning to avoid putting essential services (e.g., IT rooms, cafeterias, etc.) on floors that could potentially be surrendered.
  • One time right or multiple times. While a pre-commencement contraction right will in all likelihood be a one-time "use it or lose it" right, a post-commencement right can be either a one-time right or available at different times during the term. (such as on particular pre-set anniversary dates during the lease as referred to above).
  • Pay attention to the contraction fee. Generally, your landlord will require a payment for such contraction right. This payment will usually include the unamortized value of a portion of the remaining base rent, work allowance and brokerage commissions associated with the surrendered space, but often also includes some other set dollar payment or payment tied to an agreed upon number of months of rent for such surrendered space.
  • Do not forget to modify your other lease provisions as needed. Your fixed rent and proportionate share of escalations should be reduced, as should your tenant improvement allowance with a pre-commencement contraction, and the defined term for the "Premises" being leased must be modified. For a pre-commencement contraction option, if you go from a full floor to a partial floor, it may affect whether you or your landlord is responsible for space formerly in your premises that becomes common area (e.g., restroom construction).
  • Try not to limit your expansion rights. Your landlord may want to limit or terminate your contraction right if you have exercised an expansion right (or even if you have leased other property in the building from a third-party). The logic is that you should not need to contract if you are also expanding. Try to retain the contraction right since your needs may change over time, particularly if you are a corporate tenant that may be selling and acquiring divisions. One compromise is to limit your ability to contract for a prescribed period after exercising an expansion right (and visa versa).
  • Avoid draconian holdover penalties. Despite the best of intentions, you may find the need to holdover in the space you just agreed to surrender. Your landlord may want to make such holdover a default under the lease, a default leading to the loss of the contraction right or a holdover subject to penalties under the lease. You may have unanticipated reasons for holding over so paying a holdover penalty (on the surrendered space, not your entire space) without any other default or loss of the contraction option, at least for some agreed upon period of time, would be the best result.
It seems that the largest criticism of the U.S. men's national soccer team at the World Cup was that the U.S. players do not "dive" enough. See Netherland's Arjen Robben for an example of winning (a penalty) by losing (allegedly getting fouled). Follow the suggestions above and you can avoid being penalized for flopping when negotiating a contraction option.

About Us

 

Mintz & Gold prides itself on providing the highest quality legal representation often associated with large law firms with the attention and reasonable costs of a smaller law firm.  Mintz & Gold's Real Estate Department has a national practice specializing in a broad range of commercial real estate law, with a particular focus on commercial leasing. We have extensive experience with respect to office, retail and shopping center leasing, and have represented major Manhattan landlords, national and multinational institutional tenants and national retail chains. Most of our attorneys practiced for many years at large institutional law firms before joining Mintz & Gold.

For more information regarding Mintz & Gold's real estate practice, click here.

For a list of representative transactions of Mintz & Gold's real estate group, click here.

For Mintz & Gold's website, click here.

Contact:
Alan Katz
katz@mintzandgold.com
Telephone: (212) 696-4848
Fax: (212) 696-1231



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