Sep 08, 2016

Commercial leases: enhancing your "options"

The success of most retail/service businesses often depends upon their location. Given the cost and inconvenience of relocating an existing business, negotiating an option to extend and/or renew the lease upon the expiration of the lease term is a key component of any commercial lease.

There is a distinction between an option to extend and an option to renew a lease. With an option to renew, the original lease comes to an end at the expiration of the original term, prior to the renewal term beginning. The option to renew essentially creates a new lease, typically identical to the original lease with certain exceptions. For example, the option to renew can provide that the landlord will agree to renew the lease upon the expiration of the original term, but subject to an increase in the base rent. Conversely, with an option to extend, the original lease is extended for the additional term without any interruption or modification.

Like many terms in a commercial lease, options to extend and/or renew typically come with specific requirements relating to how such options are exercised. Many tenants overlook the technical requirements relating to notice under option clauses. However, failure to strictly comply with the specific requirements associated with the option can result in a tenant forfeiting the option and possibly losing the right to occupy its space.

Take the recent case of Double Door for instance. Since 1994, the renowned Double Door club operated at 1572 North Milwaukee Avenue in Chicago. On July 14, 2016, a Cook County judge ordered Double Door to vacate the long-occupied space. The decision came after many months of litigation arising from a dispute as to whether Double Door properly notified the landlord of its intent to renew its lease, which expired in 2015. According to the lease terms, Double Door was to send notice of its intent to extend the lease 180 days prior to the lease termination date. The landlord argued that the first time it received the notice to renew was in January 2016—three months after the notice should have been tendered to the landlord. Ultimately, the judge ruled in favor of the landlord, arguing that the option was not exercised pursuant to the terms of the original lease.

Accordingly, tenants with option clauses need to pay careful attention to the notice provisions (the time in which the tenant is required to give notice and the method by which such notice is given—certified mail, facsimile). In addition, some landlords impose certain conditions precedent before such options may be exercised by the tenant. For example, the landlord may require that the tenant not be in default at the time the option is exercised. Some landlords require that the option only be exercised by the original tenant. In order words, if the tenant has assigned or subleased its space, the successor tenant will not be entitled to the option rights. Also, some options clauses may require evidence that the tenant’s financial net worth had not materially decreased since the commencement of the original lease term before the option may be exercised.

Regardless of how well the business relationship may have developed between the tenant and the landlord, there may be certain market forces that will cause a landlord not to overlook a tenant’s failure to strictly comply with the terms of the lease. For example, the landlord may want to command higher rent or a different type of tenant.

Commercial landlords and their tenants should keep these principles in mind when negotiating and performing under the terms of a lease. The failure to properly exercise an option may give a landlord an “out” under a lease that it is looking to break. At the same time, loss of an option may cause an unnecessary interruption to the tenant’s business and goodwill associated with the neighborhood in which the tenant was operating its business.

The typical commercial lease is quite comprehensive with many legal provisions. In addition to options, there are dozens of other factors to consider beyond the monthly payment to ensure a business protects and controls its operating costs. Given that a tenant may be bound by the terms of its lease for 10 years or more, it is worth the time and expense for a business to fully understand its lease “options.” 

Client alert authored by: Phyllis K. Franklin, Principal

This alert originally appeared in the Fall 2016 Corporate Focus Newsletter.