In commercial leases, termination rights dictate the terms under which one party may terminate the agreement prior to the lease expiration date. They can be independent provisions or one party’s recourse pursuant to a particular event or default by the other party.
When they stand alone, termination rights are negotiated to protect the subject party and/or allow them to pursue a projected course of action.
For example, landlords with plans to redevelop their building in the near future may require that leases contain a termination right after a certain number of years. While they may agree to a 5-year lease with a tenant it could be conditional on the right to terminate after 3 years if market conditions make redevelopment desirable. Landlords must provide tenants with written notice of their election to exercise their right in order to give the tenant the necessary time to find another location.
On the tenant side, companies with plans to sell in the near future may not want a long-term lease on their books as a liability that could decrease their valuation. Still they may be required to sign up for a lease term with sufficient time over which to amortize the costs of any improvements to customize the space to their needs. In this case, the termination right would include language requiring the tenant to reimburse the landlord for the unamortized costs of brokerage commissions and tenant improvement allowance. Tenant termination rights also come with prescribed timeframes to provide the landlord with written notice of their election to exercise said right.
In addition to notice and unamortized costs, tenant termination rights can also come with additional monetary penalties. These amounts are specific to each landlord and reflect each owner’s calculation of damages and/or lease-up costs. Landlords want rent and do not like their spaces to sit vacant. Therefore, they are reticent to grant termination rights and have an interest in making them as onerous as possible to decrease the likelihood that tenant elects to exercise them.
Quantifying damages outside of unamortized brokerage fees and build out costs can be difficult. A good rule of thumb is to estimate the length of time necessary to lease the space to another tenant based on market absorption rates. Tenants may be able to minimize additional monetary penalties by providing the landlord with a longer notice period thereby giving them the ability to market the space while the tenant continues to occupy the premises and pay rent.