Breaking a Lease

Lately, I have received a number of questions about breaking leases. Unfortunately, many businesses are struggling right now due to COVID, and some are looking to shut down. The trouble that many are facing is that they have years remaining on a lease and they are concerned about the liability they might have if they walk away.

There are essentially three ways to end a lease: (1) normal end date, (2) negotiating the remainder of the lease, and (3) walking away from the lease.

The key to remember as a small business owner is that you have likely signed a personal guaranty as part of the lease agreement so whatever decision the business makes will affect the owner personally.

Normal End of the Lease

Every lease has an endpoint. Sometimes that endpoint is a clear date, but other times, the agreement specifies that the lease is month-to-month. When the lease specifies an end point, you can simply allow the lease to end at the predetermined time. Obviously, you should be moved out and be prepared to turn over the premises on that date.

When the lease is open-ended, like a month-to-month lease, you can end the lease by providing sufficient notice to the landlord. What is sufficient notice? You have to give notice equal to the length of time between rent payments. For example, if you pay your rent monthly, the law requires notice of at least 30 days to break the lease. If your lease if for an extended period of time, technically you should provide more notice, but most courts will agree that 30 days should be sufficient notice.

You should provide notice in writing. An email or text does constitute writing, but I recommend sending a letter via email and sending it certified mail, that way you have a receipt. Keep any correspondence between you and the landlord in case the landlord later claims you didn’t provide adequate notice.

Negotiating the Remainder of the Lease

If you have a long time left on your lease, your best option will be to negotiate it with your landlord. Under the law, you are obligated to pay the lease till the end, but if you leave the landlord has a duty to re-rent the space to mitigate damages. Therefore, most landlords are willing to settle the lease for an amount equal to the time it will take them to re-rent the space.

For some locations, the landlord may have another tenant ready to go. Therefore, settling the lease should be very easy. Unfortunately, that is rarely the case right now. I usually recommend settling a remaining lease for between three and six months of rent, depending on the difficulty in finding a new tenant.

If you do settle the remaining lease, make sure to get the agreement in writing. The last thing you want is for the landlord to claim you owe more than you do. Ideally, the agreement will specify an exact amount of money and when it is due. Most landlords will want the settlement in a lump sum so be prepared to pay it all at once.

Breaking the Lease

This is the least desirable option because it will likely end in a lawsuit. Your landlord can sue you for the rent remaining on the lease plus any costs they incurred in coming after you. Realistically, the court will not award the landlord more than a few months of rent – enough time to find a new renter. Even if you have five years remaining, the court is unlikely to enter a judgment for that amount.

The other concern with this plan is that it will cost you attorney’s fees to defend yourself in court. This works out fine for the lawyers but just ends up costing you more. You are always better off to settle before a lawsuit.

However, sometimes it’s unavoidable. Some landlords can be very difficult to deal with. I understand where they are coming from. They have costs, too. But I generally recommend that my landlord clients work with the tenants to resolve the outstanding lease. A lawsuit is almost never a benefit to anyone but the lawyers. With that said, sometimes it is necessary.

Conclusion

Before you walk away from a lease, you should try to negotiate the remaining rent with the landlord. If the landlord won’t cooperate, you might need to bring in a lawyer.

COVID has hit so many businesses hard these last few months, and I expect there will be more trouble to come. We are currently offering a COVID Escape Plan, where we negotiate with all outstanding creditors, including landlords, so that business owners can close their business without the threat of personal liability and bankruptcy. If your business is in trouble, don’t go down with the ship. Give us a call at (630) 801-8661 or email us at john@johnfbakerlaw.com.

Commercial Leases – Part 3

This is the third installment of my series on commercial leases. I have noticed a general uptick in businesses (primarily new businesses) signing leases in my area. This series aims to cover the major issues that generally come up when reviewing a lease. If you need more specific help, please feel free to contact me.

Security Deposits

Most people understand what a security deposit is, but frequently, there are some misconceptions about how it should be used.

As a tenant, you will have to pay a security deposit. Generally, the amount is equal to one or maybe two months’ rent. The deposit is meant to be held by the landlord and applied to any unpaid expenses incurred by the landlord in connection with the tenant. The most common use of the security deposit is to fix the damage that the tenant left when they vacated the space. It can also be applied to any unpaid rent.

I think the biggest misconception about security deposits comes from landlords assuming that they get to keep the deposit. I have seen many conflicts arise because a landlord willfully withholds a security deposit after a tenant vacates a space. The fact is that if the tenant is not in default, the assumption is that the security deposit should be returned. If any of the deposit is used to repair damage, I think the repairs should be well documented so that the tenant knows exactly where their money went. This would really cut down on conflict.

Common Area Expenses

Common area expenses are paid in addition to rent for the upkeep of the common areas of the building. The landlord has to maintain the outside areas of a building, like parking lots and sidewalks, and it has to maintain shared interior space like bathrooms. Therefore, landlords generally charge additional fees to cover these expenses.

The normal way to divide common area expenses is to total the expenses and divide them among the tenants based on their pro-rata share of the floor space. The share is usually a percentage of the tenants leased space as compared to the entire building. Therefore, if you lease 20% of the building, you pay 20% of the common area expenses.

This system may or may not be fair depending on the building. If, for example, you run an insurance office next door to a restaurant, it might not be fair to divide the cost of garbage removal based on square footage because the restaurant most likely generates much more garbage than the insurance office per square foot. However, if the tenants are similar, a standard percentage is usually easiest.

The important thing to understand as a tenant is what your actual costs will be. If you are told the rent will be $1,000/month, that likely does not include common area expenses or taxes. Therefore, you will need to know those costs in order to actually budget for the cost of the space.

Taxes

Taxes are usually divided like common area expenses, with each tenant paying a pro-rata share. Normal tax costs cover the standard real estate taxes for the building. This number can change from year to year based on the tax assessment so it’s important to understand how the building is being assessed.

But tax cost can (and usually does) include the cost of any special assessments or costs imposed by a governmental agency. Like many other costs associated with owning a building, the individual tenants may not reap many benefits from special assessments because of the short-term nature of their leases. Therefore, paying special assessment taxes is usually a cost with very little gain.

Just like I mentioned with common area expenses, as a tenant you need to know what the costs of renting the space will be. Rent normally does not include these additional costs so you need to budget for these items, as well.

Insurance

All leases require the tenant to obtain insurance. This is more than just renter’s insurance. They will want the tenant to obtain liability insurance to cover any claims that may occur on the premises. This is a standard provision. Normal insurance coverage is $1,000,000 in liability coverage. Personally, I think this amount is extremely high for most businesses, but it’s the standard commercial policy.

The tenant will need to add the landlord as an additional insured on the policy. Again, this is standard. The landlord doesn’t want to have to pay for an injury that occurs in your space. If someone is to fall in your space, they will likely sue everyone. This isn’t because personal injury attorneys are evil. Rather, it’s just how the system works. Therefore, everyone will want insurance coverage.

Standard commercial policies are not very expensive, and frequently they include provisions that are a benefit to the tenant. For example, many policies include coverage for theft and fire, and some cover errors and omissions, as well.

Next Time

In my next article on commercial leases, I plan to cover use, maintenance and repairs, and subleasing. Please feel free to contact me with any additional questions.

Commercial Leases – Part 2

I started this series on commercial leases one month ago. My goal is to cover all of the major issues in a commercial lease over the course of four posts (or maybe more). If you have any specific questions, please feel free to contact me for more information.

Buildout

Buildout tends to be a big topic for tenants looking to rent space for their business. By buildout, I mean the process of reconfiguring the space to suit the needs of the new tenant. Some buildouts are small, maybe moving a wall or adding a door, but some can be huge like installing a kitchen.

Sometimes landlords will do the buildout for the tenant. Generally, when this happens the landlord adds some cost to the rent every month, meaning that the tenant will pay for the buildout over the length of the lease.

I actually like this system for many new businesses, because it defers the cost of renovation for the tenant and works a bit like financing from a bank. Buildouts can cost quite a bit. Large expenses can swamp a small business early in life. By spreading the expense out, the business can more effectively manage its cash flow.

But landlord buildouts are not always a good deal. I recommend that tenants get an estimate of what the buildout will cost and seriously consider the additional rent they will pay. Sometimes the landlord is gouging the tenant on the cost of the buildout.

For example, I represented a tenant that wanted a fairly small buildout for a commercial office. He wanted some walls moved and some glass doors added. Nothing insane, but it wasn’t cheap, either. The estimate for the work was around $18,000. The landlord wanted to add an additional $600/month for the buildout. On a five-year lease that added $36,000 to the cost of the lease (not including the increase in rent every year, which was a percentage increase). The landlord wanted to charge double for the buildout. We decided it wasn’t worth that price tag and the client went elsewhere.

Options

An option allows the tenant to extend the lease at its termination. Generally, there is a period of time where an option is allowed, something like not less than 90 before the end of the lease but not more than 180 days. During that window, the tenant has the right to inform the landlord of its desire to extend the lease for a predetermined length of time. Sometimes the added time is a new term, and sometimes the added term is shorter.

Normally, the extension comes with an increase in rent, which the tenant should plan for. Otherwise, the same terms that applied to the first lease remain in full force and effect.

I consider these provisions to be a benefit to the tenant. It gives the tenant a lot of flexibility. Landlords shouldn’t mind them, either, since they encourage tenants to stay more than one term. They can easier be a win-win situation.

When possible, I encourage tenants to ask for an option. There is usually very little risk for the landlord to agree to an option up-front, whereas once the tenant has been in the space it’s harder to negotiate extensions on term because the landlord might believe that it can get more rent from another tenant.

Arbitration Clauses

Arbitration clauses are becoming very popular in virtually all agreements I review. These clauses normally call for some version of AAA arbitration. Essentially, each party chooses an arbitrator to hear the case and those arbitrators choose a third arbitrator to break ties. This all sounds great in theory, but arbitration doesn’t work for everyone.

Arbitration can be very slow. The process is somewhat unwieldy and there is no central body, like a court, to moderate disputes in the process. Frequently, parties would be happier having the matter heard by a local judge. Despite most people wanting to avoid litigation, arbitration does not necessarily save time or money.

If you are signing a lease with an arbitration clause, I urge you to read it and understand the timelines and requirements it imposes. These provisions usually contain specific deadlines for demanding arbitration and choosing arbitrators. Don’t assume that the other side is familiar with the requirements, either. I find that these provisions are included by lawyers without much discussion with clients.

Next Time

In my next post I plan to discuss security deposits, common area expenses, taxes, and insurance. I post these articles monthly so if you have a burning question before then, please do not hesitate to contact me.