Finding a big tenant is generally the paramount objective for the owner of an office building, shopping center, or other commercial facility that’s rife with vacancies. But as you search for that big tenant, one or more of your current small tenants might be interested in leasing some of that vacant space. This creates a dilemma. Every day the space remains vacant you lose money. But while taking the little bird in hand will increase your short-term rental income, it might end up costing you the chance to land that big bird in the bush that you need to make it in the long run.

The ideal solution would be to let the current tenant lease the vacant space for now while agreeing to give it up if and when you find a major tenant who wants to lease it. Sound too good to be true? It’s not, according to a New Jersey landlord’s attorney whose clients have used this arrangement effectively in many different settings. The leasing strategy is simple: Establish a landlord termination option just the way many tenants demand their own lease termination option. The attorney says that tenants will generally agree to such a provision as long as the terms are fair and the landlord provides some form of compensation.

Get 10 Legal Protections

Here’s how to negotiate and draft a landlord termination option provision that includes the 10 legal protections you need, along with a Model Lease Clause that you can adapt for your own circumstances.  

1. Make tenant acknowledge landlord’s option to terminate. The first thing you need is the tenant’s express acknowledgment of your right to terminate the lease. Specify that termination takes effect on the day you decide to terminate the lease (the “termination date”), which may occur at any point before the lease expires. The New Jersey attorney recommends picking a termination date that falls on the last day of a calendar month so that you get the full rent for that particular month [Clause, pars. a(i) & a(ii)].

2. Provide for limited advance notice of termination. Agree to provide the tenant written notice in advance of the termination date, but try to keep the advance notice period as short as possible. The attorney suggests proposing 30 days while expecting tenants to push back by demanding up to 90 days. “They might contend that 30 days isn’t enough time to move out and find new space.” You may have to compromise by picking a notification period that falls somewhere in the middle between 30 and 90 days [Clause, par. a(iii)].

3. Provide tenant compensation for exercising termination option. A tenant will likely demand compensation in consideration for granting you a termination option. Be prepared to meet that demand but not simply for having the option. Instead, make compensation contingent on your actual exercise of the option. Also specify that compensation is payable only if the tenant vacates the space on time so as to deter a potentially costly holdover [Clause, par. c].

4. Tie tenant’s compensation to month option is exercised. How and how much should you pay tenants for an early termination option? The New Jersey attorney says that many tenants in this position want a fixed cash “buyout” payment that’s typically equal to some multiple of the tenant’s monthly rent. That multiple may be as high as 12 times the monthly rent. 

Strategy: If you agree to this formula, tie the compensation amount to a monthly minimum rent for the month during which you send the termination notice rather than a future month. That should keep the buyout payment down to the extent that monthly rent typically increases as the lease runs on. However, a savvy tenant may insist that you calculate the payment using the minimum monthly rent charged on the date termination actually occurs because the rent may be higher on that later date [Clause, pars. c(i) & c(ii)].

5. End tenant’s lease rights on termination date. Clearly state that after the termination date occurs, the tenant will have no further rights under the lease or interest in the space other than those that the lease says will survive the end of the lease. The tenant should be prepared to treat your exercise of the termination option as if the lease had expired naturally [Clause, par. a(iv)].

6. Keep tenant on hook for outstanding obligations. Ensure that the tenant understands that your actions to end the lease prematurely by exercising the termination option don’t relieve it of liability for its outstanding lease obligations, including the obligations that survive the lease. For example, the tenant is still responsible for paying minimum rent, additional rent, and any other charges accruing up to the termination date. Without this language, a tenant may claim that all of its outstanding lease obligations will be immediately extinguished once you terminate the lease [Clause, par. a(v)].

7. Set three conditions for surrender of space. When and if you exercise the termination option, you want the tenant to surrender the space on or before the termination date to ensure that it’s available to the big tenant you’ve just lined up. Require the tenant to meet three conditions to satisfy its surrender obligations: 

• The tenant must cure all outstanding lease violations;
• The tenant must give you possession of the space; and
• The tenant must clean and remove any remaining occupants and property from the space.

State that you have “sole and absolute discretion” to determine whether the tenant has fulfilled these conditions [Clause, par. b(ii)].

8. Charge tenant holdover fee for not surrendering space on time. To further ensure a smooth transition, require the tenant to pay a special holdover fee if it doesn’t surrender the space on or before the termination date. This special holdover fee is different from the holdover rent you charge under the standard holdover rent clause of the lease, the New Jersey attorney explains. It essentially replaces the standard holdover rent clause to establish special rules for holdovers that occur after you exercise your termination option. 

As with standard holdover rent, it’s important to get the special holdover rent amount right. The rent must be high enough to give the tenant an incentive to surrender the space on time; but if it’s too high, a court may determine that it’s an unenforceable penalty. Recommendation: Charge a special holdover fee that’s a multiple of the tenant’s monthly minimum rent then due prorated for each day the holdover lasts until the tenant surrenders the space. All things being equal, double the minimum monthly rent should be an appropriate multiple, the New Jersey attorney suggests [Clause, b(i)].

9. Require tenant to indemnify you from third-party claims. If the small tenant holds over, the incoming big tenant won’t be able to move in on time. That could not only cause the deal to fall through but also expose you to risk of being sued by the big tenant for failure to deliver timely possession. So, in addition to paying a holdover fee, require the small tenant to indemnify, i.e., defend and hold you harmless from, all damages, costs, claims, and expenses you incur from third parties as a result of its failure to surrender the premises on time [Clause, par. b(iii)]. 

10. Reserve all legal remedies to get tenant to leave by termination date. To dispel any possible doubt, spell out that the tenant doesn’t have your permission to stay in the space after the termination date. And expressly reserve your right to use any and all available legal remedies to regain possession of the space if the tenant doesn’t leave [Clause, par. b(iv)].