Cut Commission Owed on Tenant’s Cancellation Fee

Some of your tenants may have an option to cancel the lease early by paying a cancellation fee. Under many standard brokerage agreements, when and if the tenant exercises that option, you must pay the broker commission on the full cancellation fee you receive from the tenant. That’s a raw deal for you, and you should negotiate for fairer terms.

Why Paying Commission on the Full Fee Is Unfair

The point of the cancellation fee is to cover the money you spent to get the tenant to lease the space, such as in the form of rent credits, work allowances, and other signing inducements. The original plan was to recover these expenditures via rent payments from the tenant over the course of the lease. But if the tenant pulls the plug early, all you’re left with is the cancellation fee.

It makes no sense to pay a brokerage commission on money the broker didn’t really earn and that’s intended to reimburse you for out-of-pocket costs. But if you’re using a standard brokerage agreement and don’t include express language to protect you, the broker will be entitled to a commission on every dollar of the cancellation fee.

Bayou Broker Gets Big Commission on Cancellation Fee

A Louisiana landlord learned this lesson the hard way. At issue was the cancellation fee equivalent to six months’ rent that a tenant paid to end its lease early. The broker demanded a piece of that sizeable cancellation fee under the provision of the brokerage agreement requiring the landlord to pay a 4 percent commission on all “rentals received” from any lease signed during the term of the listing agreement.

The landlord considered the broker’s demand outrageous and refused to fork over the commission. A cancellation fee didn’t count as “rentals received” under the lease, it argued. But the Louisiana federal court disagreed, finding that the brokerage agreement clearly gave the broker a commission based on the cancellation fee [Latter & Blum v. Grand Properties Ltd., 617 So.2d 578].

How to Protect Yourself

Now that you recognize the landmine, how do you go about removing it? Asking the broker to carve the cancellation fee out of the commission structure is likely to meet with heavy resistance, attorneys caution. “A savvy broker will argue that the cancellation payment is no different from rent and should thus be subject to a commission,” advises a New York attorney.

She also suggests a potential compromise: Get the right to deduct your costs for leasing the space from the cancellation fee and then pay a commission on the balance. This way the broker gets a commission and you recover your costs.

Get Back Costs Before You Pay Commission

You can use our Model Clause: Limit Cancellation Fee Commission in Brokerage Agreement, below, to put this arrangement into effect. The way it works:

Step 1: Add up all the costs you incurred in consummating the lease with the tenant, including free rent, work allowances, attorney’s fees, etc. Refer to these expenses as “transaction costs.”

Step 2: Determine what percentage of these transaction costs you recover via tenant rent payments each year. To make that calculation, amortize the costs on a straight-line basis over the lease term by dividing transaction costs by the number of years in the lease term. Thus, for example, recovery on $10,000 in transaction costs over a five-year lease is $2,000 per year.

Step 3: Calculate what part of the transaction costs you haven’t yet recovered when the tenant cancelled the lease. Example: If the tenant cancels a five-year lease after the first year, the unrecovered portion of transaction costs is $8,000 (four years remaining on the lease at $2,000 per year).

Step 4: Subtract the unreimbursed portion of transaction costs from the cancellation fee. Then pay commission on the remainder—that is, “excess amount.” Example: If the cancellation fee is $20,000 and your unreimbursed transaction costs are $8,000, the excess amount would be $12,000. So, if the brokerage fee is 5 percent, you’ll pay a $600 commission ($12,000 x 5%), as opposed to the $1,000 you would’ve had to fork over if you had to pay commission on the entire cancellation fee.