Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate, April 2009
Given the weak economy, many tenants find themselves with premises which they no longer require or which they need to dispose of in order to cut costs. This article explores some of the more common exit strategies employed by tenants.
At the outset, it is important to note that each exit strategy is fraught with business and legal issues. Accordingly, just as the tenant should retain a leasing broker and lawyer before leasing any new space, it should do the same when looking to unload excess premises. A leasing broker will be able to provide invaluable information relating to the local market, such as the likelihood of finding another user for the space and what that user might be willing to pay. Similarly, a lawyer will be able to assist in understanding what the tenant's rights and obligations are under the lease, as well as the risks associated with each possible exit strategy.
As a general rule of thumb, it is also a good idea for the tenant to meet with the landlord early on, while the tenant is still considering all its options. The tenant should use the meeting as an opportunity to explore how co-operative or receptive the landlord will be in connection with the various strategies available to the tenant.
Finally, for tenants looking to shed multiple locations, each location should be considered separately. The optimal strategy for one location may be unworkable or unrealistic in another.
This is the most common exit strategy employed. The advantage to this strategy is that it is relatively simple to carry out and the lease usually affords the tenant the contractual right to assign or sublet with the landlord's consent, which consent may not be unreasonably withheld. One significant disadvantage to this strategy is that, in almost all circumstances, the tenant likely won't be able to secure a transferee who is willing to pay the full rent payable under the lease (thereby leaving the tenant to pay the shortfall). Moreover, even if the tenant secures a transferee who is willing to pay the same rent as that payable under the lease, the tenant will remain liable to the landlord in the event the transferee defaults in its payments.
In assessing whether an assignment or sublet is a plausible exit strategy, the tenant needs to determine the rent which an assignee or subtenant would realistically be willing to pay, as well as the cost of any alterations and inducements that the tenant would likely have to perform or provide in order to secure the deal. The tenant would also need to determine how long the premises would likely need to be on the market before a transferee is secured. Once the tenant is armed with this information, as well as an estimate of brokerage, legal and landlord consent costs, it will be able to calculate its rental cost savings. If the savings are minuscule, the tenant may determine that this is not a viable exit strategy.
Where the tenant is able to achieve worthwhile cost savings through an assignment or sublet, it must still consider how co-operative the landlord will be in connection with the tenant's assignment and subletting efforts and whether it will consent to the transfer. The right to "act reasonably" provides the landlord with broad discretion. Moreover, many leases permit a landlord to withhold its consent if the landlord has space in the building which can accommodate the transferee. Where the landlord has a significant amount of vacant space in the building, the landlord will be loathe to consent to the transfer as the landlord will want to enter into its own direct deal with the prospective occupant.
A lease buy-out involves the negotiation of an early termination of the lease with the landlord. While the landlord will undoubtedly want a lump sum payment in exchange for the early termination, it may be advantageous for the tenant to pursue a buy-out for a number of reasons. In a best case scenario, the lump sum payment will be significantly less than the rent payable for the balance of term (even if the tenant were able to secure an assignee or subtenant to assume some of the rent obligation). A tenant may be able to negotiate a relatively small termination payment where the premises are likely to be re-leased by the landlord in a short period of time (a leasing broker will be able to assist in gathering this market intelligence). In any event, where the tenant is required to pay all or nearly all of the balance of the term rent, the early termination still allows the tenant to shed its overhead costs associated with the premises. A negotiated early termination will also end the tenant's liability under the lease. The opportunity for a "clean break" is not available under any of the other strategies described in this article.
There are also several reasons why a landlord might be inclined to negotiate a buy-out of the tenant's lease. For example, the landlord may have concerns about the tenant's ongoing solvency, with the result that it views cash-in-hand as a better alternative to dealing with a bankrupt tenant. Also, the landlord may view the termination as an opportunity to rid itself of an undesirable tenant or to give the space to another tenant in the building who is looking to expand. In cases where the tenant has broad assignment and subletting or use rights, the landlord may accept an early termination in order to avoid getting stuck with an undesirable transferee or use.
This strategy involves the tenant shutting down its operations in the premises but continuing to honour its rent payment and other lease obligations. This strategy allows the tenant to reduce its overhead costs associated with the premises due to the fact that the tenant is no longer actively carrying on business in the premises. By ceasing its business activities, the tenant will save on employee, inventory, and utility costs. The primary downside to going dark is, of course, the fact that the tenant remains obliged to pay full rent. While it may not be a viable long-term solution, a tenant may choose to go dark on an interim basis while it attempts to secure a lease assignee or subtenant, or while it tries to negotiate a lease buy-out with its landlord. The negative factors associated with vacant premises may place added pressure on the landlord to accept a buy-out.
It is important to note that a failure to actively carry on business from the premises may constitute a tenant default under the lease. If the lease requires the tenant to actively carry on its business, then before going dark it should discuss with its legal advisers the risks associated with doing so. These risks need to be weighed against the advantages of going dark. In some cases, it may be that the landlord will not exercise its remedies with respect to the default, as it is content with simply continuing to collect rent. By meeting with the landlord beforehand, the tenant might be able to ascertain whether the landlord would terminate the lease or exercise its other remedies if the tenant sought to go dark.
The exit strategy employed by some tenants is simply to abandon the premises, stop paying rent and repudiate all lease obligations. It must be stressed that this course of action will render the tenant in default and almost certainly expose it to liability, but it may be one of few viable options when the tenant is in financial distress. In addition, as a result of provisions contained in the Commercial Tenancies Act (Ontario), individuals assisting in removing the tenant's property from the premises (i.e., the midnight movers), may find themselves personally liable for double of the value of the property removed. This is obviously a high risk strategy that must be approached with extreme caution and with a full understanding of the risks being assumed by the tenant. Nevertheless, in certain cases, it may prove to be effective as it may motivate the landlord to come to the negotiating table. A landlord – faced with a tenant bankruptcy, or vacant premises and the prospect of spending the next several years litigating in court – may be pressured to accept a settlement which still allows the tenant to achieve an overall cost savings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.