Comprehensive Guide to Early Termination of a Commercial Lease: What You Should Know

There are two types of early Commercial Lease terminations in CRE:

• Landlord-initiated early termination – You, as the landlord, might need to terminate the lease prematurely because of the tenant’s non-payment of rent, property damage, or failure to comply with specific lease terms. You may also need to end the lease if you want to redevelop or sell the property.
• Tenant-initiated early termination – Your tenant may request to terminate the lease before its scheduled end date due to various reasons, such as business relocations or financial difficulties.

In both cases, the risk of misunderstandings and disputes increases because CRE lease agreements can be complex and open to interpretation, and emotions can run high during negotiations. But don’t worry — there are ways to minimize these risks and smooth out the CRE termination process. Let’s have a look into how to effectively handle these two scenarios:

 

Scenario 1: You (the CRE landlord) want to break the lease

You may be wondering: Can a landlord initiate an early lease termination? The answer is yes, you as a landlord can end a commercial lease early if justified by serious lease violations or a break clause in the agreement.

It’s critical to stick to the lease terms and local commercial laws to avoid legal fallouts. Always consult with legal experts to make sure that your actions are justified and lawful. Clearly communicate your reasons with your tenant to minimize disputes when ending a lease. Transparent communication maintains a professional relationship and reduces conflict.

 

Steps for landlords to break a commercial lease early

1. Review the lease agreement. Identify any clauses that allow early termination, like breach of contract or specific exit provisions.
2. Identify legal grounds for termination. Make sure you have valid reasons for ending the lease, such as rent non-payment or unlawful tenant activities. A lawyer specializing in CRE can help you determine the most appropriate grounds.
3. Serve the appropriate notice. Deliver a formal termination notice to your tenant, adhering to the lease’s required notice period. The notice should be clear, concise, and legally compliant.
4. Document all communications. Maintain records of all interactions with the tenant concerning the lease termination to prevent future disputes. These may be useful in case of legal proceedings.
5. Negotiate if necessary. Be ready to negotiate termination terms, which may include compensation or alternative arrangements beneficial to both sides.
6. Seek legal advice. Always get a legal expert’s perspective to ensure that your steps comply with local regulations and to understand your rights and obligations.
7. If the tenant contests the termination, be prepared to manage the issue through mediation or legal recourse. Handle disputes professionally.

 

Scenario 2: Your CRE tenant wants to break the lease

Sometimes, CRE tenants will ask to end their commercial lease early, and knowing how to handle these requests effectively can save you from legal headaches and financial losses.

Common scenarios leading to early termination requests include:

• Business expansion (when a tenant has outgrown the leased space and seeks to expand or relocate)
• Business contraction (when a tenant needs to downsize operations and therefore requires less space)
• Lease violations (when you as the landlord fail to fulfill your obligations under the lease)
• Mergers and acquisitions (when a tenant needs to consolidate operations with another business)

 

What should be your first steps as a CRE landlord in handling early lease termination requests?

1. Review your lease agreement to identify any clauses related to early termination. Do any of the clauses outline specific conditions, penalties, or buyout options? Typically, CRE leases don’t come with preset early termination rights. When included, these clauses generally require tenants to pay hefty fees — often three to six months of rent plus the unamortized costs of tenant improvements, free rent concessions, and brokerage fees.Note that certain leases (especially in retail) allow for penalty-free early terminations through specific clauses:

• Bailout clauses let tenants leave if their revenue drops significantly
• Co-tenancy clauses allow early termination if a key tenant exits or if the building’s occupancy falls sharply

2. If your lease doesn’t include specific provisions for early termination, you may have the opportunity to negotiate a buyout fee or other mutually agreed-upon arrangements with the tenant.
3. Assess the potential financial impact of an early termination — including lost rental income, leasehold improvements, and legal fees — so you can negotiate a fair settlement or prepare for potential losses.
4. Don’t panic. If your property is in a high-demand area, agreeing to an early termination might actually turn out to be beneficial for you, as you may be able to re-lease the space quickly at a higher rate.

 

Protecting your interests as a CRE landlord in the future

Add a termination clause to your future contracts to protect yourself going forward.  A lawyer can help you draft specific terms, but in general, it may benefit you to:

• Propose early termination rights early in the negotiation, during the Request for Proposal and Letter of Intent phases.
• Demand a notice period for early termination, setting a standard of 90 to 180 days.
• Specify which unamortized costs tenants will be responsible for if they terminate early.

 

Break clauses

Break clauses are contractual provisions that allow tenants to terminate a lease early under specific conditions. When drafting a lease, it’s essential to clearly define the terms of the break clause:

• Specify the required notice period for the tenant to exercise the break clause.
• Outline any financial penalties or fees that the tenant may be required to pay.
• Clearly define the legal responsibilities of both parties (such as property restoration or future lease commitments).

Once a tenant exercises a break clause, it’s generally irrevocable, meaning it cannot be withdrawn. This may lead to negotiations for a new lease or other arrangements.

Hand-back provisions

A hand-back provision allows a tenant to return a portion of the leased space during the lease term. This can be beneficial for tenants who need to downsize their operations or adapt to changing business needs, and for CRE landlords, this can help retain tenants and maintain occupancy rates.

Lease surrenders

A lease surrender happens when a tenant voluntarily gives up their right to occupy a leased space because they can no longer fulfill their lease obligations. To safeguard your interests, make sure that this lease surrender agreement clearly outlines all terms, including payment schedules, property restoration requirements, and any other relevant conditions. Make it clear that if a tenant offers to surrender a lease:

• They need to pay a fee to compensate you for lost rent.
• They are also responsible for covering legal costs associated with the surrender.
• They need to return the property to its original condition or pay for necessary repairs.

 

What other options are available?

Early termination is not always in the best interest of either party particularly in high-inflation environments with shifting business confidence and prevalent remote work policies that leave many with extra space. Here are other ways to handle these situations effectively:

• Subleasing – Consider allowing tenants (sublessors) to rent out part or all of their premises to another business (sublessee). However, it’s crucial to include specific subleasing conditions in the original lease agreement to mitigate risks such as tenant defaults or property damage.

Important note: Even if a tenant subleases their space, they remain fully responsible for paying rent and fulfilling all other lease obligations. To further protect your interests as a CRE landlord, you may restrict subleasing to businesses that are not direct competitors and have a solid financial standing.

• Lease assignment – A lease assignment occurs when a tenant transfers all their rights and responsibilities under a lease to another party. As a landlord, it’s your job to carefully evaluate the prospective new tenant’s financial health and suitability before approving any assignment. Their creditworthiness should be equal to or better than the original tenant.

It’s absolutely essential to understand the implications of subleasing and assignments if you are a CRE landlord, as these transactions can impact your revenue and overall tenant mix.

• Remember that your original tenant remains fully liable for all lease obligations even if they sublease or assign the space.
• Encourage your tenants to carefully vet potential subtenants and assess their financial stability and ability to uphold lease terms.
• Make sure that any subtenant agrees to comply with all original lease terms (including operating hours and permitted uses).
• Establish clear guidelines and reasonable timelines for reviewing and approving subtenants to prevent delays in the process.

 

Conclusion

Does one of your tenants want to break their CRE lease? Maintaining some flexibility (and a cool head) will help you keep your commercial properties profitable no matter the market. Be sure to engage with legal and private commercial real estate lenders if you need to manage lease break negotiations and safeguard your interests. Staying adaptable is the key to maintaining a positive relationship with your tenants and managing a successful CRE property portfolio.

Read our blog for more insights from CRE experts. And don’t hesitate to reach out to Private Capital Investors if you have a new CRE project in mind and are looking for funding solutions!