Commercial Lease Extensions: 5 Common Issues That Lead To Disputes
When signing a commercial lease, both the landlord and the tenant hope for a mutually beneficial, stable, amicable, and long-term tenancy. Such relationships result from transparency, candor, and trust developed over time. The passage of time, however, also brings a tenancy closer to the end of the lease term. At that point, the parties face a choice: renew the lease or go their separate ways.
Renewal provisions and options to extend the tenancy are contained in most commercial leases, but they are often sources of misunderstanding and conflict, even in tenancies that are otherwise ideal. Ambiguous renewal language, informality based on past practice, divergent interests and intentions, and other issues can all lay the foundation for disputes that leave both parties in a tough, disruptive, and costly spot.
Avoiding disputes over commercial lease renewals requires understanding the missteps, lapses, or failures that frequently lead to them. Here are five of the most common issues that turn smooth or perfunctory lease renewals into disastrous legal standoffs.
- Ambiguous Option Language in the Lease
As noted, options to renew or extend are standard in commercial leases. But that doesn’t mean the language outlining the terms, conditions, and requirements for exercising that option is standard as well. Vague phrasing like “the tenant shall have the right to renew under substantially similar terms” is an unwelcome invitation for a judge to resolve that ambiguity.
For example, what does “substantially similar” mean? Does it include or allow for rent increases? Does the landlord’s right to recapture space apply during the renewal term? If the original lease contained tenant improvement allowances, does the tenant expect similar concessions in the extension? Without precise drafting and clearly defined terms, neither side can predict the outcome with confidence. Unfortunately, renewal language is often an afterthought when parties are hammering out their initial lease.
- Failure to Properly or Timely Exercise the Option
All businesses plan for the future and want as much certainty as possible about what that future holds. That is why commercial leases usually require a relatively long runway – often six to 12 months – for a tenant to notify a landlord about their intention to exercise a renewal option. If a tenant inadvertently misses the notice deadline or provides notice that does not comply with the lease’s requirements, they could find themselves out on the street if the landlord decides to strictly enforce the renewal provision. In the absence of other factors, courts will likely side with the landlord and find that the tenant forefeited their option if they provided untimely or insufficient notice.
What makes this scenario worse is when the tenant believes they have properly exercised their option, even though they haven’t. A tenant could lose their renewal rights if they sent notice by email when the lease required certified mail, or if they sent their otherwise timely notice to a property management company rather than the landlord’s designated legal address. These procedural failures are avoidable, but they require someone to actively track deadlines and read the lease carefully.
- Disputes Over Fair Market Rent Determinations
Many extension options don’t lock in a fixed rent. Instead, they provide for renewal at “fair market rent,” to be agreed upon by the parties or determined by appraisal. Given the centrality of rent amounts to the landlord-tenant relationship and the impact those figures have on the financial positions of both parties, the question of what “fair market rent” means, if not clearly defined, can be fertile ground for disputes.
What “fair market” is the benchmark? Is it the submarket, the broader metro area, comparable properties in the same building, or some other metric? How do you account for a below-market build-out that the tenant funded themselves? What rent concessions are typical in the current market, and should gross rent or net effective rent serve as the benchmark? When the lease doesn’t specify a clear methodology, including how to break a deadlock between competing appraisals, the parties end up negotiating under pressure or litigating the very question the appraisal process was supposed to resolve.
- Changes in Permitted Use and Operational Restrictions
Businesses evolve, and for commercial tenants, that evolution can involve activities, services, or uses not contemplated or addressed in the original lease. Since most leases contain use restrictions, conflicts can arise if the lease doesn’t allow modifications to those restrictions or if a tenant believes a new use falls within the original lease’s parameters. This issue can become even trickier if the landlord’s leases with neighboring tenants contain exclusive use provisions that a proposed new or expanded use would implicate.
- Landlord’s Competing Redevelopment or Sale Plans
Just as a tenant’s business may evolve and expand, a landlord’s circumstances, priorities, or goals, even their ownership interest in the leased premises, can change over the course of a lease term. The landlord may sell the property during the original lease term, and the new owner may have development plans that don’t align with a renewed tenancy. It isn’t automatic that the successor landlord will be bound by a tenant’s attempt to exercise their option rights, and a tenant that wants to stay and a landlord that wants them to go can find themselves in a protracted court battle that may extend beyond the lease term, complicating matters and clouding the future for both parties.
For all these reasons, commercial landlords and tenants should give careful consideration to extension provisions at the outset of their relationship. Given that meticulous drafting can minimize the likelihood of confusion or conflict when it’s time to extend the lease term, engaging experienced counsel during lease negotiations is an imperative for landlords and tenants alike.
If you have questions or concerns about commercial lease extensions, please contact Michael Hamblin at Maddin Hauser.