An economic downturn can play havoc on a small business owner where alongside trying to break even, they must also decide what to do with the commercial lease on the premises. Suppose you have signed a long term lease (of five years or more) at the time when the economy is at its peak, the rent at its highest, and the market buoyant. Suddenly, two years into the lease, things no longer look promising, and you can no longer sustain paying rent. What options do you have regarding the lease that is now eating away at your profits? Below we will discuss the different options available to end your commercial lease before the expiry date.
1. Assigning the Commerical Lease
If you have a business with goodwill attached, it is best to try and find a buyer for the business and enter into an arrangement to assign your commercial lease. In the usual course, the incoming tenant will take on the obligations of the lease including payment of the current rent. But what if the rent payable under the lease is no longer reflective of the current market, and you cannot find a buyer who will take on the lease with the high rent?
Sometimes, it is better to be up front with the landlord and explain your situation. No doubt your landlord would also be keeping a keen eye on the market and would rather take a lesser amount in rent than having a defaulting or bankrupt tenant and vacant premises.
The commercial lease contains the procedure for an assignment. In most retail leases protected by retail legislation, the landlord cannot unreasonably withhold consent if you can demonstrate that the incoming tenant is of good financial standing with relevant business skills similar to yours. Provided that there has not been any default or unremedied breach under your lease, you will typically be discharged from your obligations under the lease after the assignment date.
In some leases, there may be a right of first refusal provision which means that you must give the landlord first preference to buy your business and take back the lease before offering it to a potential purchaser or incoming tenant. This type of provision is common in shopping centre leases where the landlord wants control over its tenancy mix. It may signal good news if the landlord decides to take back the premises from you this way.
Another option is to sublet the premises so that even though you are still held liable under your lease, you may find a subtenant to share the cost of the premises and their occupancy will be via a sublease. Here, you still require the landlord’s consent, although again, the landlord may not be permitted to withhold consent unreasonably. Importantly, subletting is treated differently to an assignment, and depends on which state retail legislation applies.
2. Surrender the Lease
If you are unable to sell your business, or you just want to make a quick (but legitimate) getaway, you could also approach the landlord and try to negotiate a surrender of your commercial lease. Surrendering your lease means asking your landlord to take back the premises and letting you off the hook before your lease expiry date. The landlord’s willingness to do so depends on a few factors. If the landlord thinks it can readily find another tenant, then you may be off the hook. As the landlord will have the upper hand in this scenario, it is usually the case that the landlord will require payment of an exit fee (referred to as a surrender amount). You may not have much bargaining power in determining how much monetary incentive it will take for the landlord to willingly release you. However, on the plus side, at least you can exit the lease and pay a lesser amount than what you would have been liable for under the lease if you were to let the lease run its course. Surrendering a lease usually involves a formal process of entering into and executing a deed of surrender prepared by the landlord’s solicitor.
3. What Happens When You Abandon the Premises?
The thought of assigning or surrendering your commercial lease can sometimes feel overwhelming. You may be then tempted just to pack up shop in the middle of the night, remove whatever property you can and just abandon the place. This scenario seems less complicated if you entered into a lease with a $2 shelf company with no personal guarantees and nothing to forfeit other than the guarantee. Here, you will be deemed to have abandoned your premises, and will trigger the default provision of your lease.
When you default on your obligations under the commercial lease, the landlord will have no choice but to call on your bank guarantee or security deposit to try to make up for the loss of rent and advertise for a new tenant to mitigate their loss. Typically, unpaid rent is the first to trigger such a provision. The landlord will also likely be fuming at the legal expenses incurred trying to serve you with a default notice and may even be out of pocket in removing your fit-out and cleaning the premises to make it tenantable. If the landlord can locate and sue you for damages, the scope of your financial liability includes:
- The remainder of rent payable under your lease (‘loss of bargain’ rent); and
- The legal costs and expenses the landlord incurred as a result of your default, less the amount the landlord can recover in its efforts to mitigate its loss.
Leasing a brick and mortar premises can be a risky venture. It is worthwhile to seek legal advice before entering into negotiations for a commercial lease, particularly around asset structuring and working out the best way to break the terms of the lease up into a few option terms rather than one long lease. That way, you still have the security of tenure for the whole duration of the lease term (with option terms included), but in the short term, if the business doesn’t work out, your rent liability is less than that of a long-term lease.
If you would like assistance in reviewing your commercial lease document or get advice before entering into your lease, get in touch with our leasing team on 1300 544 755.