Redevelopment Clauses Impair Leasehold Rights

A valuable asset of many businesses – particularly in retail-related industries – is its leasehold right or the right of a commercial tenant to temporarily occupy leased premises. A business with a secure long term lease allows a buyer enough time in which it may obtain an attractive return on their investment. Leasehold rights become impaired when the lease contains a redevelopment or renovation clause. A redevelopment clause in a commercial lease gives the landlord the right to end the lease at anytime for the purposes of renovating, altering, or expanding the commercial plaza in which the tenant operates. Redevelopment clauses are rare, but becoming more prevalent in some large commercial plazas that undergo periodic improvements and upgrades. A commercial lease redevelopment clause increases risk for potential buyers and may serve as a ‘deal-breaker’ without negotiated limitations or a significant reduction in the purchase price of the business.

Relocation Clauses Less Problematic

In contrast to a redevelopment clause which allows the landlord to terminate the lease in the event of a redevelopment or renovation of the plaza, a relocation clause allows the landlord to move the tenant to another (similar) space within the same commercial plaza. A relocation clause may or may not be triggered due to renovation-related activity that disrupts the tenant’s occupancy. A relocation clause is less problematic than a redevelopment clause since at least the tenant is offered similar and nearby space in which it may continue to conduct business. Often the lease stipulates that the landlord is required to pay for the tenant’s moving expenses and gives the tenant a rent abatement period during the move-in process. Still, relocation clauses are best avoided if possible and still may impair the value of the leasehold rights and cause disruptions to a tenant’s business.

Disclose to Qualified Buyers

When selling a business that is attached to a commercial lease with a redevelopment or relocation clause, it is essential to disclose the contents of the lease to all qualified buyers as early in the selling process as possible. This eliminates surprises later on in the formal due diligence phase where the lease is transferred to the buyer as a contingency of the deal. It is always best to be honest and upfront with potential buyers when selling a business so that trust is established and solutions to problems may be derived in a cooperative manner. Further, since redevelopment and relocation clauses may severely impair the value of the business, they should be disclosed prior to the buyer making an offer. That ensures that the possible impairment of the lease is fully reflected in the buyer’s initial offer and need not be subsequently reduced.

Negotiate Limitations to Redevelopment Clause

If a landlord adamantly refuses to remove a redevelopment clause from a commercial lease, limitations may still be negotiated which lessen its potential impact.
Ideally, such negotiations concerning the limitation or removal of a redevelopment clause occurs prior to the business being sold.
This will keep the potential sale confidential from the landlord and prevents the buyer from having to negotiate directly with the landlord during the lease assumption process.
One key area to negotiate is the amount of notice that the tenant is required to receive prior to the landlord terminating the lease.
Tenants should try to extend this period for as long as possible (6-12 months is usually fair) so they can have time to prepare and possibly move their business.
Another area of negotiation is what precisely triggers a ‘redevelopment’ in the lease.
The more broadly the redevelopment is defined (including the words ‘altering’ or ‘repairing’ any part of the commercial plaza for example) then the more latitude a landlord has in triggering the redevelopment clause.
The narrower the redevelopment is defined (confining ‘redevelopment’ only to ‘renovating’ the tenant’s actual rentable space rather than neighboring space for example), then the harder it is for the landlord to trigger the clause.
Finally, tenants may negotiate limitations on when the redevelopment clause may apply.
It is a good idea to try and limit the applicability of a redevelopment clause until only after the first 3-4 years of the lease is completed.
This provides some economic certainty that a buyer will have at least a 3-4 year period to recoup their initial investment.

Confront Landlord with Legal Assistance

Obtaining legal counsel is always a wise course of action for a business owner when negotiating a new lease or when extending an existing lease. A redevelopment or relocation clause should preferably be eliminated or limited in scope and duration at that time. If the lease is still impaired by a redevelopment or relocation clause at the time the business is being sold, then the business owner will in all likelihood need to involve their legal counsel and attempt to remove or reduce the impairment with the landlord. Otherwise, the business may be unsaleable to the extent that no reasonable buyer would purchase the business given the chance that the landlord will terminate the lease without sufficient limitations. Removing the impairments to the lease may involve litigation with the landlord as the only possible remedy

A redevelopment clause that allows the landlord to unilaterally terminate the lease is like a ‘Sword of Damocles’ always waiting to drop. The uncertainty alone may severely disrupt if not destroy a business. While not as severe, a relocation clause still creates economic uncertainty and severe costs by possibly forcing a tenant to move locations. The presence of both redevelopment clauses and relocation clauses in commercial leases reduce and may even destroy the value of a business unless removed or severely limited in scope.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.