Stephanie Friese’s article, “Avoid the White Flag by Negotiating Surrender Provisions in Commercial Leases,” in the Daily Report
Reprinted with permission from the March 3, 2023, edition of Daily Report © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com
Avoid the White Flag by Negotiating Surrender Provisions in Commercial Leases
The average base rent obligation over the term of the lease, in each commercial lease crossing my inbox in 2022, was over $1 million, exclusive of triple net charges and other potential obligations of a tenant that may arise during or after the lease term. Notwithstanding the importance of a lease to the balance sheets of both landlords and tenants, surrender provisions are commonly glossed over, and consequences can be detrimental to either side. At the end of the term, a landlord could be left with premises it is unable to lease without substantial monetary investment in renovation and repair; or a tenant may have significant liabilities to restore the premises. More frequently it is the tenant who is surprised - it understands it must pay the rent, and may anticipate investing in improvements in the premises initially, but expensive surrender obligations are usually not on its radar. Since landlords typically invest more resources in preparing the lease, and have well developed standards for how they want premises delivered at the end of the term, lease forms may contain traps for the unwary tenant.
Statutes and case law provide more protections for tenants in residential leases, but in commercial leases, freedom of contract is the general rule, so whatever the parties reduce to writing will most likely be enforced. Therefore, it is prudent for both parties to give due consideration to the condition of the premises at lease commencement, what improvements are contemplated during the term, which party is responsible for maintaining and repairing the premises throughout the term, and in what condition the premises will be surrendered at the end of the term.
Typical surrender provisions may:
- obligate a tenant to deliver possession back to the landlord with the premises in broom clean condition, free of tenant’s personal property;
- require a tenant to deliver the premises in “good order and condition” or “in the same condition as at the beginning of the term”;
- require a tenant to remove any improvements made during the term;
- require a tenant to deliver the premises in a “rent-ready” condition; or
- stipulate a tenant is holding over if tenant has failed to comply with its maintenance and repair obligations under the lease at the time of termination.
Such provisions may seem innocuous, but how are they applied in practice? Some examples of issues that may arise are:
Tenants may have to remove improvements and restore the premises to its original condition. If a tenant has moved walls, installed elaborate cabinetry or specialty systems, modified the premises in a way that it is not useful to a future tenant, or installed trade fixtures that are difficult to remove, and if the lease doesn’t specifically allow a tenant to leave those improvements, the tenant has few arguments that it is not required to restore the premises to the original condition by removing things such as cables and conduits, window tinting film, countertops, and extra ductwork. If improvements involve removing areas such as existing bathrooms, and the lease requires the tenant to restore the premises to the original condition, the tenant may be responsible for rebuilding the elements which were removed. A landlord will want the option of waiting until the end of the lease term to tell the tenant whether it wants the alterations removed or the option of requiring a cash sum in lieu of tenant restoring the premises. Tenants should either negotiate on the front end for the right to leave the improvements (and the right to remove those that it wants to remove) or discuss removal obligations at the time landlord’s consent for improvements is sought. If that discussion doesn’t happen until the termination of the lease, the tenant does not have much leverage and will likely be responsible for removal and restoration costs.
Does “good order and condition” take into consideration normal wear and tear? Normally leases do exempt “normal wear and tear” from a tenant’s restoration obligations. Georgia courts have interpreted that phrase to mean a tenant is only obligated to replace or repair items which are broken, destroyed, or damaged by willful, negligent or accidental acts, and tenants do not, by default, have to make repairs necessitated from the day to day use of the premises and from lapse of time. Unless the lease states otherwise, a landlord is not entitled to replacement of worn out elements. However, in cases where certain repair and maintenance obligations fall on a tenant, such as in industrial net leases, a tenant is not permitted to defer maintenance and thereby skirt those obligations. For example, if a tenant is responsible for the HVAC systems, it must maintain them throughout the term, and if required by the lease is required to replace the HVAC systems under the repair and maintenance obligations. Therefore, the parties must consider not only the surrender provision itself, but also other provisions of the lease relating to condition of the premises, since those other provisions will also be enforceable. Compliance with repair and maintenance obligations is likely a condition to the termination of tenant’s obligations under the lease.
What does “rent-ready” condition imply? Tenants should beware of such terms that may require additional work beyond repair and maintenance obligations. To make a space “rent-ready”, a tenant may have to re-paint or re-carpet the premises. In a recently negotiated warehouse lease, the initial draft required the tenant to replace all truck doors, repair structural steel columns, replace HVAC systems, repair cracks in the concrete floor, and replace any cracked windows, regardless of whether the tenant caused any damage to the items. Clarifications to these provisions should be negotiated to make sure they don’t expand an unsuspecting tenant’s repair and maintenance obligations.
Moreover, if a tenant fails to comply with the terms of the surrender provision, it may be deemed to have failed to vacate the premises, giving rise to the ability of the Landlord to charge the tenant for holdover rent, which may be double the regular rent rate.
Commercial leases are complex documents that govern the relationship of landlord and tenant for years to come. A mentor once said to me “whatever can happen will happen over a twenty-year lease term”, and he was correct – there are very few categories of lease provisions which have never been litigated. So it’s important to have an experienced advocate at the negotiation stage, regardless of whether you are landlord or tenant.
Stephanie Friese is co-managing shareholder in the Atlanta office and chair of the Real Estate Practice Group of Chamberlain Hrdlicka. She can be contacted at (404) 665-1220 or Stephanie.Friese@chamberlainlaw.com.