There are a number of reasons why a business owner might be motivated to end a commercial lease early.  The most common reason is that a business is not doing well enough to keep up with the lease payments.  Other reasons include changes in the local market, the need for larger or smaller space, or the simple desire to move on to other endeavors. Whatever the circumstances, a tenant desirous of terminating its commercial lease early faces an uphill battle.  Commercial landlords count on tenants to maintain their lease obligations.  They enter into long term leases to avoid the costs associated with continually looking for new qualified tenants and more importantly to avoid the loss of revenue associated with empty space.  For this reason, landlords typically demand strong lease language discouraging tenants from early termination.  See “Assignment Clauses and Related Terms in Commercial Leasing”.

sky-reflection-1453027 (1)Once a tenant decides, for whatever reason, that it wants to terminate a lease early, it should proceed cautiously.  The best approach of course is to seek the assistance of an experienced San Diego commercial lease lawyer.  Whether or not you consult with an attorney, it’s important to review your lease terms carefully so that you have a clear understanding of the options available to you and/or the consequences of early termination. What are the necessary steps for assignment of the lease to a new tenant?  Does the lease give the landlord unfettered discretion in deciding whether to accept an assignee (a new tenant)?  How does the lease define damages for early termination?  Is there a recapture clause (a clause that allows the landlord to terminate the lease merely because the tenant asks the landlord to approve an assignment).  Of course, tenants may also seek other ways to avoid early termination such as proposing flexible payment options to catch up on rent, proposing temporary reduced rent, asking to be moved to a smaller space on the same property or seeking assignment approval.  It is of course best if you can successfully avoid early termination via one of these proposals.  However, they are easier talked about than accomplished.

In most cases, a tenant terminating a lease early is liable for any unpaid rent and the unpaid rent due for the balance of the lease term less mitigation.  Mitigation is the amount a tenant can prove could have been reasonably avoided had the landlord made an effort to re-lease the space.  From a practical standpoint, tenants without the resources necessary to hire an attorney and litigate the case most often find themselves facing default judgments for the full amount of the damages requested without any mitigation.  This is why ignoring the problem isn’t an option.  At the same time litigation is extremely expensive.  However, landlords are sometimes willing to informally discuss early termination terms that factor in mitigation so long as tenants are communicating an intent to find a fair resolution.  A fair resolution unfortunately does not mean that the tenant is going to like the outcome.  Objectively, fairness would require a tenant to be responsible for the actual costs associated with the landlords quest for a new tenant (past due rents owed including common area maintenance expenses (“CAMS”), all rents and CAMS to the date of a final agreement, all costs associated with finding a new tenant, the costs of rent and CAMS while the space is empty and if the new tenant pays less rent, the difference the landlord would have earned had it received the higher rent.  These costs can be considerable.  Moreover, landlords don’t always know how long it will take and they err on the side of benefiting themselves when negotiating early termination terms.

Assignment clauses are an important part of commercial leasing. They provide successful tenants an opportunity to sell their businesses and provide failing businesses the possibility of finding replacement tenants in order to avoid breaching their leases. Generally, landlords retain significant control over the process. This article focuses on lease terms that facilitate the assignment process and/or early lease termination for new and growing business owners interested in testing the waters. While landlords are resistant to the concept of “testing the waters”, they will sometimes work with new business owners in order to secure their tenancy.

time-flies-away-801503-mIdeally, commercial tenants, especially new and growing businesses, will seek more favorable assignment and early termination terms when negotiation the lease. Depending on the circumstances (some tenants will have more bargaining power than others), landlords may agree to be more flexible. While favorable assignment and early termination language is hard to come by for tenants generally, the following concessions are worth pursuing:

  • A cancellation clause that allows tenants to cancel their lease if specific income projections are not met within a certain time period such as on the six-month or one-year anniversary of the lease commencement date.

Generally, parties are liable for their own negligent conduct.  An indemnity provision in a contract reallocates this liability from one party to another.  Viewed practically, an indemnity clause shifts insurance obligations from one party (“indemnitee”) to another party (“indemnitor”). Under an indemnity clause, the indemnitor agrees to pay the indemnitee for losses resulting from a claim brought by a third party. Absent explicit language assuming the obligation to defend, the party providing indemnity has no obligation to provide or assist in defending claims. Almost every contract includes an indemnification clause. It is important to read the clause carefully when entering into a contract of any nature, as the precise language of the clause can make a dramatic difference in each party’s financial obligations.

meet-up-1538121A typical indemnity clause looks something like the following:

To the extent caused by A’s negligence or willful conduct, A agrees to indemnify B of and from all reasonable claims, losses, causes of action, damage, lawsuits, and judgments, including attorneys’ fees and costs, provided that such claims, loss, or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property. Party A shall indemnify B only for the percentage of responsibility for the damage or injuries attributable to Party A. Nothing herein shall be interpreted as obligating A to indemnify B against its sole negligence or willful misconduct.

Percentage rent allows a retail landlord to benefit from a tenant’s success.  In addition to the base rent, tenants will pay an additional rent based on some percentage of the tenant’s gross sales typically triggered by what is termed a “breakpoint”.  New tenants asked to pay percentage rent are typically troubled by the idea mostly because they see it as a way of being penalized for success.  Clearly, landlords benefit significantly from percentage rent reaping additional profits in times of economic boom while losing nothing during downturns. However, there is a synergistic effect that can benefit tenants.  Most landlords aggressively seek to maximize profits and creating the right tenant mix and shopping center atmosphere aids in increasing the revenue stream for all tenants thereby increasing the landlords rent.  In such cases, the landlord at least arguably is creating something of value for tenants.  The value of a landlord’s labors in this scenario is of course difficult to measure, but with an earnest effort it can unquestionably have a dramatic impact on shopping center sales. 
 

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Percentage rent is typically set at five percent (5%) of gross revenue but usually doesn’t trigger until some “breakpoint”.  The breakpoint can be arbitrarily set by the parties as a stipulated breakpoint (for instance at $1,000,000).  In this case, a tenant would be obligated to pay 5% of all gross sales in excess of $1,000,000.  If gross sales were $1,500,000, the tenant would owe as additional rent of $25,000 (5% of $500,000).  Many retail leases set the breakpoint at what is termed the “natural breakpoint”.  For the natural breakpoint, you divide the base rent by the set percentage (the typical 5%).  The natural breakpoint results in a percentage rent applicable to sales over and above the point in which the base rent would equal 5% of gross revenue.  In other words, the tenant is paying 5% of gross sales or the base rent whichever is higher.  If the breakpoint is not reached, the base rent is higher than 5% of gross sales.  If the base rent in the above example was $120,000 ($10,000 a month), the breakpoint would be $2,400,000 resulting in no additional rent due.  The landlord is then guaranteed a minimum rent no matter how bad sales are, but benefits when sales are good. Tenants benefit if the stipulated breakpoint is above the natural breakpoint but not if it is below the natural breakpoint.  In the above example, if the stipulated breakpoint is $4,000,000, the additional rent would be zero.  If the stipulated breakpoint is $500,000, the tenant would pay the base rent ($120,000) plus a percentage rent of $50,000 (5% of $1,000,000).

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Because of the inherent risk of fraudulent activity, the sale of stock is a highly regulated transaction by both state and federal authorities. Unfortunately, many corporate shareholders erroneously believe that privately held corporations do not have to worry about securities regulations because of the limited number of people involved and the relatively limited share worth. They often sell shares of stock either via oral contracts or hastily thrown together written agreements without consulting a corporate attorney. While it is true that smaller privately held corporations benefit from a number of exemptions to securities registrations, the directors, officers and shareholders of these corporations must still comply with numerous state and federal regulations when it comes to selling shares of stock. In fact, it can be argued that in the smaller more intimate setting of a closely held private corporation, the risk of fraudulent activity is particularly troubling. For more on exemptions to registration requirements, see “Exemptions to Registering Federal Securities with the SEC“. Given the inherent risk and associated governmental requirements, it is important that corporate officers consult with an experienced corporate attorney before issuing shares of stock.

the-other-one-1241639.jpgA well drafted stock purchase agreement not only protects both the seller and purchaser of stock, it ensures that the corporation is in compliance with securities regulations. It should evidence a transparent transaction. Full disclosure (offering complete access to corporate transactional and financial records) is the key to complying with securities regulations. The idea of course is to ensure that the purchaser is fully informed as to the risk associated with the investment. The stock purchase agreement will also set forth the price per share, the number of shares, whose shares are being sold, the class of shares being sold, the effective date of the transfer and other terms and conditions governing the sale. The stock purchase agreement should clearly define each party’s rights and obligations going forward.

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Landlords desire radius restrictions in commercial leases for two main reasons: where the landlord is entitled to percentage rent, a competing business within the restricted radius may dilute the landlord’s income; and more generally a competing business within the restricted radius can have a negative impact on the exclusive nature of the shopping center.  For example, a national fashion chain with a significant lure draws shoppers to the center – shoppers attracted to that particular chain.  Opening the same chain too close to the center threatens to dilute the landlord’s traffic.  Retail landlords take great care to manage the shopping center’s mix to maximize foot traffic.  For either reason, reasonable radius restrictions are legitimate in San Diego commercial leasing.  However, tenants should take care to ensure that these clauses are carefully worded to limit the restrictions.  Particularly, it’s important that the “radius” of the restriction, the term of the restriction and the scope of the restriction are all specifically defined.  

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Defining the Radius:  Most commercial leases tend to broadly define the distance covered by a radius restriction – usually to about a five mile radius.  In such cases, the parties may have different understandings as to how the radius is measured.  A five mile radius might mean five miles as the crow flies in any direction from the store’s precise location or it could mean five miles in any direction from the boundaries of the shopping center.  In addition, five miles as the crow flies in a specific direction could fall on the edge of a competing shopping mall.  In that case, opening up shop just feet away from the maximum distance would still have the negative impact the landlord was attempting to avoid in the first place.  Landlords and tenants can avoid this type of confusion by clearly defining how the radius is determined.  Stating where the radius is measured from is a good start.  Defining the area more specifically on a street-by-street basis or using particular landmarks is even better.  
The Term of the Restriction:  The term of a radius restriction typically coincides with the term of the lease.  However, problems can arise when a lease is terminated prematurely.  If the tenant has an early termination right, it’s important that the radius restriction terminate simultaneously.  It’s also common for tenants to start developing new opportunities in anticipation of the end of a lease term.  This would be a problem if the radius restriction broadly defines the restricted activity as “running, operating, investing in or developing” a competing business.

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One of the most misunderstood concepts in litigation is the concept of proof. San Diego business owners know when someone or some other business has committed a wrong. They know if a business partner has stolen from them, when a deal has been broken or when someone fraudulently induced them into a bad deal. Because of this confidence, business owners often walk into an attorney’s office expecting an unqualified validation of their claims. In some rare cases, it may be true that a party has a virtually guaranteed win. Unfortunately, in most cases, prospective litigants face numerous hurdles involving significant litigation fees and costs, legal hurdles (including defenses), damages and amassing admissible evidence (proof) all of which vary the risk of loss. This article provides a brief summary of issues of proof in California litigation.

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It’s the attorney’s job to evaluate the case and give the client a frank assessment of what lies ahead. A good attorney will be careful to qualify her assessment pointing out various problems that may lie ahead including potential problems with proof. The client tells his story and while the attorney is listening, she is picturing how admissible evidence will be gathered and presented at trial. This often creates a disconnect between attorney and client leaving the client feeling flat. However the business owner might feel, it is important that he accept his attorney’s frank assessment especially when he has talked with several attorneys who are all providing similar evaluations. In fact, an attorney giving different advice might be blowing smoke to do whatever it takes to engage the client. It’s extremely important for prospective litigants to understand that what they personally know and what they can actually prove with admissible evidence are not always the same. Accepting these realities is often complicated because of the client’s personal and emotional connection to the dispute.

There are two key types of evidence presented at trial: witness testimony and documentary evidence. Both types of evidence come with a host of evidentiary and foundational requirements that in their entirety are beyond the scope of this article. However, there are some important evidentiary issues that assist the lay person in better understanding what their attorneys are trying to accomplish:

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Exclusive use clauses in commercial leasing are important to both landlords and tenants, especially in the retail context.  Landlords need to focus on the right tenant mixture, ensure that obligations to existing tenants are met and maintain the ability to attract new tenants. Prospective tenants need to know that a direct competitor won’t be setting up shop in the same shopping center or worse right next door.  In every new lease, exclusive use clauses come into play in two ways:  exclusive use clauses applicable to existing tenants and the new tenant’s desire to obtain its own exclusive use.  With respect to existing exclusive use clauses, new tenants are simply excluded from using the premises for such uses.  Language in the lease will typically refer to an exhibit itemizing the unpermitted uses based on exclusive uses already granted to existing tenants.  Whether an exclusive use is granted to a new tenant will depend on a host of factors including but not limited to the size of the new tenant in relation to the shopping center, the new tenant’s negotiating power, the current mixture of existing tenants in the shopping center and potential conflicts with existing leases (particularly with respect to anchor tenants (national chains) who maintain significant control over their operations).  

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All commercial tenants are subject to “use” restrictions. Before even entering into a lease, the parties generally have a firm understanding of just what is a tenant will be permitted to sell or serve on the premises (“Permitted Use”).  Whether this Permitted Use will be exclusive is a separate matter (but of no less importance to both landlords and tenants).  While it might seem intuitive that landlords would prefer not to be bound by exclusive use clauses, Landlords in fact benefit from a diverse tenant mixture.  First, the shopping center is generally more attractive to customers looking for the mall experience.  Second, it would be hard to attract new tenants if the landlord has a reputation of installing competitors right next door.  Finally, a significant number of prospective tenants will look elsewhere if they cannot be reasonably certain that the landlord will not lease space to competitors.   Moreover, in cases where the landlord receives a percentage of a tenant’s sales, exclusive use clauses become even more important. Because of these factors, most landlords will entertain the idea of granting an exclusive use to even the smallest tenant.  The real issue then becomes the scope of the exclusive use. 

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It may seem obvious that damages are important to litigation but it’s surprising how misunderstood the concept is amongst business owners and the general public. The misconception is understandable of course given the natural inclination to focus on wrong doing. Nonetheless, without damages (significant damages in most cases) the cost of litigation can be prohibitive even where the most egregious conduct exists. There are two very important practical reasons damages are a critical consideration in deciding whether or not to sue: 1) the costs of winning may exceed the value of the case; and 2) even if you win an amount greater than your costs, the chances of collection may be minimal.

u-s--supreme-court-hallway-658254-m.jpgIf the damages are less than what it will cost to litigate the case, there is very little benefit in suing. Aside from the moral vindication, risking $50,000.00 to fight a court battle where the damages are $50,000.00 is effectively a useless exercise no matter how low the risk of losing is. Moreover, it’s difficult to place a value on the emotional cost that comes with litigation. The battle itself takes a toll. Determining whether the damages are outweighed by the costs requires careful evaluation of numerous factors including the risk of losing and whether or not attorney fees are recoverable. The risk of losing is not always clear. The first step in analyzing risk is analyzing the merits of the case, something that should be analyzed with the assistance of an experienced litigator

Attorney fees for litigating a case through trial can easily reach $100,000.00. In more complicated cases, the fees can be far higher. Even in the most simplest cases with extraordinarily efficient litigation counsel, attorney fees through trial can exceed $50,000.00. This all of course presumes that attorney fees are recoverable in the first place either pursuant to a contract or some statute. Moreover, it’s possible that if you are awarded $5,000.00 in damages where you originally sought damages of $50,000.00, the court may not consider you a prevailing party for the purposes of awarding attorney fees. In such cases, your attorney fees will not be recoverable (you will have spent $50,000.00 in attorney fees plus costs while only recovering $5,000.00). In addition to attorney fees, actual costs are incurred. Copying fees, court filing fees, service of process fees, court reporter and transcript fees for depositions and trial and expert fees are just some of the actual costs incurred during litigation. These fees can double the cost of litigation. While most of these actual costs are recoverable to the prevailing party, the determination of who is the prevailing party is often unpredictable. In the worst case, your opponent may be determined to be the prevailing party in which case you will have to pay their costs and attorney fees along with your own (while collecting nothing in damages).

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Starting a new company with business partners requires a careful understanding of each partner’s expectations and goals.  Lengthy and detailed discussions amongst the prospective partners are common.  Unfortunately, these expectations and goals aren’t always adequately memorialized in writing.  Too often, partners rely on oral agreements – sometimes with respect to the entire partnership.  See “Why Oral Partnerships Are a Bad Idea.”  Seasoned business men and women understand that oral agreements are problematic.  They understand the importance of a formal written agreement and in today’s climate usually opt to form a business entity such as a corporation or limited liability company (“LLC”).  However, even with well drafted corporate by-laws or LLC operating agreements, the partners are sometimes still surprised by the result when one of the partners dies, goes bankrupt or merely decides that he or she wants out (perhaps because the sale price for the exiting partner’s share in the business was based on a set value which is now too low given a change in the fair market value of the business). For whatever reason, the owners neglected to ensure that a buy-sell agreement was included, or, if one was included, that it embodied the expectations they had originally discussed.  A well drafted buy-sell agreement addressing every contingency will govern precisely how shares of the business will be transferred upon the occurrence of triggering events and how the price of the shares will be determined.  This article briefly discusses important issues with respect to buy-sell agreements.  It is not a comprehensive analysis however.  Given the complexities of buy-sell agreements, it is best to work with an experienced corporate attorney.  

business-man-407618-m.jpgTriggering events include the death, incapacitation, bankruptcy, divorce or retirement of a partner or the desire of a partner to sell his ownership interest.  A good buy-sell agreement will clearly define precisely what happens upon the occurrence of any of these triggering events.  It may call for the immediate purchase of a deceased, incapacitated or bankrupt partner’s ownership interest by the company itself (Redemption Agreements), or it may grant the remaining partners a right of first refusal before the company itself is required to purchase the interest.  It might also call for the remaining owners to purchase the ownership interest (Cross Purchase Agreements).  In cases of divorce, the buy-sell agreement might require that any claimed interest of the non-partner spouse automatically transfer to the partner (the non-partner spouse will have signed a spousal consent when the buy-sell agreement was originally executed).  When one partner wishes to sell his interest in the company, the buy-sell language will usually require that the remaining partners approve of the sale or at least maintain a first right of refusal in which case the buy-sell agreement will detail the mechanism by which this right will be exercised.

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