LEASE AGREEMENT REFERENCE GUIDE 610: PRO-TENANT EXPANSION RIGHTS STRATEGIES WITH RIGHT OF FIRST REFUSAL $24.95
Tying Up The Office Landlord With Pro-Tenant Expansion Rights
This LARG looks at two lengthy pro-tenant clauses that give an office tenant broad rights of expansion at the expense of the landlord. The first clause gives the tenant an option to lease about 23,000 additional rentable square feet of office space. The second gives the tenant a right of first refusal (ROFR) for any space that becomes available in the building containing the premises or in an adjacent office building that is planned by the landlord for the office complex.
The second clause granting the tenant the ROFR is the more troublesome of the two for the landlord for two important reasons. First, that clause gives the tenant an ongoing right to lease space in the original building containing the premises and in the second office building planned by the landlord for the complex. Second, the ROFR doesn't go away--it has a revival feature that gives the tenant a ROFR for all space that becomes available in either building, even after the tenant has refused to exercise its right to lease space that became available earlier. Most sophisticated landlords, when they are forced to give rights of first refusal at all, negotiate to give the tenant only one bite at the apple, assuming the landlord and the third party tenant conclude a deal. If the tenant doesn't exercise when it has the chance, and a third party deal is done, the landlord wants the ROFR to evaporate.
The ROFR Marketing Cloud
The reason for the landlord's aversion to ROFR clauses is obvious. Trying to lease space subject to a ROFR can be the quintessential frustration for a landlord, especially in a weak market. To lease space in slow markets, landlords need to be able to act fast and make decisions for prospective tenants that are always negotiating with several landlords at the same time. But the ROFR impedes fast action by the landlord. It requires the landlord to offer the space the third party prospect wants first to the existing tenant.
Even worse, the tenant with the ROFR has fifteen days to think it over. If, by some miracle, the prospective tenant is still around after the fifteen day cooling off period, the landlord and the prospective tenant can continue negotiations. Unless, of course, those negotiations result in a modification to the proposed deal (i.e., one that lowers the rent or sweetens another economic component of the deal) that requires the landlord to offer the space to the tenant with the ROFR again. In that case, it's time for an encore performance of the ROFR mazurka.
No doubt, the clauses below came from a deal with a tenant that was planning to occupy most or all of the two buildings covered by the expansion rights. But where is the landlord left when the tenant's business sputters, and the tenant no longer needs expansion space? The tenant still has the expansion rights, and depending upon the assignment and sublease provisions contained in the lease, may assign the lease to someone that will make good use of them. Maybe someone without much cachet, like the State Department of Public Welfare.
At least the landlord was able to negotiate some protections in the provisions. The rent for any additional space leased by the tenant under the expansion option (Article 46), but not the ROFR clause (Article 47), is to be market rent. Plus the rent for space leased under the option to expand has a floor. It can't be any lower than the highest rent for any space in the complex occupied by the tenant.
Maybe everything will turn out fine for the landlord, and the tenant will expand to take up all or most of the space in both buildings at market rentals. But don't count on it. These expansion rights only benefit the tenant, and if the rent for more space turns out to exceed rentals in comparable competing projects due to the rental floor negotiated by the landlord, the tenant (or his successor) will be back to the table.
Lease Clause Critique: Pro-Tenant Expansion Rights
Two pro-tenant clauses follow. Article 46 gives the tenant the option to lease additional space, subject to certain conditions. Article 47 gives the tenant a right of first refusal to lease all office space in the two buildings affected by the clause.
OPTION TO EXPAND TENANT'S PREMISES
46.1 Landlord agrees to notify Tenant in writing and keep Tenant informed of the commencement and expiration dates of all leases of any space in the Building and in the adjacent office building designated on Exhibit B hereof ("Adjacent Building") proposed to be constructed in the Complex.
Comment: Section 46.1 obligates the landlord to notify the tenant of the commencement and expiration dates of all other leases affecting the building, or affecting the additional adjacent office building which may be built by the landlord. Of course, the landlord is obligated under Article 46 and 47 to offer the space to the tenant before leasing it to third parties anyway, which makes the notice burden for the landlord no greater than the one it already has.
46.2 Provided Tenant is not in default under this Lease on the date of the exercise or the commencement date of such leases, Tenant shall have the right, exercisable at its sole option, to lease approximately Twenty Three Thousand (23,000) additional rentable square feet of office space (the "Expansion Space") located anywhere in the Building or in the Adjacent Building. If the proposed Adjacent Building is not constructed, Tenant's option to expand, to the extent exercised, shall be satisfied by Landlord in full out of space in the Building, and without further liability to Landlord. Landlord shall deliver the Expansion Space to Tenant at any time, and from time to time, during the Twenty Fifth (25th) through the Sixtieth (60th) months of the initial term of this Lease, provided that (a) the Expansion Space delivered by Landlord may total as much as Twenty Five Thousand Five Hundred (25,500) rentable square feet and as little as Twenty Thousand Five Hundred (20,500) rentable square feet; (b) the Expansion Space is delivered in at least two (2) separate blocks of space, one containing not less than Three Thousand (3,000) rentable square feet of office space and the other containing not less than Five Thousand (5,000) rentable square feet of office space; (c) such two blocks of space shall be delivered to Tenant at least one year apart from each other; and (d) in no event shall Landlord deliver more than Eleven Thousand Five Hundred (11,500) rentable square feet to Tenant during any twelve (12) month period. Prior to its lease by Tenant, Landlord may lease any or all of the Expansion Space to third parties, so long as the terms and conditions of such leases are not inconsistent with Landlord's obligations under this Article 46 or Article 47 below. Tenant's option to expand shall be exercised and the Expansion Space shall be delivered by Landlord as further provided in Section 46.3 and 46.4 below.
Comment: Section 46.2 grants to the tenant options to lease additional space in the building containing the original premises, and in the adjacent building if it is ever completed by the landlord. These options to lease additional space are conditioned upon the tenant's not being in default under the original lease when the options are exercised or when the terms of the leases for the additional space commence. If the landlord does not construct the additional office building, then the tenant must satisfy its need for space from the building containing the original premises. Note that the landlord has wisely inserted language to protect it from liability to the tenant for expansion space if the adjacent building is not constructed. Such language acknowledges that the decision to construct the adjacent building may not be within the landlord's total control (e.g., the financing for the adjacent building may not be finalized, and pre-leasing requirements by lenders may affect whether or when the additional building is constructed).
Section 46.2 provides that the expansion space covered by the tenant's option (as opposed to its rights of first refusal covered in Article 47) is to be delivered to the tenant between the 25th and 60th months of the original term of the lease. However, a number of requirements attend the delivery of any additional space to the tenant. First, the amount of expansion space actually delivered by the landlord may vary from the 23,000 square feet of space specified above, so long as it ranges between 20,500 and 25,500 rentable square feet. Second, the expansion space must be delivered in at least two separate blocks of space, and one block must contain not less than 3,000 rentable square feet and the other must contain not less than 5,000 rentable square feet.
Third, the two blocks of space must be delivered to the tenant no sooner than one year apart. Finally, the landlord may not deliver more than 11,500 rentable square feet to the tenant during any twelve month period. Section 46.2 also provides that the tenant's option to lease additional space is subject to the landlord's right to lease portions of the building to third parties so long as the tenant's rights under the option are not affected, and the formalities of the right of first refusal are observed.