Tenant Negotiating Strategies for Diabolical Expansion Rights
Markets with high vacancy rates give quality tenants the opportunity to negotiate expansion rights they could never get in times of low vacancies. Such expansion rights can be very valuable to tenants planning to increase the size of their operations in a particular location, whether due to plain business success or the acquisition of, or merger with, a competitor. If properly negotiated, rights to expand the premises give the tenant all the space planning flexibility it needs, and they rarely obligate the tenant to do anything.
Of course, just about any contractual right permitting the tenant to expand the premises operates in the tenant's favor. Such rights include:
- Expansion Options which give the tenant a fixed period of time in which to notify the landlord that it wants to lease additional space. The rent for the expansion space may be stipulated in the option, or it may be subject to fair market determination. Sometimes, particularly if the expansion space is directly comparable to the original premises (in terms of location and improvements), the rent for the expansion space is exactly the same as the rent for the original premises. In such cases, the expansion space is merely added to the definition of "premises" contained in the lease, and the tenant's rent and pro-rata share of operating expenses are adjusted.
- Rights of First Refusal (ROFR) which give the tenant the right to lease additional space triggered by the actions of third parties, (i.e., other potential tenants seeking to lease space in the same office building or complex). Garden variety ROFR clauses give the benefited tenant a period of time to decide if it wants to lease the space offered by the landlord to the third party tenant on the same terms and conditions applicable to the third party deal. Normally, if the tenant benefited by the ROFR doesn't take the space, and if the landlord does not make the deal with the third party tenant within a certain period of time, the ROFR "revives" (i.e., the landlord must again offer the benefited tenant the right to lease the space if a third party deal arises.
- Rights of First Offer (ROFO) which obligate the landlord to notify the tenant benefited by the ROFO that it desires to lease space subject to the ROFO. Although the landlord may or may not have a specific tenant in mind for the space, a ROFO usually requires the landlord to makes a proposal covering the business terms of a proposed lease for the applicable space. With a ROFO, usually no third party deal provides the business terms for the landlord's proposal.
- If the tenant benefited by the ROFO doesn't elect to lease the space on the terms offered by the landlord in its notice, the landlord is normally free to try to lease such space to any third party, provided it does so based upon the terms in its notice (or, in some cases, on terms no more favorable than those in the landlord's ROFO proposal). In many cases, the landlord must make a deal for the space involved within a certain period of time, or the ROFO will "revive," requiring the landlord to offer the space to the tenant benefited by the ROFO anew.
Overlapping Expansion Rights
Assuming the tenant has the leverage required to negotiate the kind of expansion rights described above, there is no reason (at least as far as the tenant is concerned) not to try to negotiate a multi-tiered expansion scheme (e.g., an expansion option and a ROFR which overlap).
A multi-tiered approach can have considerable benefits for the tenant. For example, a tenant that has negotiated both an expansion option and a ROFR covering the same space may have the luxury to choose which device it will use to take down certain expansion space. As a result, the tenant may be able to obtain the expansion space under the ROFR cheaper than it could under the option, provided the rent specified for the expansion option exceeds the rent contained in a third party deal which triggers the ROFR.
Any sort of expansion right in favor of the tenant in the lease is going to cause problems for the landlord when it tries to lease the space subject to the provision. Even so, the most diabolical (as far as the landlord is concerned) expansion provisions include several distinct contractual rights which operate in multiple layers in favor of the tenant.
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