The Leader Magazine

SEP 2016

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SEPTEMBER 2016 17 Part of a trend Landlords traditionally have not liked tenant options. Notwithstanding this, during the past few years options of all kinds have become increasingly common. Even contraction rights and complete termination rights are now being included in leases. While the basic economic and legal components of the various kinds of options have become fairly standard, the details are typically deal-specific and can be intricate. The timing of the exercise of an option right, the space covered by the right, and whether or not the right, if not exercised, rolls over and becomes available again (or is lost forever) are all closely negotiated issues. Increasingly, tenants are succeeding in getting lengthy lists of these rights that cover a variety of spaces and that arise (and sometimes re-arise) over a lengthy portion of the lease term. Before we review the general outline of each kind of option right and the standard set of issues that you as a tenant should be prepared to discuss for that right, let's look at what you should do to position yourself for the best chance of getting the package of option rights that you want. That is, to put this requirement in a request for proposals (RFPs). If an RFP process is not being used, at the very least, these rights must be stated in the letter of intent. t hree primary types of tenant options 1) Extension options have been common for many years. This is the option that allows the tenant to extend the lease term for a specified period. Typically, an extension option must be exercised no later than nine to 12 months before the original lease expiration date. Issues to be addressed in structuring this option include: how many times the tenant may extend the term and for what period each time; what the measure of rent for the extension term will be and how it will be determined; and whether or not the option will be exercisable for less than all of the leased space. 2) Expansion options come in two forms: traditional fixed-option rights and rights of first offer (ROFO). Traditional fixed options are a right for a tenant to expand to a specified additional area (often a contiguous floor or an adjacent suite) that is exercisable for a short period (e.g., six months) after the lease commencement date. Most often the expansion space, if taken, will be included in the lease on the same economic terms, including the base rent rate, as the original space. An issue to be negotiated will be whether any landlord work or tenant-improvement allowance will be available for the expansion space. ROFOs are the other type of expansion option. Many varieties of this option right exist, but typically they all include the obligation of the landlord to offer certain identified space to the tenant first, before it is offered to third parties. The landlord's offer to the tenant must be on the same terms that the landlord intends to offer to the third-party market. The tenant will have a relatively short period of time to accept or reject the offer before the landlord can offer the space on the open market. If the tenant accepts the offer, the ROFO space is rolled into the existing lease on all of the terms of the lease, except for the terms specified in the landlord's offer for the ROFO space. If the tenant fails to timely accept the terms of the offered ROFO space or rejects the offer, then the landlord is free to offer the space on the open market. With most ROFO options, if the landlord cannot lease the space within some defined period of time (e.g., six to nine months) after the tenant fails to exercise, or, if the landlord elects to make the offer to prospective third-party tenants better by some agreed-upon percent (e.g., 5 or 10 percent) of value compared with what was offered to the tenant with the ROFO right, then the landlord must come back to the tenant that had the ROFO right and re-submit its offer to that tenant. Issues to be discussed that are specific to ROFOs include whether or not a rejected ROFO space must ever be re-offered to the tenant if it becomes available later in that tenant's lease term, and whether there are any other tenants that have a right superior to that of the tenant that has obtained the new ROFO right. It is recommended that if the lease will state that there are tenants with superior rights, that those tenants be named in an exhibit to the lease, along with the general dates within which their superior ROFOs must be exercised. This level of specificity will help eliminate misunderstandings and disputes later.

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