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Lease Expirations and Tenant Holdover
Tuesday, March 14, 2006
Lease Expirations and Tenant Holdover – AAvoiding Multi-Party Disputes
A recent controversy between an office tenant in holdover after a lease expiration, the tenant’s landlord, and the new tenant for the same space may redefine how commercial office space leases are negotiated.
A New York state supreme court judge ruled that a tenant (Tahari, Ltd.) who’s lease expired but remained in its office space was liable for damages to the new tenant (Kronish Lieb Weiner & Hellman, LLP) for delaying the law firm’s move into Tahari’s expired lease space.
When office market conditions are soft, as has been the case in Houston over the past several years, tenants can often holdover in expired lease space with little concern of being pressured to renew long-term or move out on a timely basis. The situation is rapidly changing, however. Houston’s office leasing market reached a 5-year high in absorption at the beginning of 2006, with over 2.3 million square feet of net new space leased. This was the highest space absorption since 2000 and drops Houston’s total office vacancy from 20.1% to 17.5% within a two year time period.
What is different about this dispute is the potential double liability incurred by the holdover tenant. Typically, a holdover tenant is liable to the landlord for damages, which can be extensive. Coincidentally, the landlord in this case is also a major landlord in Houston, who owns over 4 million square feet of office space here. In this case, however, the new tenant has also filed suit against Tahari for damages due to not moving out of their sublease space on a timely basis, claiming $1 million in damages for the delay. The fact that the new tenant is a law firm doesn’t bode well for the holdover tenant.
Tenants often don’t realize how market dynamics can affect their lease negotiations. A tenant that had considerable leverage in negotiating their original lease, may find that changing market conditions have moved subsequent negotiations in the landlord’s favor. Assuming that following the letter of the law is not necessary when it comes to timely exercising a renewal, expansion, or termination option could be a very costly mistake, no matter how large or financially strong a tenant may be.
Most multi-tenant office buildings have existing tenant encumbrances which means when tenant “A” doesn’t vacate when required, tenant “B” is also forced into holdover in its old space and construction is delayed in both premises. Also, in some cases, a tenant “C” is also forced into the same predicament, causing a domino effect.
The most significant aspect of this tenant/landlord/tenant dispute is that the court permitted the new tenant to file a separate, stand-alone action from the landlord’s action against the holdover tenant, which is new legal ground in real estate in the United States.
Moral of the story: When negotiating a lease agreement, don’t overlook the underlying obligations.
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