Early Termination Provisions: A Landlord's Saving Grace … If Done Right

a) In no event shall the effective termination date be prior to June 30, 2010.

b) Provided tenant vacates on or before the effective termination date, landlord shall pay tenant the sum of $36,000.00 should said cancellation occur during the period July 1, 2011 through June 30, 2012. The amount to be paid the tenant shall decrease by the sum of $7,200 with each subsequent year.

We chose this provision as our case study in order to learn from the oversights of its author. (For pedagogical purposes, and to protect the innocent, our case study has been minimally doctored.) While there are numerous ways that our case study can be improved upon, for the sake of brevity we focus on four mistakes, which, if corrected, would dramatically increase the provision's potency:

1. Ambiguity over the meaning of “demolition;”
2. Ambiguity as to what notice or event triggers the right to terminate;
3. Ambiguity as to the timing of tender of the tenant's termination payment; and
4. Ensuring the termination provision is drafted as a conditional limitation.

Each of these four issues is explored, in turn, below.

Ambiguity over the Meaning of 'Demolition'

Our case study allows a landlord to terminate in only one instance — a building demolition (to wit, “in the event the building of which the demised premises forms a part is to be demolished …”). This is not only vague (what qualifies as a “demolition”?), but unnecessarily restrictive as well.

To overcome the vagueness problem, the term “demolition” should be specifically defined in the lease. In crafting such a definition, the negotiating parties must consider whether a razing of the entire building is necessary in order to qualify as a “demolition,” or whether a gut rehabilitation or other less onerous dismantling will suffice. See, North Shore Mart v. F.W. Woolworth, 124 A.D.2d 574 (2d Dept. 1986) (demolition defined in subject lease as a replacing “of more than 50 percent of the ground floor building area … in the shopping center of which the demised premises is a part”). If the latter suffices, then the parties may consider simply replacing the term “demolition” with the phrase “substantial rehabilitation as defined under 9 N.Y.C.R.R. 2520.11(e) as may be applicable to commercial tenancies.”

Using “substantial rehabilitation” provides a precise and measurable legal definition of the standard to be met — to wit, a replacing of 75% (or some other negotiated percentage) of the building-wide systems, all ceilings, flooring and plasterboard or wall surfaces in common areas, and all ceiling, wall, and floor surfaces — without spilling much ink. This “substantial rehabilitation” standard is all the more useful in light of the fact that New York law (and presumably the law of other states) does not clearly define “demolition.” See, e.g., 12 N.Y.C.R.R. 23-1.4(a)(16) (“The work incidental to or associated with the total or partial dismantling or razing of a building or other structure including the removing or dismantling of machinery or other equipment”); Peckham v. Calogero, 12 N.Y.3d 424 (2009) (“gut[ting] the interior of the building, while leaving the walls intact, has been held as sufficient” to constitute a 'demolition'”).

Notably, a termination right may be triggered not only in connection with a demolition/substantial renovation, but in the event of a sale or transfer of ownership interests as well. In such a “sale” situation, it is likewise important to think outside the box as to the conditions of the “sale” and tenant's entitlement. See, Miller v. Levi, 44 N.Y. 578 (1871) (lease granting landlord the right “to terminate the lease at the end of any year by giving sixty days previous notice, in case he should sell or desire to rebuild”). It must be noted that there are a host of ambiguities to be addressed in instances of termination based on “sale” as well. For instance, do transfers of shares or assignments of ownership interests in a building constitute a “sale” of that building? Is the right personal to the landlord on the lease or even to subsequent purchasers? Is a physical transfer of title required? And, if not, at what point in the transaction has the termination right accrued to the purchaser? Is the granting of a right of first refusal sufficient to trigger owner's “intent to sell”? What happens if the deal aborts?

Ambiguity as to What Triggers the Right to Terminate

Our case study grants the landlord the right to terminate “in the event the building of which the demised premises forms a part is to be demolished.” Such a clause is ambiguous because, in addition to the reasons stated above, at what point are the “demised premises … to be demolished”? In other words, is a landlord's genuine mental intent to demolish, without more, sufficient to trigger the termination right? Is it the retention of an architect to prepare plans? Is a filing with the Department of Buildings (DOB) necessary? Is the obtaining of DOB approved demolition plans or the issuance of certain permits a prerequisite? “To be demolished” when? In a year? In five years? What if a contract of sale is entered into but is later canceled after the tenant vacated? Such questions are fertile grounds for litigation (and therefore delay).

In Barbes Restaurant v. ASRR Suzer 218, LLC, 140 A.D.3d 430 (1^st Dept. 2016), a similar ambiguity played right into the hands of the tenant. There, the lease's termination provision provided as follows: “The parties understand and agree that if landlord has a bona fide intention to demolish or alter the building or the area of the Building in which the demised premises is located, then and in such event landlord may cancel the unexpired portion of the term of this lease … upon not less than six (6) months prior written notice to tenant.”

The landlord in Barbes served the tenant with a termination notice announcing the landlord's “election to demolish the area of the building” where the tenant's restaurant was located, seemingly in accordance with this provision. The court, however, struck down the landlord's termination notice, and held that the landlord “lacked 'a bona fide intention to demolish' the building or area of the building where its restaurant was located, as required by section 79 (A) of the lease rider. Up through the commencement of this action, defendant had not filed a demolition application with the Department of Buildings, and, although it had retained architectural and engineering firms to prepare architectural drawings, and had conducted geological and structural tests, its plans were still in the early stages and it was still evaluating different redevelopment options.”

Interestingly, Barbes made no mention of Plaza Operating Partners v. Maison Mendessolle, 18 HCR 542A (App. Term 1st Dept. 1990), where the court more strictly construed the subject lease termination provision (this time triggered by sale instead of demolition). Plaza Operating, decided 26 years earlier, held as follows: “Landlord's … notice of termination … was effective to terminate the lease. The governing termination clause permitted landlord to terminate the lease upon it determination to sell; it was not required that the sale actually be consummated ….”

One may read Barbes and ask, if the contracting parties intended “bona fide intention to demolish” to mean that a demolition application had to be filed with DOB, then why didn't the lease simply say so? Indeed, the lease did not, and bewilderment at the court's unexplained thrusting of phantom obligations upon the landlord, especially in light of Plaza Operating, would be understandable.

Clearly, New York's Appellate Division, First Department, took precedent-setting liberties in Barbes for which landlords must now account when drafting termination provisions. In order to avoid similar such outcomes, landlords should employ a clear and objective standard — a triggering event — as to when the right to terminate is triggered.

Ambiguity As to the Timing of Payment of the Tenant's Termination Fee

Our case study provides that the tenant is entitled to a termination payment in exchange for vacatur (i.e., “provided tenant vacates on or before the effective termination date, landlord shall pay tenant the sum of $36,000 ….”) However, the case study is ambiguous as to when the landlord is required to tender this payment. Is the payment to be tendered at the time that the landlord serves its termination notice cancelling the subject lease, or at the time that the tenant vacates the premises? Also, would the tenant be entitled to the payment if, at the time of vacatur, the tenant is in default of the lease? Our case study is glaringly silent on these issues.

The tenant would likely insist that payment be tendered in advance of vacatur, or, at a minimum, that such payment be held in escrow pending the vacatur. The landlord, on the other hand, would likely insist that payment be tendered simultaneously with (or a fixed number of days after) the tenant's full and timely vacatur in accordance with the lease. Because neither side's position is supported by the terms of our case study, litigation (and therefore delay) would be necessary to ascertain the intent of the parties. (See, Plaza Operating, id. (“recognizing that the question of whether covenants of a lease are to be construed as mutually dependent upon or independent of each other is to be resolved by reference to the intent of the parties and by the application of common sense to each case”) The court ultimately held that “payment … to the tenant … was not required as a condition precedent to the tenant's surrender of possession” and that payment was to be made after the tenant properly vacated. Plaza Operating has apparently not been cited by any court for the propositions of law referenced in this article.)

In addition to specifying the timing of the termination payment, a termination provision should provide, at a minimum, that “time is of the essence,” and require tender of all keys to the premises and the building, along with a surrender affidavit, at the time of vacatur as a pre-requisite to payment.

Finally, where, as in our case study, the value of the termination payment is based on a sliding scale, amortized over the remaining life of the lease, it is imperative that the negotiating parties specify the point in time that the payout meter stops accruing. In our case study, the termination payment amount decreases by $7,200 over time, depending on the calendar year. Is it the calendar year in which the notice is given or is it the calendar year in which the termination date occurs? The difference can be tens of thousands of dollars. And if the triggering notice must be a certain number of “months,” is that calendar months or 30-day periods of time? Here, precision in the drafting stage would save much in the way of time, money and resources litigating later.

Conditional Limitation Versus Condition Subsequent

While our case study provides for a termination of lease, it is nevertheless problematic because it is drafted as a “condition subsequent,” and not as a “conditional limitation.” (For a detailed discussion of “conditions subsequent” and “conditional limitations,” see, “To Eject or Evict —A Lease's Conditional Dilemma,” N.Y.L.J., Aug. 30, 2010).

The distinction between a “condition subsequent” and a “conditional limitation” is critical because it determines a court's subject matter jurisdiction. If the language of a lease's termination provision is drafted as a “conditional limitation,” then the landlord would have the right to unilaterally terminate the lease, and then commence a summary proceeding in Civil Court to “evict” a holdout tenant.

If, however, the language of a lease's termination provision is drafted as a “condition subsequent,” then the landlord does not have the unilateral right to terminate the lease, and the Civil Court lacks jurisdiction to hear the case, thus requiring that the landlord utilize the longer and more expensive Supreme Court plenary action in order to terminate the lease and “eject” the holdout tenant. Obviously, landlords favor termination provisions drafted as “conditional limitations.” Clarity in drafting conditional limitation provisions is paramount. See, Nordica Soho LLC v. Emilia, Inc., 44 Misc.3d 76 (App. Term 1st Dept. 2014); 34th Street Penn Assoc. v. Payless Shoesource, N.Y.L.J., March 7, 2014 (Civ. Ct. N.Y. Co.)

To qualify as a “conditional limitation,” a termination provision must first grant the landlord the right to terminate the tenancy, and second, must set forth an objective sequence of steps for the landlord to put into motion in order to effectuate such termination (such as the service and expiration of a notice). Only when both of these pre-requisites are satisfied will the termination provision in question qualify as a “conditional limitation.” The most common example of the requisite “objective sequence of events” is the giving of a notice of default or termination coupled with the expiration of that notice upon the passage of time. See, Gouveneur Gardens Housing Corp. v. Lee, 2 Misc.3d 525 (Civ. Ct. N.Y. Co. 2003) (Lebovits, J.) (“In contrast, upon the occurrence of a conditional limitation, the agreement automatically expires; no other act is necessary to end it. To create a conditional limitation rather than a condition, the agreement must state clearly that it will expire upon the happening of some objective event.”)

Here, while our case study gives the landlord the right “to cancel the within lease,” a court would likely find that it does not contain the “objective sequence of events” necessary to effectuate the termination. In other words, it says that the landlord can terminate but does not say how that termination is to be brought about. Therefore, our case study likely does not qualify as a conditional limitation, which means that the landlord would likely have to commence a Supreme Court action to “eject” its holdout tenant.

Crafting the Perfect Provision

Thus, the ideal termination provision may address the problems discussed above, of (a) definitional vagueness and restrictiveness, (b) termination trigger, (c) timing of payment, and (d) condition subsequent, by utilizing the following provisions:

Notwithstanding anything to the contrary contained in this lease, if at any time during the term of this lease [or after a certain number of lease years], landlord shall (A) (i) decide, in its sole and absolute discretion, to alter, demolish, or substantially renovate (pursuant to 9 N.YC.R.R. 2520.11[e] as may be applicable to commercial tenancies) the building or portions thereof in which the demised premises are situated, and (ii) the NYC Department of Buildings has approved landlord's demolition or renovation plans [or the landlord has submitted an application for the demolition the building or portions thereof in which the demised premises are situated]; or (B) Landlord has entered into a contract or agreement to sell the building or to transfer or assign [a majority or other designated percentage of] its rights and interests under this paragraph __ to a bona fide third party in compliance with section __ of this lease, landlord shall have the right, exercisable at any time after the date hereof [or after a certain number of lease years], to terminate this lease (the “termination option”). Landlord, in its sole and absolute discretion, may exercise the termination option upon notice to tenant sent pursuant to paragraph _ of this lease, which notice shall set forth the date upon which this lease shall terminate (the “termination date”), and which date shall be not less than three hundred and sixty-five (365) days after the date of such notice. Upon the termination date, the term of this lease shall irrevocably end, terminate and expire as if such termination date were the date set forth in this lease for the expiration of the term thereof.

If (A) on or before the earlier of the termination date, or on such earlier date as the parties may otherwise agree in writing (the “effective date”), (i) tenant (and all persons and entities claiming by, through or under tenant) quits and surrenders the premises to landlord in the condition provided in this lease for the surrender of the premises to landlord on the expiration date set forth in this lease, and (ii) tenant executes, acknowledges and delivers to landlord the “vacatur affidavit” in the form attached hereto as exhibit __, together with all the keys to the premises and building; and (B) on the earlier of the termination date or effective date tenant is not in default of its obligation to pay any fixed rent or other charges payable under this lease and is not in default of any other terms, covenants or conditions on tenant's part to observe, perform or comply with (subject to the expiration of any cure period provided in the lease) (such date satisfying [A] and [B] above, the “actual vacate date”), then, within thirty (30) days after the actual vacate date landlord shall pay to tenant the “termination amount” (as hereinafter defined) to be calculated as of the actual vacate date. Tenant's breach of this paragraph __ (TIME BEING OF THE ESSENCE and NO DEFAULT SHALL BE DE MINIMIS) shall result in the full and irrevocable forfeiture of the termination amount. (As noted above, there are many other factors to be considered in the drafting of a proper termination provision , such as the inclusion of: (i) an enforceable liquidated damages provision, (ii) an indemnification provision, (iii) a self-help provision, (iv) a paragraph detailing the calculation of the termination payment (if any) to be paid to the tenant if based on amortization of tenant improvements, (v) a provision requiring an escrow at the time the notice is given, (vi) a provision requiring that the landlord shall have served all tenants in the building with similar Termination Notices, and (vii) a provision placing the onus of compliance with all applicable legal requirements in connection with the termination payment (if any), including tax regulations, on the tenant. These and other issues were not discussed in this article due to space restrictions.)

Parting Thoughts

Termination provisions are often significant because landlords, purchasers, and real estate developers will base their decision to sell, purchase and develop property on the effectiveness of such provisions. And as New York courts generally go to great lengths to rescue tenants from having to forfeit their leaseholds — see, 135 East 57th Street LLC v. Daffy's, 91 A.D.3d 1st Dept. 2011) — it is crucial that landlords arm themselves with a detailed understanding of not only how to avoid the pitfalls associated with such provisions, but also how to draft such provisions in the most optimal way possible. If drafted correctly, termination provisions should give tenants no hope of being able to hold-up a sale with anything more than a frivolous (and sanctionable) lawsuit.

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Menachem J. Kastner heads the real estate litigation division of the commercial litigation department of Cozen O'Connor's New York office. Ally Hack is a member in the department. This article also appeared in the New York Law Journal, an ALM sibling of this newsletter.