It is no secret that the landlord/tenant industry in Florida is still experiencing Covid-19 residential effects. As such, it is important for landlords and tenants to understand their rights and remedies when faced with a breach or potential breach of a commercial lease. Each party’s rights and remedies are derived from either the lease agreement or state law, so effective lease drafting and knowledge of Florida specific laws are necessary.
Commercial real property leases in Florida typically have a fixed term, such as five to ten years, for example, and establish an expiration date for the lease term. When the lease expires on the expiration date stated in the lease, the parties usually rely on the language in the lease establishing their respective rights and obligations at lease termination. Sometimes, a lease terminates on an earlier date, either: involuntary, such as: casualty or condemnation, failure to timely deliver the premises, co-tenancy requirements, and/or tenant exclusives. These risks often adequately addressed during the lease negotiations and the conditions on which the lease terminates are established in the lease.
Sometimes, however, unforeseen circumstances arise creating particular problems for the landlord or the tenant that are not addressed in the lease, such as: (1) major business disruptions affecting the tenant’s ability to continue operations; (2) the tenant’s poor business performance affecting its ability to meet its financial obligations under the lease; and/or (3) the landlord’s need to quickly regain possession of the premises after a tenant default.
In these circumstances, the landlord or the tenant may need to evaluate additional concerns if they desire to voluntarily terminate the lease before the stated expiration date. Real estate leases and their ancillary documents are generally governed by state and local laws where the premises are located. Before negotiating a lease termination, the landlord and the tenant should understand Florida laws that may impact the lease termination and surrender, such as: (1) the imposition of sales or transfer taxes on any required termination payments; (2) requirements relating to returning or retaining security deposits; and/or (3) whether a tenant may terminate the lease after a landlord default.
If the lease termination requires a termination payment in exchange for terminating the lease, the parties should confirm whether the payment triggers any taxes under Florida law.
Florida Sales Tax
The State of Florida imposes a sales tax on the total rent charged under a commercial lease (§ 212.031, Fla. Stat.). If a landlord charges the tenant a fee to cancel or terminate the lease, the termination payment is presumed taxable if the landlord records it as rental income in its books and records. This presumption can be overcome if the landlord or the tenant provides sufficient documentation that the termination payment was other than for the rental of the real property. (§ 212.031(8), Fla. Stat.)
If the termination payment is not intended as rent, the parties should reflect the appropriate characterization in the lease termination agreement. The parties often include language prohibiting either party from reporting the termination payment as rental income or a rental expense in their books and records.
Florida Transfer Tax
Florida imposes a documentary stamp tax on certain transfers of real property for consideration (§ 201.02, Fla. Stat.).
The cancellation or extinguishment of a commercial space lease for consideration does not trigger Florida documentary stamp taxes. However, the assignment or other conveyance of a leasehold interest for consideration is subject to the documentary stamp tax based on the amount of consideration given for the transfer (Fla. Admin. Code Rule 12B-4.013(23)).
Accordingly, if the landlord pays the tenant a termination payment in exchange for terminating the lease, the parties usually structure the termination as an extinguishment of the lease rather than an assignment of the lease.
Return of Security Deposit
Many commercial leases require that the tenant provide the landlord with a security deposit as security for its obligations under the lease. In Florida, commercial tenants generally do not have any special statutory protections for security deposits. Florida statutory law only addresses the administration, retention, and return of a security deposit for residential tenancies. See § 83.49, Fla. Stat.
Accordingly, the terms of a commercial lease govern the treatment of the tenant’s security deposit. The parties should carefully review the lease security deposit provisions to understand their respective obligations regarding the retention or return of the security deposit after the lease is terminated.
If the parties agree to terminate the lease earlier than the stated expiration date, the parties should consider whether the landlord: (1) may retain some or all of the security deposit; (2) must return any remaining security deposit either: (a) when the termination agreement is signed, or (b) a specified number of days after the termination agreement is signed.
Tenant Statutory Termination Rights
Generally under Florida statutory law, unless expressly stated in a commercial lease, a breach by the landlord does not give the tenant the right to terminate the lease. However, a commercial tenant may have the right to terminate its lease before the express expiration date if the lease is silent on the procedure for making repairs, but expressly requires that the landlord make those repairs and the landlord fails to do so rendering the premises wholly untenantable. Before exercising this termination right, the tenant must give the landlord: (a) written notice stating the premises are wholly untenantable; (b) at least 20 days to complete the required repairs (or any longer period required by the lease terms). See § 83.201, Fla. Stat.
Early Termination Concerns for Landlords
Third-Party Approvals for Landlord
The landlord should consider whether approvals from third parties are required to terminate the lease. If third-party approval is required, the landlord should obtain those approvals before terminating the lease.
In particular, the landlord should carefully review the terms of any mortgage loans documents encumbering the real property to verify whether the mortgage lender’s consent is required for early lease termination. Mortgage loan financing documents often contain restrictions limiting the landlord’s ability to terminate tenant leases without lender consent. Violating those restrictions may result in a default under the mortgage loan resulting in adverse consequences for the landlord.
Before agreeing to an early lease termination, the landlord should verify whether any other leases in the building or shopping center contain co-tenancy provisions. Anchor tenants and other credit tenants sometimes negotiate co-tenancy requirements in their leases. Co-tenancy provisions usually require that during the term of the lease, either: (a)specified percentage of the other tenants in the building remain open and operating; (b) certain named tenants remain open and operating in the building.
Failure to satisfy the co-tenancy requirements may allow a tenant negotiating for co-tenancy protections to reduce its rent payments or terminate its lease, or both. In many cases, the landlord may satisfy co-tenancy requirements by leasing space to a suitable replacement tenant.
Co-tenancy violations may create significant issues for the landlord. Consequently, the landlord should weigh the risks associated with triggering a co-tenancy violation by agreeing to an early termination of a tenant’s lease if other tenant leases in the building or shopping center contain co-tenancy requirements.
Unavailability of Self-Help
The landlord should consider whether negotiating a voluntary lease termination with a defaulting tenant is a better alternative to pursuing a court action to recapture the premises. In Florida, a landlord may not use self-help to evict a commercial tenant. A landlord may only retake possession of the premises if either: (a) The landlord pursues a court action; or (b) the tenant voluntarily surrenders or otherwise abandons the premises.§ 83.05, Fla. Stat.
Pursuing a court action in Florida to regain possession of the premises can be a costly process. A landlord may be motivated to save time and costs by negotiating a voluntary lease termination with a defaulting tenant, especially if the tenant’s breach impacts other tenants in the building.
For example, if a retail tenant breaches an operating covenant in its lease by closing its business, the breach may impact other significant leases in the shopping center containing co-tenancy provisions. To prevent a breach of those co-tenancy provisions, the landlord may need to regain possession of the defaulting tenant’s premises so that it can lease the space to a new tenant that intends to quickly open and operate. Pursuing a voluntary lease termination to regain possession of the premises from the defaulting tenant can be faster than an eviction proceeding.
Recouping Unamortized Leasing Expenses
Some commercial leases are structured so the landlord incurs initial expenses that the landlord recoups from the tenant’s monthly rent payments over the term of the lease. These expenses often include: (a)Tenant improvement allowances; (b) broker commissions; (c) free rent.
An early lease termination may prevent the landlord from recouping the unamortized portion of these expenses. If the initial leasing costs are significant, the landlord should consider requiring that the tenant reimburse the landlord for the unamortized portion of the initial leasing costs before agreeing to a lease termination.
Environmental Condition of Premises
Before agreeing to an early lease termination, the landlord should evaluate the environmental impacts from the tenant’s use of the premises (particularly if the tenant engaged in industrial or manufacturing work). The landlord may require an updated environmental report, air quality study, or another similar assessment to determine whether the tenant created conditions requiring mitigation or remediation. The landlord may still agree to terminate, but may require additional mitigants from the tenant as a condition to the termination.
At a minimum, the landlord should ensure that any environmental indemnity and cleanup obligations imposed on the tenant survive lease termination. The tenant may need to offer additional inducements depending on the nature and duration of its activities and the outcome of the landlord’s investigation, such as: (1) adopting and completing a surrender plan addressing the environmental effects of its operations; or (2) offering to escrow funds pending completion of any remediation.
Early Termination Concerns for Tenants
Third-Party Approvals for the Tenant
The tenant should consider whether approvals from third parties are required to terminate the lease. If third-party approval is required, the tenant should obtain those approvals before terminating the lease.
For example, in ground lease financing, the leasehold mortgage lender typically prohibits a voluntary termination of the ground lease unless the leasehold lender gives its express written consent. Violating this prohibition may result in a default under the tenant’s leasehold mortgage resulting in adverse consequences for the tenant.
Most commercial leases contain provisions addressing the tenant’s surrender obligations at the end of the lease. A lease typically requires that the tenant surrender the premises in a specific condition. The tenant should assess the extent of any remaining surrender obligations in light of the reasons for the proposed early termination (for example, if the landlord proposes the early termination, the landlord may accept the premises in their current condition). The tenant may need to negotiate a termination date that allows the tenant to: (1) remove its personal property; (2) complete any restoration obligations required of the tenant under the lease.
Recouping Tenant Leasehold Improvement Costs
Some tenants pay substantial amounts to build-out their premises before the lease begins assuming they can reap the benefits over the term of their lease. If the lease is terminated early, the tenant may not recover the full benefit of the money spent on those improvements. This may be a significant loss for a tenant, especially if the termination is early in the lease term.
Before agreeing to a lease termination request from the landlord, the tenant should: (1) evaluate the extent of those unamortized costs; and (2) consider requiring the landlord to reimburse the tenant for the unamortized portion of those costs in exchange for agreeing to an early lease termination.
Documenting the Early Lease Termination
When the lease termination results from either the landlord or the tenant exercising a termination right granted in the lease, the parties typically rely on the lease to govern their respective rights and obligations relating to the termination. However, if the parties agree to terminate the lease as a result of an unforeseen event not addressed by the lease, the parties often enter into a lease termination agreement to clearly outline their respective rights and obligations.
A lease termination agreement is used to: (1) memorialize the termination of the lease agreement; (2) release the parties from claims and liabilities under the lease; (3) provide finality to the relationship between the parties; and (4) document any payments made by or to the parties as consideration for the early termination. Key provisions in a lease termination agreement often include: (1) a termination clause; (2) mutual releases; (3) representations and warranties; (4) indemnities; (5) required termination payments.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.