Recapture Rights In Leases

Recapture Rights In Leases 

by Bryan Mashian, Esq. 

With today’s low commercial rents, the landlord would like to be able to share in the anticipated future rise in rents by including a “recapture” provision in the lease which allows the landlord to terminate the lease if the tenant wants to assign the lease or sublease the premises.

The “Recapture” Right 

• The landlord is more likely to exercise the recapture option if the market rents are above the lease rent, or if the landlord needs the space to accommodate an existing tenant that needs more space.
• The tenant, however, loathes granting the recapture right in the first place since if the landlord exercises the recapture right, the tenant can be forced to relocate its business.

Trigger for Recapture Options 

To lessen the impact of the landlord’s exercise of a recapture right, the tenant should consider limiting this right.

• The landlord’s recapture right should not be triggered for any or all proposed subleases or transfers.
• For example, the landlord should not be able to recapture and uproot the tenant’s business if the tenant wants to transfer the lease to a proposed buyer of the tenant’s business.
• Similarly, if the tenant wants to enter into a short term sublease of part of its premises, the landlord should only have the right to recapture the space proposed to be transferred for the proposed term.

Timing of Recapture  

• The existence of a landlord’s recapture right impedes the tenant’s ability to market the premises because a broker cannot tell whether the landlord will eventually recapture and thereby thwart a deal.
• By the time the tenant reaches the stage of requesting the landlord’s consent to an assignment or sublease, the tenant has often vacated the space, hired a broker to market the space, and nearly finalized a deal. Ironically, having a prospective new tenant for the space will increase the landlord’s motivation for exercising the recapture option.
• One way to lessen this adverse impact on the tenant of the recapture option is to require the landlord to decide whether it wants to recapture before the tenant starts marketing the space.
• By moving up the date for the landlord’s exercise of the recapture option, the tenant may save itself from having to find a replacement tenant. If the landlord does not recapture, the tenant would then have a certain amount of time, such as 3 to 6 months, to lease the space without being subject to the landlord’s recapture option.
• A possible downside to the recapture option for the landlord is that if the landlord does recapture, then typically the landlord pays the costs associated with the new lease, such as brokerage commissions, free rent and tenant improvement allowance.
• Another disadvantage for the landlord is that it bears the risk of recapturing and possibly not being able to subsequently make a deal with the prospective tenant.

Structuring the Recapture  

• One way to structure the recapture right is to provide that the recaptured space is subleased by the tenant back to the landlord. The landlord (as the subtenant) pays rent to the tenant, and then the landlord sub-subleases such space to third parties, presumably at a profit.
• Or, the recaptured space can be eliminated from the tenant’s leased premises, as a result of which the tenant’s rent is reduced by rent the tenant was to pay for the recaptured space, and then the landlord directly leases the recaptured space to third parties.
• The tenant prefers eliminating the recaptured space because the tenant avoids any liability for the recaptured space altogether and does not bear the risk of default by the landlord under the sublease.
• Under either structure, the landlord should ensure that the recaptured space and the remaining portion of the premises are readily leasable.