Exit options in commercial leases

The main types of setting up physical premises include purchase and leasing. FILE PHOTO | POOL

Inflation in Kenya has steadily increased impacting the cost of living. One of the sectors affected is real estate where it has resulted in higher construction costs, property values, rent and other operational and maintenance charges such as service fees.

To combat inflation, property owners have resorted to increasing rent and costs related with property management. Over time, tenants have found it challenging to meet rising rental demands, and have been forced to give up or source and move to alternative cheaper commercial space to optimise profits.

This has resulted in an upsurge in requests by tenants for early exit and termination of existing leases prior to expiry of the agreed term.

As per the well-established law and practice, most commercial leases do not include a termination or exit clause except for breach of covenants.

Pursuant to the Landlord and Tenant (Shops, Hotels and Catering Establishments) Act (Chapter 301, Laws of Kenya), inclusion of a termination provision, save for a breach of covenant, results in the creation of a ‚Äúcontrolled tenancy‚ÄĚ.

A controlled tenancy arises where a tenancy agreement has not been reduced into writing or which has been reduced into writing but is for a period not exceeding five years or contains provisions for termination otherwise than for a breach of covenant within five years from the commencement of the tenancy.

A controlled tenancy is detrimental to landlords as it restricts their ability to deal with the leased premises including the option to increase rent and terminate the tenancy without obtaining leave of the Business Premises Rent Tribunal.

Given this, landlords are advised not to include a termination clause in the lease to avoid creating a controlled tenancy.

How then can a tenant who is unable to meet its rental obligations due to financial constraints terminate their lease? Some possible strategies and options available are for the landlord and tenant to negotiate an early termination of the lease upon mutually agreed terms.

In the process of negotiating a premature exit plan, a tenant can propose finding a replacement tenant for the landlord to ensure that the landlord is guaranteed continous regular rental income.

A tenant may also propose a buy-out of the remainder of the term of the lease and either pay the landlord some consideration in lieu or agree that the landlord retain part or all of the security deposit held by the landlord as consideration for agreeing to an early termination.

There are other more innovative and practical options which are yet to be tested by the Kenyan courts. One such avenue is that where parties are yet to enter into a commercial lease in excess of five years, a landlord and tenant can discuss and agree on the early termination procedures during negotiation of the lease.

The agreed terms for early termination can be captured in a side letter or letter of comfort . Such letters should clearly state that the intention of the parties is not to create a controlled tenancy to safeguard a landlord but to allow an option for early exit to the tenant.

Such side letters are intended to be personal to a particular tenant and the terms of the side letter do not appear on the face of the lease.

It is important that parties clearly state in the side letter that they intend the side letter to be legally binding in order for it to constitute a contract.

Side letters provide a practical mechanism that allows parties to mutually agree to terminate the lease without straining business relationships and also circumvent the issues around controlled tenancies.

A word of caution here is that as such side letters and letters of comfort have not as yet been tried in the Kenyan courts, their legal position is unclear as jurisprudence is not available.

It is important for landlords and tenants to consult their legal professionals before entering into a lease agreement in order to ensure that their respective legal rights and obligations are protected for a better business corelation.

Amrit is consultant in the Real Estate and Finance Practice Group at DLA Piper Africa, IKM Advocates. Tesrah Wamache and Grace Gitau are Associates in the same practice.

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