Negotiating a contraction option? Here are some details to consider.

A contraction option is a fixed right in your lease to reduce the size of your premises at some future date.  You can use it to downsize an office space prior to the lease’s scheduled expiration date.

As you might expect, landlords (and their lenders) vigorously resist giving tenants this right.  However, a creditworthy tenant in the market for a reasonable amount of space may be able to extract this concession if the tenant directs its broker to emphasize the issue early in negotiations.

Checklist for negotiating a contraction option

  • Do you have the right to contract the Premises periodically through the lease term (i.e., multiple options) or is it a one-time right?
  • Is the contraction date variable?  Or is it fixed?
  • Size of contraction space variable within a specified size range?  Or is it fixed?
  • How much prior notice in advance of the contraction date are you required to provide the landlord?
  • May you identify the particular space when exercising the option?  Or is the contraction space specified at the time the lease is signed?
  • If you may identify the contraction space when exercising the option, is the landlord’s approval limited to concerns of access, code compliance, and marketable configuration?  Or are you limited to giving up a full floor or floors, not a partial floor?
  • Is the contraction fee limited to unamortized tenant improvement allowances, commissions, and concessions?  Is the landlord required to substantiate (e.g., provide copies of paid invoices) the costs to be amortized?  Are the total costs specified by category in a lease commencement memo?
  • Is the method of amortization and the discount rate, if any, clearly stated?  Is the amortization period specified?  Are the costs to be fully amortized over a period no longer than the initial lease term?
  • Is there an additional agreed-upon penalty sum added to the fee?  If you have an ongoing right to downsize, does this additional fee decrease as the remaining lease term shortens?
  • If the contraction space is a partial floor, are demising costs the landlord’s responsibility?  Or does the contraction fee also include an estimate of the landlord’s actual, reasonable, and necessary demising costs?
  • Contraction fee due upon exercise of option or at effective date of contraction?  If due upon exercise of option, may it be paid in installments?  Do you receive a pro rata credit for any prepaid utilities or taxes against the final fee installment?
  • Are you compensated by the landlord for any fixtures and the unamortized value of any improvements left behind in the contraction space?
  • Is there a pro rata reduction of the amount of any security deposit or letter of credit?
  • Are you released from any claims and liabilities relating to the contraction space after the contraction date?
  • So long as there is no material Tenant default that has occurred and continued beyond any applicable notice and grace period, do you retain your Contraction Option?
  • Are expansion rights, signage rights, exclusivity rights, or other tenant rights impacted by your exercise of the Contraction Option?
  • May an assignee or subtenant exercise the Contraction Option or is it personal to you?

Don Wenig
Blackacre Advisors LLC

DISCLAIMER.   Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).

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