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Philadelphia Skyline

Claw Back of Free Rent for Defaulting Commercial Tenant Backed by Venture Capital

May 5, 2019

In this story, I represented a large commercial landlord in a dispute with its tenant, a growing business that had received several big infusions of venture capital. It was early in the relationship, yet tenant was swiftly falling behind. [FN1]  

It is not unusual for start-ups to fail and fail early. It is also not unusual, that when start-ups get big infusions of other-people’s-money (“OPM”), they overspend on Manhattan premises, especially on fancy build-outs. Often, landlords give tenants generous periods of free rent in order to achieve such build-outs. This makes sense for a commercial landlord who thinks she is getting an above-market rate for a lease that will last 10 to 15 years. It is also not unusual for the guarantors of these leases to be other companies, subsisting on the same OPM, which always makes me skeptical that such guaranty is worthwhile. When such tenants fail, therefore, it’s a big disaster for the landlord. 

In these situations, when I am the landlord’s lawyer, the first thing I try to do is claw back the free rent. I find this achieves several objectives. One objective is that it startles the tenant’s principals. Start-up principals are often not seasoned business people who pay close attention to the fine print of their commercial leases. Such principals often never figured on ever having to pay rent for that initial tenancy period. When they receive my claw-back notice, they not only need to tell their investors that they owe some rent, they need to tell their investors that they suddenly owe a ton of rent. This gets the powers-that-be behind the tenant focused on the default and a possible settlement.

It worked in this case. Someone swept in and gave the ailing tenant...more money. The landlord was paid. All is well that ends well. 

What’s the lesson? The lesson is that renting to start-ups is always going to be risky, and a landlord’s and tenant’s leasing counsel (which I am not, I do not do leasing) should be very careful about free-rent clauses, particularly by setting up clear mechanism for recovery of the free rent if the tenant defaults. 

Respectfully submitted,

Michelle Itkowitz

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FN1. Some of the details have been changed to protect the innocent.

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