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Gotchas: Cancellation Clauses

Q. What is a lease cancellation clause?

A. If a tenant is required to sign a lease for a longer than desired lease term, it is possible to negotiate a lease termination clause at some point earlier than the end of the lease term. Because the landlord has expected to recover its initial capital outlay over the longer lease term, they will require a cancellation payment or penalty, in order to terminate the lease. Typically, the amount of this payment is defined as landlord’s unamortized costs.  

Typically, the amount of this payment is defined as landlord’s unamortized costs, whereby the total transaction costs (including tenant improvements, free rent, legal fees and brokerage commissions) are amortized or spread out (with an interest factor) over the entire lease term. At whatever point the termination becomes effective, the tenant agrees to pay the remainder of those costs upon termination. For example, if a tenant signs a five (5) year lease with a termination option after three (3) years and the transaction costs total $100,000, the unamortized costs after the third year (using straightline amortization without an interest factor) would be $40,000. Essentially, $20,000 of the total costs is amortized each year and the unamortized amount for the two remaining years is twice this amount.