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How Disastrous Can Early Termination of a Fixed-Term Lease Be?

Did you receive an offer for a new lease with more favorable terms than those of your actual lease? Do you need to move to a bigger office space but still have several years to go under your current office lease? In such cases, the termination of an existing fixed-term lease may be unavoidable. However, the termination could lead to disputes.

Lilla Szepsi Szűcs, Attorney, Schoenherr Hetényi Attorneys at Law

As a general principle, a lease agreement with a definite term may not be terminated under an “ordinary termination” unless the parties agree otherwise in the lease agreement.  As lease agreements often do not contain any contractual break-options, the situation must be resolved based on general legal principles and the applicable laws. If a party terminates a fixed-term lease agreement by an unlawful measure which causes damage to the other party, the non-breaching party will be entitled to seek compensation and the breaching party must pay compensation for damage incurred by the non-breaching party.

How is Damage Assessed?

The damage or loss may be of many kinds. In the event of an early termination of a fixed term lease, the lessor usually suffers not only a loss of income of rent fees. The loss of a high prestige lessee may, for example, also affect the lessor’s own prestige and marketing potential adversely. Moreover, the lessor must find a new lessee which may also cause additional costs. The amount of the compensation will depend also on the length of the period between the unlawful termination and the signing of the new, replacement lease agreement, and the market conditions.

In a reverse case, where the lessor reverts to early termination, the lessee may also suffer damage: it must procure a new lease in changed market conditions. This case is usually relatively clear: If the new rent is more expensive, the difference in the rent fee will clearly give rise to a claim against the lessor in addition to the costs of the search for, and the moving to, a new place. In these cases, the lessor will have to pay compensation to the lessee covering the aforementioned costs.

But let’s go back to the less clear cases: when the early termination occurs on the lessee’s side.

Duty to Mitigate the Damage/Loss

In legal theory, one rule is clear: The lessor will not be entitled to claim all outstanding rents. Attention should be paid to the duty to mitigate the damage. The lessor must do everything reasonable to mitigate its damage. For example, the parties can agree that the lessor fulfils its obligation to mitigate the damage by engaging a reputable real estate agent to assist in finding a new lessee for the leased area. However, it is not clear what the lessor’s reasonable duty would consist of: What if the lessor could only obtain a new lessee for a shorter term than the original? How will the amount of the compensation reflect such a change? Unfortunately, there are no evident answers to these questions due to the lack of proper case law. However, the courts examine the fulfilment of this duty in every case. If the lessor did not act appropriately, the court will decrease the amount of the compensation, and the result will be very different from case to case.

According to one case of the Court of Arbitration attached to the Hungarian Chamber of Commerce and Industry, the tribunal found that the amount of the damage must be determined based on the actual status of the office market. In this case, the damage was determined to be six months’ rent. However, in another case, the tribunal awarded that the lessee must pay the outstanding rents until the end of the agreed term of the lease, the contractual penalty, and any additional direct damage suffered by the lessor.

Recommendations

In practice, a carefully drafted clause should be included in the lease agreement and contain express wording relevant to the possibility of an unlawful early termination without cause, and especially to the payable damages. A proper lease agreement may cover such risks appropriately and, for example, clearly contain a formula for the amount of the payable damages, the payment method, the date from which the lessee is obliged to pay damages and requirements for the new lessee (e.g. good financial standing).

AdriánMenczelesz, Associate, Schoenherr Hetényi Attorneys at Law