Beware of Surprise Brokerage Fees in Lease Renewals and Expansions

By Eric Rubenstein

Well drafted brokerage agreements clearly define the obligations and responsibilities of building owners and brokers who bring the parties together and procure the tenant.  To avoid unanticipated disputes and expense, these agreements should cover not only commissions payable for the initial term and the original space, but also any commissions payable upon renewals and expansions. 

New York law is clear that no broker’s commission is payable for a lease extension without a special agreement.  Not surprisingly, standard brokerage agreements prepared by brokers generally seek commissions on renewals and expansions.  Renewal commissions commonly would be calculated as if the extension period were included in the initial term of the lease.  For example, the parties may agree on brokerage commissions of 7% of base rent for years 1-3 and 3% thereafter.  If the initial term of the lease was for five years and the lease contained an option to extend for an additional five years, the commission payable for the option period would be at 3%, and not 7%.  It would not make sense to pay brokers’ commissions for renewal periods at year one (7%) rates if the lease contemplates renewals beyond the first five years.   

Conversely, agreements proposed by brokers generally seek commissions calculated at year one amounts (7%) when expansion space is taken by a tenant.  In seeking the higher commissions, brokers argue that renting the additional space is tantamount to a new lease benefiting the landlord, even though the tenant is already in the building. 

Owners should be able to negotiate provisions requested by brokers in several respects.  First, the commission schedule should terminate in a certain year and should not continue indefinitely.  Brokers earn their commissions by identifying and procuring tenants to initially occupy the space for a standard term, usually five or ten years with an option to extend for an additional five year period.  From an owner’s standpoint, a broker is receiving an unearned windfall by receiving commissions ad infinitum during a tenant’s occupancy. 

Second, if the renewal option in the lease provides for a fixed rental rate during the renewal period rather than a fair market value rate, an owner should argue that no commission should be payable in the renewal period.  Negotiation of the rental rate has already been completed and is in the lease, in addition to any other material provisions governing the renewal period.  Unless the owner asks the broker to participate in the renewal negotiations, a brokerage commission is not warranted, in the owner’s view. 

There may be a different result, however, if the renewal option in the lease calls for a “fair market value” rental amount and the owner enlists the broker’s assistance in negotiating that rental rate.  A knowledgeable broker’s advice on current market conditions would be advantageous to the owner, particularly where the broker’s information lends support to the owner’s valuation. In this case, the broker is adding value to the process and a commission would be justified.  Of course, the owner should insist that the amount of the commission should reflect the broker’s efforts and results in determining a fair market value that is favorable to the owner.

Third, if the tenant exercises an expansion option in the lease, the broker should agree that the commission will be calculated at a rate as if the expansion space was part of the originally leased space. In other words, if the expansion space is in year 4, when the commission rate is 3% rather than the 7% rate in years 1-3, the commission for the expansion space should be 3%.  The commission  should not be determined on the basis of a new lease.  It is not as if the broker procured a new tenant for the additional space.  Since the expansion option is contained in the lease, the tenant and landlord have already negotiated the parameters of the economic deal for the additional space, and it is just a matter of the tenant “pulling the trigger.” 

Fourth, whatever favorable provisions are negotiated by an owner in a brokerage agreement should apply to a tenant’s parent, affiliates, subsidiaries and successors by merger and the like.  This provision is especially important in leases with start-up, “dot com” companies.  Consolidation in that industry is likely to occur soon and the ownership structure of the tenants will change.  There is no reason why a commission should become payable simply because the entity exercising the subject option is not the named tenant, but is a related company.   

Some courts in New York have held that where a tenant has refused to exercise a renewal option in accordance with the terms of the lease, the landlord and tenant are free to make a new lease, and no brokerage commission is payable.  The reasoning is that the broker procured the tenant and was instrumental in finalizing the lease in which tenant had a specific renewal option with defined terms.  However, if the tenant ultimately decides not to make the deal outlined in the lease and a new lease arrangement is made, the broker is viewed as not having bought the parties together and the broker is not entitled to a commission. 

Sometimes, owners will attempt to avoid paying commissions where the terms of a renewal or expansion do not conform exactly with the option provisions in the lease.  Owners would argue that such non-conformity constitutes a new economic deal that the broker did not procure and that, therefore, no commission is due.  

Courts in New York will examine the extent of the differences between the material terms of the renewal option contained in the lease and the terms of the deal ultimately consummated between the landlord and tenant.  Generally, if the terms differ, the broker will not be entitled to a commission.    
Owners should be leery of attempting to deny brokers commissions by modifying the transaction to differentiate it from the renewal option in a lease.  Courts are not sympathetic to such conduct and will hold landlords liable for brokerage commissions if the intent behind the modification was to avoid paying commissions. Similarly, commissions have been found payable when an owner and tenant agree to terminate an existing lease containing a renewal option and enter into a new lease. 

In some cases, there is no brokerage agreement to refer to when a tenant seeks to renew its lease. An owner and broker, for whatever reason, may not have reduced their agreement to writing.  Perhaps a purchaser of a property is not provided with or advised of a brokerage agreement from the seller.  In such instances, the owner should review the specific lease to determine if a broker is named.   

If no broker is named, the likelihood of a broker surfacing to claim a commission is remote.   If a broker is identified in the lease, the owner must review the lease carefully to ensure that there is no requirement to pay a commission to the broker.  If no such terms are contained in the lease, the owner may hear from the broker after the option is exercised, particularly where the transaction is substantial and garners publicity in trade publications.  

Owners need to be careful in drafting and reviewing brokerage agreements and leases in order to avoid unexpected commission claims and disputes.   Consultation with experienced counsel is advisable before the owner is locked into a bad deal.  A little foresight can go a long way in saving owners significant dollars.

 

Eric Rubenstein is a partner and Co-Chair of the Real Estate Department at Ruskin Moscou Faltischek, P.C.  He can be reached at 516-663-6513 or erubenstein@rmfpc.aw-develop.com.

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