Breaking the lease when your business goes bust

August 8, 2008: 9:37 AM ET

Hit by the slow-down? Gotta get out? What to do when you can't pay.

Gopal, Broomfield, Colo.
Business hasn't been good recently at my dollar store, due to the shaky economy and high fuel prices. I'm not making enough to even pay the rent this month. If I close, I will have nearly three years still left on my 5-year lease. If I do out of business, must I still pay rent - it's roughly $5,000 per month - for the remainder of the lease? How can I get out of my lease without running afoul of the law?

By Kathleen Ryan O'Connor, Fortune Small Business contributor
Dear Gopal: First, don't worry about getting in trouble with the law in the criminal sense - defaulting on or walking away from a commercial lease would be a civil matter. However, you could still face some stiff penalties, so before doing anything, grab your lease and a magnifying glass and start reading the fine print.

In a perfect world, you would have negotiated a sublet or assignment clause into your lease before signing it. This would allow another tenant to come in and take over the remainder of your lease, or some portion of the space. That would not necessarily mean you weren't still legally obligated, but you wouldn't be on the hook for the full $5,000 every month, which is the goal here.

But even if you don't have that clause in your lease, don't be shy about asking for permission to sublet after the fact. Truth is, the landlord knows you can just move out in the dead of night anyway. Plus, in most states he or she is required to mitigate damages by at least trying to find someone to take your place to reduce the payment load you have.

Another option that might already be in your lease is an early termination clause. That would allow you, with far fewer penalties (say one year's rent, or some other lump sum) to get out of the remaining years of the lease free and clear, says Peter Sarasek, partner and head of the national real estate group for the Chicago office of Quarles & Brady.

If none of the above works, there are other options, but all carry the possibility of litigation, Sarasek says.

"Stop paying rent and move out," Sarasek says. "People do that."

If you are lucky, it might be a nice location and easy to re-rent. Say the remaining rent under your lease is $1,000 per month and the new landlord rents for $1,500 per month and incurs $400 in new costs; his net is $1,100, or $100 more than he had from you, Sarasek says, so "he really hasn't suffered any damages." If that's not the case, though, and there is a shortfall or he can't re-rent the space you had, you may have to go to court.

If you are in a strip mall and the landlord has other tenants, Sarasek suggests talking to them as well, since they may be looking for more or different space.

You can fight back, too. If the landlord isn't maintaining the center - say huge potholes, missing lights - then you may actually have a justifiable cause for not paying rent. It's called "untenantability," Sarasek says, meaning you can't use the space as it was intended.

What about going bankrupt?

The last way out is to file for bankruptcy. "I'm not encouraging it," Sarasek says, "but sometimes it's the final thing to do." Filing bankruptcy will essentially terminate your lease, and the landlord will have to get in line with all your other creditors.

Get a lawyer to help you out. A local sole proprietor will be your most affordable bet, says Tom Sestanovich, a commercial real estate expert and partner at Moldo Davidson Fraioli Seror & Sestanovich in Los Angeles.

Whatever you decide to do, make absolutely sure your next commercial lease, if there is one, provides for the possibility things may go south.

Sestanovich  recommends considering these questions before you sign: What is your exposure if things go wrong? What surrender provisions can be worked out? Can you get broad sublet and assignment rights? "It all starts before the lease is signed," he says.

Give us your advice: Check out recent "Ask & Answer" questions.

Related links:

When bankruptcy looms

My business can't pay its taxes!

The bankruptcy option that's right for you

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