What Landlords Should Know When Restaurant Tenants Go Under

Originally published by the Daily Journal of Commerce on September 12, 2024.

As anyone who has watched FX’s “The Bear” knows, running a restaurant is hard work. When restaurants occupying leased commercial space fail, commercial landlords need a game plan to protect their interests. Some key considerations when terminating a commercial restaurant lease are outlined below.

If the restaurant tenant owes money under the lease, then depending on the terms of the lease, the landlord may draw on the security deposit or look to any guarantors who have provided financial support for the tenant. If neither the tenant nor any guarantor can make the necessary payments, then the landlord needs to determine whether it is worth the legal costs to pursue a claim for damages.

Once the landlord determines that the restaurant will not survive and pursuit of a claim for damages may not be worth the expense, the first step is to regain control of the leased premises. The parties can enter into a simple agreement wherein (i) the tenant surrenders possession of the leased premises to the landlord without terminating the lease, (ii) the tenant reserves its defenses and (iii) the landlord reserves all rights and remedies available under the lease. This way, the landlord can get the space back quickly without going through the eviction process, which can save both parties time and money.

With possession of the leased premises established, the landlord can attempt to relet the space. Landlords typically have obligations to mitigate the damages caused by the tenant’s breach of the lease, so efforts to relet the premises should commence as soon as possible. If the landlord can relet the premises to another restaurant, then the space may need little work to meet the needs of its new occupant. If the premises will receive modifications to accommodate a new use, then removal of existing improvements (such as vented hoods and grease traps) may be required in connection with the build-out of a new space. While attempting to relet the premises, the parties should commence work on a formal lease termination and settlement agreement. Here are some key issues to address in such an agreement:

Kitchen equipment and furnishings

Restaurant tenants often lease appliances and major equipment, which means that when the lease terminates, they will need to be returned to the vendors that provided them. If the tenant owns any such equipment, then the landlord has a lien on personal property under the terms of the lease for past due rents, and the landlord may be able to foreclose on the lien and sell the personal property to offset the tenant’s debts under the lease.

Trade dress and tenant signage

The tenant may own the intellectual property rights to certain improvements and fixtures in the premises (such as a distinctive countertop shape, lighting system, or bar area). In such an event, the landlord may not be able to repurpose such fixtures for another tenant. Similarly, any unique signage and branding equipment belonging to the tenant will need to be stripped from the premises prior to the space being turned over to a new occupant.

Termination fee

In exchange for the landlord releasing the tenant from future claims relating to the lease and the premises, the tenant should pay a single “termination fee” at the time of executing the termination letter. Ideally, the termination fee accounts for both past due sums and future rents owed under the lease. The amount of the settlement will be negotiated between the parties, and if the restaurant tenant is a small independent business, the settlement may represent the landlord’s last best chance to obtain a payment from the tenant. If the restaurant tenant is part of a larger chain, then the landlord may be able to go after the parent company for past due sums.

Protection from tenant bankruptcy

If the tenant files for bankruptcy, the bankruptcy trustee may claw back the termination fee from the landlord through a bankruptcy preference action. The termination agreement should account for this scenario by clarifying that the landlord’s release of the tenant shall be voidable if the termination fee is clawed back by a trustee. Further, the landlord should reserve the option to receive the payment of the termination fee outside of the statutory 90-day preference period to protect its right to collect the termination fee.

Clear termination date

The termination agreement should make it clear which items must be satisfied for the termination (and accompanying release) to become effective. The landlord should require receipt of the termination fee, the tenant’s vacation and surrender of the premises and any other essential items as conditions precedent to the effectiveness of the termination.

Restaurants bring vibrancy to neighborhoods, and everyone wants them to succeed. However, when times get tough and restaurants go under, commercial landlords need to be ready. Experienced commercial real estate attorneys can help landlords review the existing restaurant lease, regain possession of the premises and terminate the lease in a way that minimizes the damage and maximizes the future opportunity for the space.