Room to Grow or Shrink: Expansion and Contraction Rights in Commercial Leases

Expansion and contraction rights can be valuable tools in the commercial leasing context, benefitting both landlords and tenants by balancing tenant adaptability with landlord predictability. However, because these rights reallocate risk, costs and control between the parties, they should be carefully negotiated to reflect business realities and clearly drafted to ensure risks are appropriately addressed.

Here are five things to consider as a landlord or tenant when building expansion or contraction rights into your lease:

1. Know your expansion options. Expansion rights typically take three forms: a straight right to expand into predetermined space, a right of first refusal (ROFR) where the tenant can match a third-party offer for available space, or a right of first offer (ROFO) where the tenant gets the first opportunity to negotiate for available space. A straight expansion right offers the most predictability, with terms often negotiated upfront, while ROFRs and ROFOs are less predictable, with terms often negotiated during the lease term and based on current market conditions.
2. Contraction rights manage risk. For tenants, contraction rights eliminate the uncertainty of subleasing and the cost of carrying unused space. For landlords, they serve as tenant retention tools and provide predictability on when space will be recaptured.
3. Space selection matters. For expansions, tenants will want space adjacent to their current premises, but availability may be limited by other tenants’ existing options. For contractions, landlords typically want full floors or pre-designated areas to be recaptured, while tenants prefer to choose which space to surrender.
4. Rent and fees need clear terms. Expansion pricing, whether fixed-rate or fair market rent, directly impacts each party’s risk. On the contraction side, landlords will often require a surrender fee to recoup leasing costs, making the fee calculation a key negotiation point.
5. Clear drafting prevents disputes. To minimize disputes, expansion and contraction rights should be drafted with specificity. Key items to consider include the space involved, timing and notice periods, rent or fee calculations, whether the right is a one-time option or ongoing, and any conditions for exercise, such as no tenant default.

Have more than five minutes? Contact the author or any other member of our Commercial Real Estate group, or watch our past seminar addressing this topic and more.