The commercial real estate market in the United States is undergoing a profound shift as building vacancy increases in most major markets and as trillions of dollars of financing are coming due in 2024.
At the same time, most government agencies are reconsidering their long-term space needs1 and shrinking their footprints as remote work and hybrid work have become the norm. Compounding the impacts of these reductions in office space, roughly 50 percent of the General Services Administration (GSA) leases are scheduled to expire within the next five years, and GSA is entering into more and more short-term lease extensions as tenant agencies continue to consider their real estate requirements.
These dramatic changes in the markets and in government requirements are directly impacting landlords and developers in a number of ways. This Holland & Knight alert will focus on early terminations of government leases and what to do in the event that the government seeks to vacate a lease before the expiration of the lease term. This will be the first of two alerts addressing special considerations of government leasing in this rapidly transforming commercial real estate market. Part II will address distressed assets leased to the federal government and transfers of title to government-leased properties.
Background: Know Your Rights If the Government Seeks to Terminate a Lease Early
The good news: Unlike traditional government contracts, leases with GSA (and with most other federal agencies with leasing authority) do not provide the government with the right to terminate the lease at the government's discretion.2 In fact, the only early government termination right for GSA leases is for lessor default,3 and it's uncommon for lessors to be unable to remedy a default once construction is complete and after commencement of the lease term.
If the government does elect to vacate the premises early, its only contractual right to relief is through the Vacant Premises clause of the lease, which allows the government to reduce rent by a certain amount – usually about $1.50 to $2 per rentable square foot – which is intended to offset the windfall that a lessor might receive in operating costs associated with the vacated space.
The bad news: The lack of a legal right to terminate the lease doesn't mean that the government won't attempt to do so anyway. We have encountered a number of situations recently in which the government either seeks to terminate for its convenience (seeking lessor consent to an early termination) or it makes a dubious claim of default or fraud in the inducement to walk away from its obligations. Industry observers have also seen the government attempt to force a reduction in rent when it holds over in only a portion of the leased premises following the expiration of a lease. The increase in remote work and the downsizing of agency requirements appear to be driving the uptick in this trend.
When the government abandons a leased property and ceases paying rent, the government effectively forces the lessor to file a claim under the Contract Disputes Act in order to protect its rights. But, as explained below, early engagement can potentially prevent the government from terminating early, or it can lead to more favorable buyout terms or a better litigation position if the government elects to terminate the lease.
What to Do When the Government Attempts to Leave Early
- Engage Counsel. Lessors should engage counsel with federal real estate expertise at the first indication that the government may intend to seek an early termination of the lease. This will help the lessor to make an informed decision with full knowledge of its legal rights and remedies. Additionally, the best defense against an early government departure may be to communicate early and effectively to the government that the lessor understands its rights and is prepared to litigate if necessary.
But if early engagement with the government is unsuccessful, counsel should be able nonetheless to effectively document the lessor's refusal to agree to an early termination, as well as refute any government claims of default or noncompliance that may used as a pretextual basis to justify termination. And in any event, fully understanding the legal landscape will be necessary to effectively negotiate a settlement if the government attempts to buy out the landlord for the value of the remaining term.4
- Mitigate Your Damages. If and when it becomes clear that the government intends to breach its obligations and abandon a lease, the lessor must take reasonable steps to mitigate its damages. It is a basic tenant of government contracts law that a party injured by a breach of contract has a duty to mitigate its damages. See Indiana Michigan Power Co. v. United States, 422 F.3d 1369, 1375 (Fed.Cir.), reh'g denied (2005). In mitigating damages, the law requires only that the non-breaching party make "those efforts that are fair and reasonable under the circumstances." First Heights Bank, FSB v. United States, 422 F.3d 1311, 1316 (Fed.Cir. 2005) (quoting Home Sav. of Am., FSB v. United States, 399 F.3d 1341, 1353 (Fed.Cir. 2005)). Notably, "a party cannot recover damages for loss that he could have avoided by reasonable efforts." Robinson v. United States, 305 F.3d 1330, 1333 (Fed.Cir. 2002) (emphasis in original) (quoting Restatement (Second) of Contracts § 350, cmt. b (1981)).
This begs the question: What are "fair and reasonable" mitigation actions? This will be a fact-specific analysis for lessors and their counsel to undertake, but the case law addressing the duty to mitigate in the context of lease procurement – though limited – provides some examples of reasonable mitigation efforts. Lessors should consider whether it would be appropriate to re-advertise or seek new tenants, and should be prepared to justify their actions as reasonable mitigation steps. It should be noted that the marketplace is sufficiently sophisticated to understand that if the tenant is the federal government, the lessor may be unable to offer a firm availability date for the space. Nonetheless, advertising the space may be a prudent approach to pursuing mitigation.
- File a Claim. The claim is the first step to enforcing your rights in the event of a government breach and is a necessary preliminary action in order to bring a lawsuit against the government. As a general rule, under the doctrine of sovereign immunity, the government is immune from lawsuits unless it has expressly waived its immunity through a statute. The Contract Disputes Act5 is just such a statute, and it provides a legal basis for suits against the government.
However, this waiver of sovereign immunity is contingent upon the lessor filing a claim with the Contracting Officer and receipt of a Contracting Officer's final decision.6 The U.S. Court of Appeals for the Federal Circuit defines a valid Contract Disputes Act "claim" as "a written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to this contract."7
Claims must be filed within six years of when they accrue, and a claim accrues when all events that fix the alleged liability and permit assertion of the claim were known or should have been known.8 Six years is a fairly generous window, but lessors would be well served to file a claim as soon as possible to help ensure prompt resolution and to prevent any loss of relevant evidence over time.
Once a claim has been denied by the government or the government fails to respond within the allotted time, lessors can bring suit at either the U.S. Civilian Board of Contract Appeals within 90 days of the denial or deemed denial, or the U.S. Court of Federal Claims within one year of the denial or deemed denial.
- Establish Damages. Though the Court of Federal Claims has not yet opined on the calculation of damages from an improper early lease termination, the Civilian Board of Contract Appeals has held9 that in the event of such a breach by the government a lessor is entitled to "expectancy" damages, which are defined as the profits (essentially rent minus the anticipated operating expenses) that a lessor would have realized but for the government's breach, discounted for present value and the likelihood of the lessor to be able to mitigate its damages with a follow-on tenant.
Conclusion
Unfortunately, in the current real estate market and with government agencies under pressure to shrink their real estate footprints, there is a very real risk of the government seeking to terminate its leases early, despite having no legal basis for doing so. The best way to protect against this risk is to know and understand your rights and to communicate effectively with the government as soon as it becomes clear that the government may intend to seek an early termination.
Notes
1 Office of Management and Budget (OMB) Memorandum M-22-14 (whitehouse.gov) requires agencies to restart their annual planning process by developing and submitting their fiscal year (FY) 2024-FY 2028 capital plans to OMB and the Federal Real Property Council, taking into account "broader workforce and workplace trends" and "lessons learned from agency operations during the COVID-19 pandemic."
2 The Federal Acquisition Regulation (FAR) requires government agencies to include a termination for convenience clause in all contracts for supplies and services. See 48 C.F.R. Subpart 49.5: Contract Termination Clauses. These clauses provide the government with the right to terminate the contract at any time "if the Contracting Officer determines that a termination is in the Government's interest." 48 C.F.R. § 52.249-2(a). Courts have interpreted this clause to the give the government broad latitude in terminating contracts. However, the FAR does not apply to government lease. See 48 C.F.R. § 570.101(d). ("The FAR does not apply to leasehold acquisitions of real property.") Because the FAR provides the only applicable requirement for termination for convenience rights in government contracts, the inapplicability of the FAR to government leasing has historically meant that government leases do not include any such termination rights for the government.
3 The standard GSA lease default clauses – 48 C.F.R. § 552.270.18 and 48 C.F.R. § 552.270.22 – provide the government's default termination rights and obligations.
4 GSA's Leasing Desk Guide acknowledges that GSA can and will offer buyouts for lessors under certain circumstances when requirements have shifted and lowered. See Leasing Desk Guide – Chapter 6, pg. 6.2-18.
5 41 U.S.C. § 7101 et seq.
6 41 U.S.C. § 7103(a)(1).
7 Zafer Constr. Co. v. United States, 40 F.4th 1365, 1367 (Fed. Cir. 2022) (quoting 48 C.F.R. § 52.233-1(c)).
8 A claim "accrues" when "all events, that fix the alleged liability . . . and permit assertion of the claim, were known or should have been known," and some injury has occurred. 48 C.F.R. § 33.201.
9 PJB Jackson-American, LLC v. General Services Administration (Feb. 11, 2016).
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.
