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Your business contracts could benefit from a downturn clause

May 10, 2017

As a business owner, you should always be looking for the most favorable language in your contract negotiations. Whether it be length of term, assignability, or pricing, you need to think about the ramifications of each section and what it could mean to your company.

One often overlooked – and usually unknown – clause that can benefit a young company is a business downturn clause. A business downturn clause helps protect businesses from suffering long term liability in an agreement when unexpected events make completing the obligations in the agreement near impossible. It works like this:

Assume you’re about to sign a 5-year lease for your first office (putting personal guarantees aside for a moment). You can ask your landlord to insert a business downturn clause in your lease that will allow you to terminate the lease early in the event that your sales drop below a certain agreed upon amount, or are forced to close before the end of the lease.

As you can imagine, these clauses are heavily negotiated by landlords, as they likely won’t give you an out without a fight. However, if the deal is right for both parties, and you show a good faith effort toward completing your side of the bargain, you may be able to work in a downturn clause. Here are the items to consider in your downturn clause.

1. Loss of revenue. You should have a detailed revenue plan for the length of your lease (if not, break out the calculator and get started). Share the revenue information with the landlord and negotiate a point of failure, where you both feel comfortable that the business won’t recover and the lease can be terminated early without penalty.

2. Extra security deposit. Your landlord may require additional security in exchange for the downturn clause; and rightfully so. Keep in mind that unless you agree otherwise, your deposit money will be forfeited if you invoke the downturn clause.

3. Sublet. Many commercial leases will not allow you to assign the lease to a third party. In a downturn clause, you could require assignability be permitted in efforts to mitigate the termination of the lease.

There are plenty of other uses for downturn clauses aside of commercial leases, so consider them when negotiating your business contracts. A properly thought out – and properly worded – downturn clause could be a solid lifeline in time of need.

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