In the last post, we discussed the basic concepts and procedures involving co-tenancy in commercial leases. We also threw out some questions about how all of this plays out in the current real estate environment. This week, we will delve further into important issues for landlords, tenants and their lenders to consider when grappling with co-tenancy at the drafting stage and after the lease is signed. In addition, we will suggest some answers to the questions from last week….
1. Key and Replacement Tenants
The Co-Tenancy provisions will likely be tied to the Center’s large and medium Anchors. In most scenarios, the smaller Tenants will usually require that the Anchors be open for business before they have a duty to operate or perhaps to begin paying rent. Alternatively, Tenants may agree to a percentage of stores or square footage becoming operational as the trigger for their rent and operational requirements. Obviously, economies of scale will play a major role in determining the leverage each Tenant will have in negotiating the terms, procedures and remedies for breach (see below) by Landlord. For Landlords, keeping a close eye on construction completion, stocking and opening of the Anchors is essential to avoiding problems here. This process can be complicated by unplanned or unforeseen delays in obtaining zoning rights, permitting and coordination of Landlord’s completion of infrastructure and common area improvements as well.
If the Anchors go dark or vacate, most Tenants will also want to have a requirement that Landlord be required to fill the empty store(s) with similar Tenants who will provide as much or more foot traffic and drawing power as the vacating Anchor. The challenge for Landlords is to balance this concern with the flexibility needed to react to Anchor closings/bankruptcies and changing market trends that would drive different Anchors to the Center.
2. Conditions Precedent, Cure and Remedies
Even in this time of relative parity between Landlords and Tenants, Landlords will want to require a certain amount of triggers for the Co-Tenancy provisions to be activated by Tenants. Among these are:
A. Tenant must be operating at the time of the alleged default;
B. Tenant must not be in an uncurable default situation;
C. The Co-Tenancy provisions should be personal to the Tenant and not Assignees or Sub-Lessees, nor applicable to option terms;
D. The remedy elected by the Tenant in the situation of a default should be their sole remedy (see below); and
E. Tenants who claim a breach of the Co-Tenancy provisions should be required to show a drop in sales unrelated to independent events.
As a precaution Landlords should also insist upon strict language allowing a cure period of a reasonable time if the provisions of the Co-Tenancy are alleged to be breached by the Tenant. In terms of Remedies, Tenants will want to preserve their right of Termination if the Landlord does not take diligent efforts to cure. On the front end of the Lease, this could be found in a conditional period for opening until an Opening Co-Tenancy provision is properly complied with by Landlord. During the term, Tenants will likely seek a specific time period to allow Landlord to cure before termination rights ripen, while Landlord will seek flexibility of Replacement Tenants and a “reasonable efforts” standard if an Anchor closes or goes bankrupt. One twist on the Remedies is to require Tenant to make an election to terminate or return to paying full rent if they continue to operate after the deadline for Landlord to cure the Co-Tenancy clause breach. In that case, Landlord will likely seek Tenant to agree to an election of Remedies: either stay and pay full rent or the Lease is terminated.
For Tenants, the Termination remedy is not always a panacea from a bad situation where Anchor(s) close. If the unwary Tenant has not negotiated a return of unamortized improvement costs, the net may be less of a gain than a mitigation of dollars already spent.
3. Lender Limitations
This is a key factor for not only Landlords, but Tenants as well. For the owner, their Lender will likely look down on stringent Co-Tenancy provisions as a hindrance to sales and potential increased value of the Center. Again, the more concessions allowed to non-anchor Tenants in this regard, the more difficult Landlord will find construction and/or permanent financing. On the other hand, if Tenants do not negotiate Co-Tenancy, their business and equipment Lenders may be less likely to finance the Tenant, especially if it is a franchised business. Factors Lenders are attuned to include:
A. Negative effects on the value of the Center based upon projected income streams;
B. Standards for gross sales for Anchors and Shop Tenants; and
C. Occupancy, Occupancy, Occupancy!
NOW THE FUN STUFF:
We would like your input on several questions that relate to this topic, including:
A. Is the fact that Landlords are developing, reconstructing and expanding Retail Centers with more availability for financing lead to Tenants having more or less negotiating power to ask for strong Co-Tenancy rights ? Cause or effect?- One would think so, but how is this playing out? (be honest!)
B. Does the effect of e-commerce and perhaps less demand for brick and mortar stores give Landlords more or less leverage to whittle down Tenant requests for strong rights and remedies? (This could lead to another article as well). One would say that showrooms are still needed at worst. At best, retail stores could function as display and distribution centers with less square footage….
C. Does the consolidation or expansion of certain Retail sectors (clothing, home improvement, entertainment and groceries among others) create new or different concerns for the parties? – do we all need to get along, or can Landlords still call the shots?
Looking forward to your responses!