Matters that Require Careful Consideration When Structuring the Continuing Co-Tenancy

First, the developer should require the tenant to be open and operating in substantially all of the premises in order to enjoy the benefit of the continuing co-tenancy. If the tenant has satisfied its operating covenant and elects to close its premises in the absence of a failure of the continuing co-tenancy condition, the tenant's business at the project would not be damaged by the subsequent failure of the continuing co-tenancy condition. Further, the tenant's failure to remain open may directly or indirectly contribute to the closure of other tenants in the project, whether pursuant to continuing co-tenancies or otherwise. This domino effect may trigger a failure of a continuing co-tenancy condition in other tenants' leases and ultimately permit the tenant to pay a reduced rent pursuant to the tenant's own continuing co-tenancy. Accordingly, the developer should not permit the tenant, and the tenant should not expect, to leverage its way into paying a reduced rental as a result of its own actions. Moreover, the alternative rent remedy based on a percentage of sales would be rendered meaningless if the tenant were not operating in the premises.

Second, for leases with both opening and continuing co-tenancies, the tenant should not be permitted to exercise any rights under the continuing co-tenancy clause unless and until the opening co-tenancy has been satisfied. The tenant should not be permitted to double-dip in the exercise of remedies for what is essentially a single triggering event. If the tenants required to satisfy the opening co-tenancy have not opened by the expiration of the cure period, then, in the absence of the continuing co-tenancy, the tenant would be forced to decide whether to terminate the lease or waive the benefit of the opening co-tenancy. If, however, the tenant were permitted to waive the benefit of the opening co-tenancy and instead rely on the continuing co-tenancy (assuming similar co-tenant requirements), the tenant could defer its ultimate decision by immediately exercising its continuing co-tenancy rights, thereby emasculating the spirit and intent of the opening co-tenancy. The tenant would then begin a fresh cure period while continuing to pay reduced rent. Instead, the continuing co-tenancy should only become operative after the opening co-tenancy conditions have been satisfied.

Additional Considerations

For both opening and continuing co-tenancies, the developer should be careful in negotiating a handful of other matters as part of the applicable co-tenancy.

First, if the co-tenancy condition is not satisfied, the developer should seek to preserve the full rental rate for the negotiated lease term. In other words, if the co-tenancy condition is not satisfied when the tenant opens and the tenant pays a reduced rental for a period of time, then the expiration date of the lease should be extended for the period of time the tenant pays the reduced rent. This permits the developer to amortize its capital lease costs fully over the entire term and avoids potential underwriting concerns of the project lender. Similarly, the developer should decide whether to delay rent escalations, if any, set forth in the lease for the period of time that the tenant pays reduced rent pursuant to the co-tenancy or whether to leave the rent escalation dates in place and apply the last rental rate to the additional period added at the end of the term.

Second, the co-tenancy rights should be personal to the tenant, such that if the tenant were to assign its lease or to sublet its space, the co-tenancy right would expire. After all, the developer granted the co-tenancy right to the assigning tenant, and the successor entity may simply not enhance the tenant mix or have sufficient bargaining strength to warrant co-tenancy protection. In addition, a lease providing the successor tenant with continuing co-tenancy protection is more valuable, all other things being equal, than a lease without such protection, and therefore, more readily marketable and assignable. Moreover, if other project tenants have continuing co-tenancies tied to the presence of the assigning tenant and the assigning tenant leaves, such departure may trigger the exercise of numerous continuing co-tenancy rights, with the successor tenant ultimately being able to exercise co-tenancy rights as a result of the departure of the assigning tenant and, in turn, such other tenants, an unintended and counterintuitive result.

Third, if the tenant fails to notify the developer in a timely fashion of the tenant's desire to terminate the lease under the applicable co-tenancy, such failure should be deemed a waiver of the termination right. A co-tenancy is a concession to the tenant and, as such, it should not be the developer's responsibility to monitor. If the applicable co-tenancy is sufficiently valuable to the tenant, the tenant should determine whether and when it is entitled to exercise any rights there under.

Fourth, in the context of a continuing co-tenancy, the tenant should not have the right to exercise any continuing co-tenancy remedy occasioned by a casualty or condemnation event. The casualty and condemnation clauses of the lease should adequately address termination rights, restoration obligations and rent abatements, and the tenant should not expect to be able to aggregate remedies.

Fifth, if either the opening co-tenancy or the continuing co-tenancy condition is not satisfied prior to the expiration of the cure period, and the tenant elects to terminate the lease, the developer should attempt to obligate the tenant to pay full minimum rent and all pass-through charges from the expiration of the cure period through the effective date of the lease termination. This will encourage the tenant to exercise its termination right promptly, if at all, and persuade the tenant to vacate the premises quickly, making it available to the developer to re-market.

Finally, the tenant should not be able to exercise any rights under the co-tenancy clause if the tenant is otherwise in default under the lease. For example, with respect to an opening co-tenancy, if the lease requires the tenant to submit interior store drawings for the developer's approval on or before a certain date and the tenant misses the date by four weeks, the tenant, while obligated to pay rent, may not be able to open its store at the time contemplated by the lease. This failure to timely open may hinder a smooth opening of the shopping center and may trigger other tenants' termination rights granted pursuant to their co-tenancies, stalling the development momentum of the project. Accordingly, the tenant should not be able to exercise its co-tenancy rights if it creates the project's gridlock.

Conclusion

With an ever-increasing number of lifestyle centers, main street developments and town square projects relying on a core group of upscale national retailers, project synergies have become a key to fashioning a successful development, with co-tenancies serving as the principal arrow in the tenant's quiver. By being mindful of the risks involved and structuring co-tenancies accordingly, the careful developer can satisfy the co-tenancy concerns of an upscale national retailer while preventing such concerns from evolving into a self-fulfilling prophecy.

D. Albert Daspin is a partner and James H. Marshall is an associate with Holland & Knight, LLP, in Oakbrook Terrace, IL.

Parts One and Two of this article described what a co-tenancy provision is and discussed the issues involved, for both the landlord and tenant, when drafting one. The conclusion will address the continuing co-tenancy.

The Continuing Co-Tenancy

The principal difference between the continuing co-tenancy and the opening co-tenancy is the period of time addressed by each. The opening co-tenancy clause is triggered when the opening co-tenancy conditions have not occurred on or before the date the tenant's rental obligations commence. The continuing co-tenancy clause, on the other hand, provides the tenant relief if one or more of the continuing co-tenants or a certain portion of the project goes dark after the tenant opens. Otherwise, the structure of the two clauses is substantially similar. The continuing co-tenants are either named or are to occupy a certain portion of the floor area at the project (floor area is the typical yardstick), and the tenant would be permitted to exercise similar remedies upon the occurrence of the continuing co-tenancy event, including terminating the lease after the expiration of a cure period. As a result of the timing differences between the two co-tenancies, two additional matters should be considered and warrant careful consideration in structuring the continuing co-tenancy.

First, the developer should require the tenant to be open and operating in substantially all of the premises in order to enjoy the benefit of the continuing co-tenancy. If the tenant has satisfied its operating covenant and elects to close its premises in the absence of a failure of the continuing co-tenancy condition, the tenant's business at the project would not be damaged by the subsequent failure of the continuing co-tenancy condition. Further, the tenant's failure to remain open may directly or indirectly contribute to the closure of other tenants in the project, whether pursuant to continuing co-tenancies or otherwise. This domino effect may trigger a failure of a continuing co-tenancy condition in other tenants' leases and ultimately permit the tenant to pay a reduced rent pursuant to the tenant's own continuing co-tenancy. Accordingly, the developer should not permit the tenant, and the tenant should not expect, to leverage its way into paying a reduced rental as a result of its own actions. Moreover, the alternative rent remedy based on a percentage of sales would be rendered meaningless if the tenant were not operating in the premises.

Second, for leases with both opening and continuing co-tenancies, the tenant should not be permitted to exercise any rights under the continuing co-tenancy clause unless and until the opening co-tenancy has been satisfied. The tenant should not be permitted to double-dip in the exercise of remedies for what is essentially a single triggering event. If the tenants required to satisfy the opening co-tenancy have not opened by the expiration of the cure period, then, in the absence of the continuing co-tenancy, the tenant would be forced to decide whether to terminate the lease or waive the benefit of the opening co-tenancy. If, however, the tenant were permitted to waive the benefit of the opening co-tenancy and instead rely on the continuing co-tenancy (assuming similar co-tenant requirements), the tenant could defer its ultimate decision by immediately exercising its continuing co-tenancy rights, thereby emasculating the spirit and intent of the opening co-tenancy. The tenant would then begin a fresh cure period while continuing to pay reduced rent. Instead, the continuing co-tenancy should only become operative after the opening co-tenancy conditions have been satisfied.

Additional Considerations

For both opening and continuing co-tenancies, the developer should be careful in negotiating a handful of other matters as part of the applicable co-tenancy.

First, if the co-tenancy condition is not satisfied, the developer should seek to preserve the full rental rate for the negotiated lease term. In other words, if the co-tenancy condition is not satisfied when the tenant opens and the tenant pays a reduced rental for a period of time, then the expiration date of the lease should be extended for the period of time the tenant pays the reduced rent. This permits the developer to amortize its capital lease costs fully over the entire term and avoids potential underwriting concerns of the project lender. Similarly, the developer should decide whether to delay rent escalations, if any, set forth in the lease for the period of time that the tenant pays reduced rent pursuant to the co-tenancy or whether to leave the rent escalation dates in place and apply the last rental rate to the additional period added at the end of the term.

Second, the co-tenancy rights should be personal to the tenant, such that if the tenant were to assign its lease or to sublet its space, the co-tenancy right would expire. After all, the developer granted the co-tenancy right to the assigning tenant, and the successor entity may simply not enhance the tenant mix or have sufficient bargaining strength to warrant co-tenancy protection. In addition, a lease providing the successor tenant with continuing co-tenancy protection is more valuable, all other things being equal, than a lease without such protection, and therefore, more readily marketable and assignable. Moreover, if other project tenants have continuing co-tenancies tied to the presence of the assigning tenant and the assigning tenant leaves, such departure may trigger the exercise of numerous continuing co-tenancy rights, with the successor tenant ultimately being able to exercise co-tenancy rights as a result of the departure of the assigning tenant and, in turn, such other tenants, an unintended and counterintuitive result.

Third, if the tenant fails to notify the developer in a timely fashion of the tenant's desire to terminate the lease under the applicable co-tenancy, such failure should be deemed a waiver of the termination right. A co-tenancy is a concession to the tenant and, as such, it should not be the developer's responsibility to monitor. If the applicable co-tenancy is sufficiently valuable to the tenant, the tenant should determine whether and when it is entitled to exercise any rights there under.

Fourth, in the context of a continuing co-tenancy, the tenant should not have the right to exercise any continuing co-tenancy remedy occasioned by a casualty or condemnation event. The casualty and condemnation clauses of the lease should adequately address termination rights, restoration obligations and rent abatements, and the tenant should not expect to be able to aggregate remedies.

Fifth, if either the opening co-tenancy or the continuing co-tenancy condition is not satisfied prior to the expiration of the cure period, and the tenant elects to terminate the lease, the developer should attempt to obligate the tenant to pay full minimum rent and all pass-through charges from the expiration of the cure period through the effective date of the lease termination. This will encourage the tenant to exercise its termination right promptly, if at all, and persuade the tenant to vacate the premises quickly, making it available to the developer to re-market.

Finally, the tenant should not be able to exercise any rights under the co-tenancy clause if the tenant is otherwise in default under the lease. For example, with respect to an opening co-tenancy, if the lease requires the tenant to submit interior store drawings for the developer's approval on or before a certain date and the tenant misses the date by four weeks, the tenant, while obligated to pay rent, may not be able to open its store at the time contemplated by the lease. This failure to timely open may hinder a smooth opening of the shopping center and may trigger other tenants' termination rights granted pursuant to their co-tenancies, stalling the development momentum of the project. Accordingly, the tenant should not be able to exercise its co-tenancy rights if it creates the project's gridlock.

Conclusion

With an ever-increasing number of lifestyle centers, main street developments and town square projects relying on a core group of upscale national retailers, project synergies have become a key to fashioning a successful development, with co-tenancies serving as the principal arrow in the tenant's quiver. By being mindful of the risks involved and structuring co-tenancies accordingly, the careful developer can satisfy the co-tenancy concerns of an upscale national retailer while preventing such concerns from evolving into a self-fulfilling prophecy.

D. Albert Daspin is a partner and James H. Marshall is an associate with Holland & Knight, LLP, in Oakbrook Terrace, IL.