Limiting the Impact of Co-Tenancy Requirements

Part Two of a Two-Part Series

A co-tenancy requirement may have substantial negative effects, including a domino effect if more than one tenant ceases to operate. Part One of this series discussed defining co-tenancy requirements, limiting their duration, and defining violations. The conclusion addresses notice and cure rights and limiting the tenant's remedies.

Provide for Notice and Cure Rights

Once a violation is deemed to have occurred, the landlord can create another hurdle before the tenant can exercise its remedies by requiring written notice to the landlord and an opportunity to cure the failure to comply with the co-tenancy requirement. The landlord may need a significant period of time to obtain a suitable replacement tenant. The time period may be longer for an anchor tenant. The violation should preferably be deemed cured when the landlord has entered into leases with tenants that satisfy the required co-tenancy if such tenants are required to open within a specified time, rather than actual opening for business (the timing of which may be substantially beyond the landlord's control).

Limiting Remedies

Once a violation of the co-tenancy requirement has occurred, and all notice and cure rights have lapsed, the impact of the co-tenancy requirement can be further limited by restricting the tenant's remedies.

The violation of a co-tenancy requirement should not be a default under the benefited tenant's lease; it should be clearly provided that such violation is a failure of a condition, not a default under a covenant. The tenant's remedies may be limited to payment of alternative rent, such as an amount equal to a percentage of gross sales or a lower minimum rent. The tenant, however, should continue to be obligated to pay additional rent (such as operating expenses, utilities, insurance, and taxes) at least so long as it is operating. If the alternative rent is solely a percentage of gross sales, the landlord should ensure that any breakpoint provision in the percentage rent clause is deleted (since, if there is no minimum rent, there should be no breakpoint). The parties will also need to negotiate the effect on the percentage rent breakpoint if percentage rent remains payable but the minimum rent is reduced.

The benefited tenant may insist on having the right to terminate the lease after a violation. A compromise may be to allow the tenant to pay alternative rent for a specified period (perhaps a year), at which time the tenant must elect either to terminate its lease or to resume paying full rent if the co-tenancy requirement remains unsatisfied. If the tenant elects not to terminate its lease, the tenant should not be able to exercise its remedies for a continuing failure of the co-tenancy requirement, at least for some period of time and so long as the failure does not significantly worsen. Should the tenant have a right to cease to operate after a violation, then this right should be in lieu of a percentage rent alternative rent since no rent would be payable.

Another way to limit the tenant's remedies is to require proof that the tenant has actually suffered a decline in its gross sales before the tenant may exercise any remedy and to tie damages to the extent of the decline. The tenant will argue that the absence of a decline is not a good indication of the damage it has suffered because its sales might have significantly increased but for the failure of the co-tenancy requirement.

Conclusion

When executing a lease, the landlord bets that its tenant will remain open for business (whether or not the landlord has bargained for an operating covenant). If the landlord agrees to a co-tenancy requirement in a second lease (with respect to that original tenant), the landlord has now effectively doubled its bet because it may lose the benefited tenant in addition to the original tenant if the original tenant ceases to operate.

If additional co-tenancy rights are granted, the landlord is putting its entire center at risk as the dominos start to fall. Co-tenancy provisions are, nevertheless, a fact of retail life. A landlord must carefully consider the escalating risk and impact each co-tenancy requirement can have on the future of its center and attempt to limit such impact through specific language in the letter of intent and in the lease.

Sheldon A. Halpern is a partner and Xavier Gutierrez is an associate in Pircher, Nichols & Meeks, a national real estate law firm with offices in Los Angeles and Chicago.

Part Two of a Two-Part Series

A co-tenancy requirement may have substantial negative effects, including a domino effect if more than one tenant ceases to operate. Part One of this series discussed defining co-tenancy requirements, limiting their duration, and defining violations. The conclusion addresses notice and cure rights and limiting the tenant's remedies.

Provide for Notice and Cure Rights

Once a violation is deemed to have occurred, the landlord can create another hurdle before the tenant can exercise its remedies by requiring written notice to the landlord and an opportunity to cure the failure to comply with the co-tenancy requirement. The landlord may need a significant period of time to obtain a suitable replacement tenant. The time period may be longer for an anchor tenant. The violation should preferably be deemed cured when the landlord has entered into leases with tenants that satisfy the required co-tenancy if such tenants are required to open within a specified time, rather than actual opening for business (the timing of which may be substantially beyond the landlord's control).

Limiting Remedies

Once a violation of the co-tenancy requirement has occurred, and all notice and cure rights have lapsed, the impact of the co-tenancy requirement can be further limited by restricting the tenant's remedies.

The violation of a co-tenancy requirement should not be a default under the benefited tenant's lease; it should be clearly provided that such violation is a failure of a condition, not a default under a covenant. The tenant's remedies may be limited to payment of alternative rent, such as an amount equal to a percentage of gross sales or a lower minimum rent. The tenant, however, should continue to be obligated to pay additional rent (such as operating expenses, utilities, insurance, and taxes) at least so long as it is operating. If the alternative rent is solely a percentage of gross sales, the landlord should ensure that any breakpoint provision in the percentage rent clause is deleted (since, if there is no minimum rent, there should be no breakpoint). The parties will also need to negotiate the effect on the percentage rent breakpoint if percentage rent remains payable but the minimum rent is reduced.

The benefited tenant may insist on having the right to terminate the lease after a violation. A compromise may be to allow the tenant to pay alternative rent for a specified period (perhaps a year), at which time the tenant must elect either to terminate its lease or to resume paying full rent if the co-tenancy requirement remains unsatisfied. If the tenant elects not to terminate its lease, the tenant should not be able to exercise its remedies for a continuing failure of the co-tenancy requirement, at least for some period of time and so long as the failure does not significantly worsen. Should the tenant have a right to cease to operate after a violation, then this right should be in lieu of a percentage rent alternative rent since no rent would be payable.

Another way to limit the tenant's remedies is to require proof that the tenant has actually suffered a decline in its gross sales before the tenant may exercise any remedy and to tie damages to the extent of the decline. The tenant will argue that the absence of a decline is not a good indication of the damage it has suffered because its sales might have significantly increased but for the failure of the co-tenancy requirement.

Conclusion

When executing a lease, the landlord bets that its tenant will remain open for business (whether or not the landlord has bargained for an operating covenant). If the landlord agrees to a co-tenancy requirement in a second lease (with respect to that original tenant), the landlord has now effectively doubled its bet because it may lose the benefited tenant in addition to the original tenant if the original tenant ceases to operate.

If additional co-tenancy rights are granted, the landlord is putting its entire center at risk as the dominos start to fall. Co-tenancy provisions are, nevertheless, a fact of retail life. A landlord must carefully consider the escalating risk and impact each co-tenancy requirement can have on the future of its center and attempt to limit such impact through specific language in the letter of intent and in the lease.

Sheldon A. Halpern is a partner and Xavier Gutierrez is an associate in Pircher, Nichols & Meeks, a national real estate law firm with offices in Los Angeles and Chicago.