In the Spotlight: Supporting Struggling Tenants

In the current economic climate, owners of retail shopping centers and office buildings alike are being barraged by tenant requests for rent forgiveness or deferral. Since landlords are loathe simply to forgive a tenant's payment obligations, the popular approach has been for landlords to defer a portion of the rent for payment later during the lease term. The hope is that the improvement to the tenant's cash flow will allow the tenant to avoid going dark in the short term. When the economy eventually improves, and tenant's cash flow along with it, the tenant should be able to resume full rent payments and also repay the accumulated deferred rent amount over a period of time. In deciding whether to grant a rent deferral, landlords should consider certain issues and strategies. This two-part article will discuss nine factors every landlord should consider.

Is There Really a Need? Verify Financial Distress

Prior to engaging in a substantive discussion of the terms of a deferral arrangement, a landlord would be wise first to verify that tenant's financial need. The landlord should require the tenant to provide financial statements ' and in the context of retail leases, gross sales reports ' covering the previous year or two. This will not only allow the landlord to assess the tenant's current economic state, but will also provide information about trends in the tenant's business throughout this economic slide. Any financial statements and gross sales reports furnished by the tenant should be certified by the chief financial officer or other suitable corporate officer.

This financial information will provide the landlord important insight into whether to negotiate a deferral arrangement with the tenant, and what terms would be appropriate. In some cases, the landlord may discover that the tenant is capable of making full payments but is attempting to leverage the current hysteria into a short-term windfall. However, these situations are rare. More often, reviewing the tenant's financials will provide the landlord with the information necessary to calibrate appropriate economic concessions. The landlord will not want to be the only party providing concessions to the tenant, so it may offer terms that give some relief, but which also require the tenant to negotiate with its other creditors to obtain similar concessions, thus spreading the risk equally. Evidence of such agreements with other creditors can be a prerequisite to the landlord's agreement to finalize its own deferral arrangement.

In extreme cases, a landlord may determine from a review of the financial statements and gross sales reports that the tenant's outright failure is inevitable, and to defer payments may result in the landlord's ultimately recouping less than it would if it continued to collect as much rent at possible in the short term.

Do I Need Permission First? Lender Approval Requirements

Any landlord's initial step in deciding whether to grant a tenant a rent deferral should be to review its loan documents to determine whether lender consent to the deferral arrangement is required. Many loans require that any amendments to the economic terms of a lease be submitted to the lender for prior approval, at least for tenants that exceed certain square footage thresholds. While these provisions are often focused on prohibiting rent abatements or forgiveness, or the reduction in the size of the premises, sometimes the language may be broad enough to pick up deferrals, as well. If this is the case, obtaining lender approval may be a laborious process, as many lenders and loan servicers are presently devoting most of their energy and staff support to dealing with what they consider to be more immediate problems, such as currently defaulted loans. Thus, getting a lender's attention to consider such a request in a timely manner may prove difficult.

Another consideration for a landlord is whether making such a request will raise the landlord's profile with its lender. Many landlords are flirting with a potential loan default as a result of the poor performance of their asset. Even if they are keeping current on loan payments, they may already be in technical default as a result of failing to satisfy debt service coverage ratio requirements, or having too many dark or closed premises, among other transgressions. In this case, a landlord should carefully consider whether seeking such consent may have adverse consequences in its relationship with its lender.

The Goal Is Short-Term Relief

While in a perfect world struggling tenants would approach their landlords in advance of a payment default, the practical likelihood is that many tenants seeking rent relief do so only after they have defaulted on several monthly rent payments. Landlords are then faced with the decision whether to evict the tenant and pursue legal remedies, or to try and work with these tenants and get them back into good standing. Because many tenants have defaulted on successive rent payments because they simply do not have the cash flow to make full payments, pursuing judgments against these tenants may be somewhat futile. Even when they obtain a judgment, landlords are often unable to collect, and the premises are very difficult to re-lease in this current economic climate.

Therefore, many landlords are agreeing to reduce the future monthly rent obligations in the short term, and to defer repayment of the reduced amount (and any existing past due amount) for repayment later during the lease term. The landlord should make clear to the tenant (especially one that is less sophisticated) that this reduction is merely a deferral of the obligation to pay these amounts and does not constitute free or abated rent. The hope is that once the economy rebounds, and presumably the tenant's business along with it, then the tenant will able to resume full rent payments and also to repay the deferred amounts. For example, a common scenario has been rent deferral of a specified percentage of the monthly rent obligation (e.g., 25% or more) for calendar year 2009, with repayment of the deferred amount beginning in calendar year 2011 to be made without interest (or with a minimal interest rate) over a period of 12-24 months.

A landlord should also decide whether or not a deferral will include cost pass-throughs, such as common area maintenance expenses, insurance and taxes. Since these are straight pass-throughs, the impact to the landlord of deferring these amounts in addition to rent may be difficult to absorb.

Landlord's Acceleration Rights

In the event a landlord agrees to such a deferral arrangement, it should be made clear that such an agreement is personal to the present tenant, and that it is premised upon that tenant's remaining otherwise solvent and in good standing under the lease and the deferral agreement. If the tenant later becomes insolvent, declares (or is forced into) bankruptcy, defaults under the lease or deferral agreement for any reason, or attempts to transfer its rights under the lease via assignment or sublease, the deferral agreement should provide that the deferred amount shall automatically accelerate and become immediately due and payable. To the extent not already covered by the subletting and assignment provision in the underlying lease, these acceleration rights should also apply in the event of a tenant's change of ownership, merger or acquisition or the purchase of all or substantially all of the tenant's assets by a third party.

Another acceleration trigger should be the tenant's failure to remain open and operating. While the enforceability of continuous operating covenants is in question in the context of putting a tenant in default of a lease, tying the privilege of rent deferral to such a requirement should not meet with the same challenges. Since the landlord's primary goal in consenting to a deferral arrangement is to keep the space occupied and the “lights on,” a tenant going dark undermines that purpose.

The conclusion of this article will discuss improving the original deal, confidentiality, tax implications and releases.

Kevin Corbett is a Partner in the California firm of Horner & Singer, LLP. Mr. Corbett practices commercial real estate and corporate Law. His commercial real estate practice includes representation of developers, owners, investors, and tenants in commercial transactions

In the current economic climate, owners of retail shopping centers and office buildings alike are being barraged by tenant requests for rent forgiveness or deferral. Since landlords are loathe simply to forgive a tenant's payment obligations, the popular approach has been for landlords to defer a portion of the rent for payment later during the lease term. The hope is that the improvement to the tenant's cash flow will allow the tenant to avoid going dark in the short term. When the economy eventually improves, and tenant's cash flow along with it, the tenant should be able to resume full rent payments and also repay the accumulated deferred rent amount over a period of time. In deciding whether to grant a rent deferral, landlords should consider certain issues and strategies. This two-part article will discuss nine factors every landlord should consider.

Is There Really a Need? Verify Financial Distress

Prior to engaging in a substantive discussion of the terms of a deferral arrangement, a landlord would be wise first to verify that tenant's financial need. The landlord should require the tenant to provide financial statements ' and in the context of retail leases, gross sales reports ' covering the previous year or two. This will not only allow the landlord to assess the tenant's current economic state, but will also provide information about trends in the tenant's business throughout this economic slide. Any financial statements and gross sales reports furnished by the tenant should be certified by the chief financial officer or other suitable corporate officer.

This financial information will provide the landlord important insight into whether to negotiate a deferral arrangement with the tenant, and what terms would be appropriate. In some cases, the landlord may discover that the tenant is capable of making full payments but is attempting to leverage the current hysteria into a short-term windfall. However, these situations are rare. More often, reviewing the tenant's financials will provide the landlord with the information necessary to calibrate appropriate economic concessions. The landlord will not want to be the only party providing concessions to the tenant, so it may offer terms that give some relief, but which also require the tenant to negotiate with its other creditors to obtain similar concessions, thus spreading the risk equally. Evidence of such agreements with other creditors can be a prerequisite to the landlord's agreement to finalize its own deferral arrangement.

In extreme cases, a landlord may determine from a review of the financial statements and gross sales reports that the tenant's outright failure is inevitable, and to defer payments may result in the landlord's ultimately recouping less than it would if it continued to collect as much rent at possible in the short term.

Do I Need Permission First? Lender Approval Requirements

Any landlord's initial step in deciding whether to grant a tenant a rent deferral should be to review its loan documents to determine whether lender consent to the deferral arrangement is required. Many loans require that any amendments to the economic terms of a lease be submitted to the lender for prior approval, at least for tenants that exceed certain square footage thresholds. While these provisions are often focused on prohibiting rent abatements or forgiveness, or the reduction in the size of the premises, sometimes the language may be broad enough to pick up deferrals, as well. If this is the case, obtaining lender approval may be a laborious process, as many lenders and loan servicers are presently devoting most of their energy and staff support to dealing with what they consider to be more immediate problems, such as currently defaulted loans. Thus, getting a lender's attention to consider such a request in a timely manner may prove difficult.

Another consideration for a landlord is whether making such a request will raise the landlord's profile with its lender. Many landlords are flirting with a potential loan default as a result of the poor performance of their asset. Even if they are keeping current on loan payments, they may already be in technical default as a result of failing to satisfy debt service coverage ratio requirements, or having too many dark or closed premises, among other transgressions. In this case, a landlord should carefully consider whether seeking such consent may have adverse consequences in its relationship with its lender.

The Goal Is Short-Term Relief

While in a perfect world struggling tenants would approach their landlords in advance of a payment default, the practical likelihood is that many tenants seeking rent relief do so only after they have defaulted on several monthly rent payments. Landlords are then faced with the decision whether to evict the tenant and pursue legal remedies, or to try and work with these tenants and get them back into good standing. Because many tenants have defaulted on successive rent payments because they simply do not have the cash flow to make full payments, pursuing judgments against these tenants may be somewhat futile. Even when they obtain a judgment, landlords are often unable to collect, and the premises are very difficult to re-lease in this current economic climate.

Therefore, many landlords are agreeing to reduce the future monthly rent obligations in the short term, and to defer repayment of the reduced amount (and any existing past due amount) for repayment later during the lease term. The landlord should make clear to the tenant (especially one that is less sophisticated) that this reduction is merely a deferral of the obligation to pay these amounts and does not constitute free or abated rent. The hope is that once the economy rebounds, and presumably the tenant's business along with it, then the tenant will able to resume full rent payments and also to repay the deferred amounts. For example, a common scenario has been rent deferral of a specified percentage of the monthly rent obligation (e.g., 25% or more) for calendar year 2009, with repayment of the deferred amount beginning in calendar year 2011 to be made without interest (or with a minimal interest rate) over a period of 12-24 months.

A landlord should also decide whether or not a deferral will include cost pass-throughs, such as common area maintenance expenses, insurance and taxes. Since these are straight pass-throughs, the impact to the landlord of deferring these amounts in addition to rent may be difficult to absorb.

Landlord's Acceleration Rights

In the event a landlord agrees to such a deferral arrangement, it should be made clear that such an agreement is personal to the present tenant, and that it is premised upon that tenant's remaining otherwise solvent and in good standing under the lease and the deferral agreement. If the tenant later becomes insolvent, declares (or is forced into) bankruptcy, defaults under the lease or deferral agreement for any reason, or attempts to transfer its rights under the lease via assignment or sublease, the deferral agreement should provide that the deferred amount shall automatically accelerate and become immediately due and payable. To the extent not already covered by the subletting and assignment provision in the underlying lease, these acceleration rights should also apply in the event of a tenant's change of ownership, merger or acquisition or the purchase of all or substantially all of the tenant's assets by a third party.

Another acceleration trigger should be the tenant's failure to remain open and operating. While the enforceability of continuous operating covenants is in question in the context of putting a tenant in default of a lease, tying the privilege of rent deferral to such a requirement should not meet with the same challenges. Since the landlord's primary goal in consenting to a deferral arrangement is to keep the space occupied and the “lights on,” a tenant going dark undermines that purpose.

The conclusion of this article will discuss improving the original deal, confidentiality, tax implications and releases.

Kevin Corbett is a Partner in the California firm of Horner & Singer, LLP. Mr. Corbett practices commercial real estate and corporate Law. His commercial real estate practice includes representation of developers, owners, investors, and tenants in commercial transactions