How Sweet Is the Pot?

The underwriting and due diligence involved in determining the financial viability and creditworthiness of a prospective commercial tenant and the methods by which landlords obtain comfort with regard to a prospective tenant's ability to perform its obligations (payment or otherwise) under a lease are concepts that all commercial leasing lawyers come to understand very early on in their careers. If a landlord questions a tenant's creditworthiness but is otherwise willing to move forward with the deal, the landlord will require ' or even the most novice leasing attorney will advise ' that the tenant provide security for its obligations under the lease, which typically takes the form of either an up-front security deposit or a guaranty from a creditworthy entity or individual, and sometimes even a combination of the two.

An issue that is not nearly as developed as that of tenant's security, but one that has become increasingly relevant during and in the aftermath of the recent economic recession as vacancies have forced landlords of commercial space of all types to “sweeten the pot” by offering sizable tenant improvement allowances, rent concessions and other kinds of tenant inducements, is how to address a situation where the tenant has reason to question a landlord's creditworthiness or longevity in the marketplace and must take steps to protect its ability to realize the benefits of the inducements promised. A tenant faced with such a situation in light of the current economic climate must downplay the allure of the offered inducement, take a cynical view of the world and think through how certain events (for example, a landlord bankruptcy or lender foreclosure) could negatively impact its ability to receive the benefit of its bargain.

This article, by way of drawing on an example to which many commercial landlords and tenants can relate in the current economic climate, offers considerations for tenants when evaluating the terms of a particular tenant inducement ' in this case, a tenant improvement allowance coupled with free rent ' and the means by which tenants can protect against losing the benefit of their bargain in a time when insolvency and bankruptcies of commercial real estate owners and commercial real estate foreclosures are all too common events.

Example

A single-asset landlord comprised of a developer/sponsor and other equity investors in the lease-up stage of a recently completed project is offering a sizeable tenant an improvement allowance, with the tenant to control the build-out of its space, coupled with one year of free rental. The original construction lender still has a mortgage encumbering the project, and unfunded amounts remain under the loan for application toward tenant improvement and leasing costs incurred during the lease-up and stabilization phase of the project.

Initial Considerations and Letter-of-Intent Stage

Before evaluating the tangible, economic viability of the landlord and its ability to deliver on the inducements promised, the tenant should take some time to assess the intangible qualities of the landlord, its principals and the lender. Do the landlord and, more specifically, the principal investors and managers of the landlord, have a proven track record and do they seem committed to the long-term viability of the project, notwithstanding the current economic climate? Is the lender supportive of the landlord's outlook and vision for the project, or is it just waiting for an opportunity to seize control? If the tenant can get a feel for these issues and get comfortable with the answers generated, it can then turn its attention to tangible qualities of the landlord and the offered inducement.

Now more than ever a tenant needs to perform diligence on the financial wherewithal of the landlord. Just as a covenant by the tenant to pay rent is only as good as the financial stability of the tenant, so too a promise by the landlord to contribute funds toward the build-out of the space and to provide the free rental promised is only as good as the availability of funds to make the contribution, and the landlord's longevity in the marketplace. As early as the letter-of-intent stage, the tenant should attempt to seek some level of comfort from the landlord that the money being offered will actually be there when needed. In the proffered example, given the presence of a single-asset landlord (as is often the case based on lender requirements), the tenant might want to require that the principal equity investors in the landlord confirm the availability of funds out of equity or, if money is going to be funded with debt under the construction loan, request a comfort letter from the lender confirming the availability of funds prior to going forward with the transaction. The last thing a tenant wants to do is incur out-of-pocket legal and other advisory fees only to get to the lease-negotiation stage and figure out that the landlord cannot come up with the funds.

Lease Negotiation and Strategy

Generally speaking, if the tenant is going to be controlling the build-out of its space, the landlord will require as a condition to disbursing installments of the allowance funds (whether it be in one lump sum upon completion of construction (landlord's preference) or at various stages of completion of the work in question (tenants' preference)) that the tenant submit, at a minimum, copies of the invoices for the work performed and lien waivers from the applicable contractors performing the work. This is especially true in the example presented where at least a portion of the tenant improvement funds will likely originate with the landlord's construction lender, and presumably the landlord has similar delivery requirements vis-'-vis its lender in order to trigger advancements under the construction loan.

But how can the tenant ensure that the money will be there when it actually completes the work and delivers the documentation required? It could obtain a guaranty from one of the landlord's principal equity investors or the lender, but that may not be obtainable. Moreover, all a guaranty does is provide a platform to bring a claim against a creditworthy entity in the event that the landlord fails to live up to its obligations ' it does not guarantee that the money will be there when needed to pay off the tenant's contractors, subcontractors and the like.

The tenant could also require that the funds be delivered into an escrow upon lease execution, which ensures that the money is in fact available, but requires the introduction of another document to be negotiated. No matter how “unconditional” the tenant's ability to draw down on the escrowed funds might be pursuant to the escrow agreement, the interjection of a third-party escrow agent always gives rise to some level of uncertainty.

Short of having the funds delivered directly to the tenant up front, the most fail-proof way to ensure the funds will be there when needed upon the tenant's satisfaction of the completion and delivery obligations under the lease is a standby, unconditional, irrevocable letter of credit from an issuing bank with a strong credit rating, allowing for the tenant to draw down funds in the amount of the improvement allowance owed at any time it feels entitled to do so under the lease. In such a situation, the tenant need only submit a sight draft to the issuing bank to obtain the funds to which it believes it is entitled, and possibly a statement certifying that it is so entitled, and the issuing bank is required to deliver the funds requested. If the landlord subsequently feels that the allowance funds were unjustly drawn, it must then bring a claim against the tenant in order to retrieve the ill-gotten funds. Simply stated, the letter of credit allows for immediate availability of the allowance funds, and effectively shifts the burden of proving that the applicable build-out work was completed from the tenant to the landlord.

The problem that none of these options solve, however, is that of an intervening landlord bankruptcy. Whether a landlord covers an allowance payment itself, via draws on its construction loan, or the tenant draws down the funds based on landlord's failure to perform by way of an escrow or a letter of credit, an intervening landlord bankruptcy can jeopardize a tenant's ability to retain allowance funds received.

Pursuant to ' 547 of the Bankruptcy Code, any payments made by or on behalf of the landlord on an antecedent debt (in this case, payments made on work already performed by or on behalf of tenant) within the 90-day period immediately preceding a landlord's bankruptcy filing could very well be treated as an avoidable preference in a bankruptcy setting. Any payment deemed an avoidable preference can, in the absence of available defenses, be clawed back from the tenant by the bankruptcy court or appointed bankruptcy trustee and rolled into the landlord's bankruptcy estate, thereby delaying (and most likely reducing) the tenant's claim to the funds.

Depending on the length of the bankruptcy proceeding and the timing of the appointment of a bankruptcy trustee, if one is in fact appointed, this “clawback” of the funds can take place up to three years after the landlord's bankruptcy filing. The intricacies of preference law and available defenses (as well as the potential for rejection of the lease in a bankruptcy setting) are beyond the scope of this article, but suffice to say, the possibility of an inducement payment being clawed back as an avoidable preference in a landlord bankruptcy well into the term of a tenant's lease is reason enough for the tenant to strongly consider alternative means to receiving the benefit of the inducements.

At the end of the day, the simplest and cleanest way to ensure a tenant's receipt of the allowance in the time period needed without potential “clawback” in bankruptcy is to have the landlord or its lender fund the full amount of the allowance up front, in which case the payment would constitute a contemporaneous exchange, thereby avoiding any preference concerns. Ignoring the possible objections from the landlord's lender, a landlord presented with this option will argue that the up-front payment eliminates its ability to manage the progress of the build-out and to ensure that the build-out is completed in a timely and proper fashion (and, of course, there is always the possibility of the tenant's absconding with or misappropriating the funds, but assume for the purposes of this article that we are dealing with two sophisticated, reputable parties).

One way to address this in the lease is to have a “deemed earned” concept implemented with respect to the up-front payment, such that, for the purposes of any termination of the lease (by tenant default or otherwise) occurring prior to or during the pendency of any build-out of the tenant's space, which is of the utmost concern to the landlord in the case of an up-front funding, the amount of the allowance the tenant is deemed to have spent for the purposes of determining the landlord's recourse upon any lease termination is to be based on the level of completion of the build-out in question, regardless of the amounts actually spent by the tenant. A landlord may ask for some kind of security for the repayment of any unspent or “deemed unspent” allowance in the event of a termination-triggering event, but that might be something the tenant is willing to provide in consideration for the up-front payment. Of vital importance in determining the level of completion with this “deemed earned” approach is the need for the tenant and landlord mutually to approve a detailed and complete set of plans and specifications for the build-out prior to commencement of construction so that completion can be objectively determined at any and every stage of the build-out.

If the landlord (or landlord's lender) is not amenable to up-front funding, it is of paramount importance that the tenant demand maximum and express offset rights in the lease, so that any unfunded or any clawed-back allowance money can ultimately be realized under the lease by offsetting amounts owed by the landlord for the allowance against rent owed by the tenant. Of course, in the example presented, it may take the tenant a while to reimburse itself fully by way of offset, given the free rental period, and even longer in a retail setting where a large component of rent to be paid under the lease may be based on percentage rentals from gross revenues derived from the tenant's operation at the premises, which provides the tenant with all the more ammunition to argue to the landlord that an up-front payment is the only way to proceed.

Lender Recognition

Equally as important as gaining a sufficient level of comfort from the landlord that the inducement dollars will be available for the tenant's use and will not be clawed back in the event of a landlord bankruptcy is the need to obtain agreement from the existing lender that the tenant's lease and the rights to which the tenant is entitled under the lease will be recognized by the lender in the event of a foreclosure of the existing mortgage or the exercise of any other remedy under the mortgage documents resulting in the ownership or control of the project and the premises changing hands. This is particularly true in the example presented where the project is still being leased-up and has not yet achieved stabilization, and the probability of a future foreclosure or default under the loan is much higher than it would otherwise be for a stabilized project.

Commonly known in the commercial leasing world is the prevailing legal precept that the foreclosure of a superior mortgage (i.e., a mortgage that pre-exists the lease) will allow for the foreclosing lender (or, if different, a purchaser at foreclosure) to elect to terminate ' or, in some jurisdictions, will automatically terminate ' the lease and the tenant's right to occupy the premises. Thus, a tenant entering into a lease of premises subject to an existing mortgage should always request or, depending on the size of the lease and the bargaining strength of the tenant, require as a condition to entering into the lease or as a condition to commence paying rent, that the landlord cause its lender to execute a recognition agreement in favor of the tenant. More often than not, the recognition agreement takes the form of a subordination, non-disturbance and attornment agreement, or “SNDA,” whereby the tenant confirms the subordination of its lease to the lien of the mortgage, but at the same time, the lender confirms for itself and any purchasers at foreclosure that it will recognize the lease and assume the landlord's obligations thereunder upon foreclosure (subject to certain exceptions described below), and the tenant agrees to attorn or recognize the lender or the purchaser at foreclosure as the new landlord under the lease.

Generally, a tenant will at least be able to obtain agreement by the landlord's lender to execute the lender's form SNDA; the problem with most form SNDAs, however, is that the lender specifically excepts from those lease obligations of the landlord assumed upon foreclosure, the obligation to pay for any unfunded portion of any improvement allowance or recognize any free rental periods or offset rights under the lease. A lender's typical argument for this exception is that, to the extent of any payment obligations remaining under the lease, the tenant must look to the original landlord (now likely insolvent or possibly even dissolved) for the payment of those amounts and, as to any free rentals or offsets, the lender will argue that it had no control over the lease negotiations and should not be subject to any “deal-sweeteners” that the original landlord provided the tenant.

In the current real-estate climate, however, and particularly with respect to the example presented, the lender's argument simply does not hold much water, especially if the lender is ultimately going to be the source of the allowance funds. Additionally, in the aftermath of the meltdown of the CMBS market, which many believe to be the primary cause (or, at least, a catalyst) of the real-estate market's most recent decline, lenders are becoming increasingly involved and, in some cases, are the ultimate drivers behind the economic terms of the lease. Lenders can no longer hide behind the veil of an uninvolved, unknowing third party. And, on a more fundamental level, the success of the development and the landlord's ability to meet its obligations under the loan is necessarily dependent upon the income derived from the project; the lender, like the landlord, needs to make as many accommodations as possible to provide for the continuing success of the project. All that being said, the SNDA proffered by the lender will most certainly not acknowledge this reality, and the tenant will have to raise these arguments in support of gaining recognition by the lender of the tenant inducements (assuming that up-front funding of the allowance is not an option) and other express rights granted under the lease.

Conclusion

In a tenant-friendly environment where tenant inducement offers are as sweet as they come, it is important for tenants to take a step back, evaluate the offer, perform due diligence on the landlord and the space in question, both from a tangible and intangible perspective, and take steps to protect the tenant's rights in the inducements offered to ensure that they are ultimately realized. An inducement is only as good as a landlord's ability to provide it or, in the event the landlord succumbs to foreclosure, the lender's or purchaser at foreclosure's obligation to recognize those rights. Depending on the needs and desperation level of the landlord and its ability to ensure cooperation from its lender, the tenant can all but guarantee receipt of the benefit of its bargain with respect to the tenant inducements in play.

Andrew R. “Drew” Allen is a senior associate in the Atlanta office of Alston & Bird LLP. He concentrates his practice on the acquisition, financing, development, leasing and disposition of commercial real estate. He has experience representing large institutional and pension fund investors, developers, landlords and tenants of retail, office and industrial properties, and publicly traded real estate investment trusts.

The underwriting and due diligence involved in determining the financial viability and creditworthiness of a prospective commercial tenant and the methods by which landlords obtain comfort with regard to a prospective tenant's ability to perform its obligations (payment or otherwise) under a lease are concepts that all commercial leasing lawyers come to understand very early on in their careers. If a landlord questions a tenant's creditworthiness but is otherwise willing to move forward with the deal, the landlord will require ' or even the most novice leasing attorney will advise ' that the tenant provide security for its obligations under the lease, which typically takes the form of either an up-front security deposit or a guaranty from a creditworthy entity or individual, and sometimes even a combination of the two.

An issue that is not nearly as developed as that of tenant's security, but one that has become increasingly relevant during and in the aftermath of the recent economic recession as vacancies have forced landlords of commercial space of all types to “sweeten the pot” by offering sizable tenant improvement allowances, rent concessions and other kinds of tenant inducements, is how to address a situation where the tenant has reason to question a landlord's creditworthiness or longevity in the marketplace and must take steps to protect its ability to realize the benefits of the inducements promised. A tenant faced with such a situation in light of the current economic climate must downplay the allure of the offered inducement, take a cynical view of the world and think through how certain events (for example, a landlord bankruptcy or lender foreclosure) could negatively impact its ability to receive the benefit of its bargain.

This article, by way of drawing on an example to which many commercial landlords and tenants can relate in the current economic climate, offers considerations for tenants when evaluating the terms of a particular tenant inducement ' in this case, a tenant improvement allowance coupled with free rent ' and the means by which tenants can protect against losing the benefit of their bargain in a time when insolvency and bankruptcies of commercial real estate owners and commercial real estate foreclosures are all too common events.

Example

A single-asset landlord comprised of a developer/sponsor and other equity investors in the lease-up stage of a recently completed project is offering a sizeable tenant an improvement allowance, with the tenant to control the build-out of its space, coupled with one year of free rental. The original construction lender still has a mortgage encumbering the project, and unfunded amounts remain under the loan for application toward tenant improvement and leasing costs incurred during the lease-up and stabilization phase of the project.

Initial Considerations and Letter-of-Intent Stage

Before evaluating the tangible, economic viability of the landlord and its ability to deliver on the inducements promised, the tenant should take some time to assess the intangible qualities of the landlord, its principals and the lender. Do the landlord and, more specifically, the principal investors and managers of the landlord, have a proven track record and do they seem committed to the long-term viability of the project, notwithstanding the current economic climate? Is the lender supportive of the landlord's outlook and vision for the project, or is it just waiting for an opportunity to seize control? If the tenant can get a feel for these issues and get comfortable with the answers generated, it can then turn its attention to tangible qualities of the landlord and the offered inducement.

Now more than ever a tenant needs to perform diligence on the financial wherewithal of the landlord. Just as a covenant by the tenant to pay rent is only as good as the financial stability of the tenant, so too a promise by the landlord to contribute funds toward the build-out of the space and to provide the free rental promised is only as good as the availability of funds to make the contribution, and the landlord's longevity in the marketplace. As early as the letter-of-intent stage, the tenant should attempt to seek some level of comfort from the landlord that the money being offered will actually be there when needed. In the proffered example, given the presence of a single-asset landlord (as is often the case based on lender requirements), the tenant might want to require that the principal equity investors in the landlord confirm the availability of funds out of equity or, if money is going to be funded with debt under the construction loan, request a comfort letter from the lender confirming the availability of funds prior to going forward with the transaction. The last thing a tenant wants to do is incur out-of-pocket legal and other advisory fees only to get to the lease-negotiation stage and figure out that the landlord cannot come up with the funds.

Lease Negotiation and Strategy

Generally speaking, if the tenant is going to be controlling the build-out of its space, the landlord will require as a condition to disbursing installments of the allowance funds (whether it be in one lump sum upon completion of construction (landlord's preference) or at various stages of completion of the work in question (tenants' preference)) that the tenant submit, at a minimum, copies of the invoices for the work performed and lien waivers from the applicable contractors performing the work. This is especially true in the example presented where at least a portion of the tenant improvement funds will likely originate with the landlord's construction lender, and presumably the landlord has similar delivery requirements vis-'-vis its lender in order to trigger advancements under the construction loan.

But how can the tenant ensure that the money will be there when it actually completes the work and delivers the documentation required? It could obtain a guaranty from one of the landlord's principal equity investors or the lender, but that may not be obtainable. Moreover, all a guaranty does is provide a platform to bring a claim against a creditworthy entity in the event that the landlord fails to live up to its obligations ' it does not guarantee that the money will be there when needed to pay off the tenant's contractors, subcontractors and the like.

The tenant could also require that the funds be delivered into an escrow upon lease execution, which ensures that the money is in fact available, but requires the introduction of another document to be negotiated. No matter how “unconditional” the tenant's ability to draw down on the escrowed funds might be pursuant to the escrow agreement, the interjection of a third-party escrow agent always gives rise to some level of uncertainty.

Short of having the funds delivered directly to the tenant up front, the most fail-proof way to ensure the funds will be there when needed upon the tenant's satisfaction of the completion and delivery obligations under the lease is a standby, unconditional, irrevocable letter of credit from an issuing bank with a strong credit rating, allowing for the tenant to draw down funds in the amount of the improvement allowance owed at any time it feels entitled to do so under the lease. In such a situation, the tenant need only submit a sight draft to the issuing bank to obtain the funds to which it believes it is entitled, and possibly a statement certifying that it is so entitled, and the issuing bank is required to deliver the funds requested. If the landlord subsequently feels that the allowance funds were unjustly drawn, it must then bring a claim against the tenant in order to retrieve the ill-gotten funds. Simply stated, the letter of credit allows for immediate availability of the allowance funds, and effectively shifts the burden of proving that the applicable build-out work was completed from the tenant to the landlord.

The problem that none of these options solve, however, is that of an intervening landlord bankruptcy. Whether a landlord covers an allowance payment itself, via draws on its construction loan, or the tenant draws down the funds based on landlord's failure to perform by way of an escrow or a letter of credit, an intervening landlord bankruptcy can jeopardize a tenant's ability to retain allowance funds received.

Pursuant to ' 547 of the Bankruptcy Code, any payments made by or on behalf of the landlord on an antecedent debt (in this case, payments made on work already performed by or on behalf of tenant) within the 90-day period immediately preceding a landlord's bankruptcy filing could very well be treated as an avoidable preference in a bankruptcy setting. Any payment deemed an avoidable preference can, in the absence of available defenses, be clawed back from the tenant by the bankruptcy court or appointed bankruptcy trustee and rolled into the landlord's bankruptcy estate, thereby delaying (and most likely reducing) the tenant's claim to the funds.

Depending on the length of the bankruptcy proceeding and the timing of the appointment of a bankruptcy trustee, if one is in fact appointed, this “clawback” of the funds can take place up to three years after the landlord's bankruptcy filing. The intricacies of preference law and available defenses (as well as the potential for rejection of the lease in a bankruptcy setting) are beyond the scope of this article, but suffice to say, the possibility of an inducement payment being clawed back as an avoidable preference in a landlord bankruptcy well into the term of a tenant's lease is reason enough for the tenant to strongly consider alternative means to receiving the benefit of the inducements.

At the end of the day, the simplest and cleanest way to ensure a tenant's receipt of the allowance in the time period needed without potential “clawback” in bankruptcy is to have the landlord or its lender fund the full amount of the allowance up front, in which case the payment would constitute a contemporaneous exchange, thereby avoiding any preference concerns. Ignoring the possible objections from the landlord's lender, a landlord presented with this option will argue that the up-front payment eliminates its ability to manage the progress of the build-out and to ensure that the build-out is completed in a timely and proper fashion (and, of course, there is always the possibility of the tenant's absconding with or misappropriating the funds, but assume for the purposes of this article that we are dealing with two sophisticated, reputable parties).

One way to address this in the lease is to have a “deemed earned” concept implemented with respect to the up-front payment, such that, for the purposes of any termination of the lease (by tenant default or otherwise) occurring prior to or during the pendency of any build-out of the tenant's space, which is of the utmost concern to the landlord in the case of an up-front funding, the amount of the allowance the tenant is deemed to have spent for the purposes of determining the landlord's recourse upon any lease termination is to be based on the level of completion of the build-out in question, regardless of the amounts actually spent by the tenant. A landlord may ask for some kind of security for the repayment of any unspent or “deemed unspent” allowance in the event of a termination-triggering event, but that might be something the tenant is willing to provide in consideration for the up-front payment. Of vital importance in determining the level of completion with this “deemed earned” approach is the need for the tenant and landlord mutually to approve a detailed and complete set of plans and specifications for the build-out prior to commencement of construction so that completion can be objectively determined at any and every stage of the build-out.

If the landlord (or landlord's lender) is not amenable to up-front funding, it is of paramount importance that the tenant demand maximum and express offset rights in the lease, so that any unfunded or any clawed-back allowance money can ultimately be realized under the lease by offsetting amounts owed by the landlord for the allowance against rent owed by the tenant. Of course, in the example presented, it may take the tenant a while to reimburse itself fully by way of offset, given the free rental period, and even longer in a retail setting where a large component of rent to be paid under the lease may be based on percentage rentals from gross revenues derived from the tenant's operation at the premises, which provides the tenant with all the more ammunition to argue to the landlord that an up-front payment is the only way to proceed.

Lender Recognition

Equally as important as gaining a sufficient level of comfort from the landlord that the inducement dollars will be available for the tenant's use and will not be clawed back in the event of a landlord bankruptcy is the need to obtain agreement from the existing lender that the tenant's lease and the rights to which the tenant is entitled under the lease will be recognized by the lender in the event of a foreclosure of the existing mortgage or the exercise of any other remedy under the mortgage documents resulting in the ownership or control of the project and the premises changing hands. This is particularly true in the example presented where the project is still being leased-up and has not yet achieved stabilization, and the probability of a future foreclosure or default under the loan is much higher than it would otherwise be for a stabilized project.

Commonly known in the commercial leasing world is the prevailing legal precept that the foreclosure of a superior mortgage (i.e., a mortgage that pre-exists the lease) will allow for the foreclosing lender (or, if different, a purchaser at foreclosure) to elect to terminate ' or, in some jurisdictions, will automatically terminate ' the lease and the tenant's right to occupy the premises. Thus, a tenant entering into a lease of premises subject to an existing mortgage should always request or, depending on the size of the lease and the bargaining strength of the tenant, require as a condition to entering into the lease or as a condition to commence paying rent, that the landlord cause its lender to execute a recognition agreement in favor of the tenant. More often than not, the recognition agreement takes the form of a subordination, non-disturbance and attornment agreement, or “SNDA,” whereby the tenant confirms the subordination of its lease to the lien of the mortgage, but at the same time, the lender confirms for itself and any purchasers at foreclosure that it will recognize the lease and assume the landlord's obligations thereunder upon foreclosure (subject to certain exceptions described below), and the tenant agrees to attorn or recognize the lender or the purchaser at foreclosure as the new landlord under the lease.

Generally, a tenant will at least be able to obtain agreement by the landlord's lender to execute the lender's form SNDA; the problem with most form SNDAs, however, is that the lender specifically excepts from those lease obligations of the landlord assumed upon foreclosure, the obligation to pay for any unfunded portion of any improvement allowance or recognize any free rental periods or offset rights under the lease. A lender's typical argument for this exception is that, to the extent of any payment obligations remaining under the lease, the tenant must look to the original landlord (now likely insolvent or possibly even dissolved) for the payment of those amounts and, as to any free rentals or offsets, the lender will argue that it had no control over the lease negotiations and should not be subject to any “deal-sweeteners” that the original landlord provided the tenant.

In the current real-estate climate, however, and particularly with respect to the example presented, the lender's argument simply does not hold much water, especially if the lender is ultimately going to be the source of the allowance funds. Additionally, in the aftermath of the meltdown of the CMBS market, which many believe to be the primary cause (or, at least, a catalyst) of the real-estate market's most recent decline, lenders are becoming increasingly involved and, in some cases, are the ultimate drivers behind the economic terms of the lease. Lenders can no longer hide behind the veil of an uninvolved, unknowing third party. And, on a more fundamental level, the success of the development and the landlord's ability to meet its obligations under the loan is necessarily dependent upon the income derived from the project; the lender, like the landlord, needs to make as many accommodations as possible to provide for the continuing success of the project. All that being said, the SNDA proffered by the lender will most certainly not acknowledge this reality, and the tenant will have to raise these arguments in support of gaining recognition by the lender of the tenant inducements (assuming that up-front funding of the allowance is not an option) and other express rights granted under the lease.

Conclusion

In a tenant-friendly environment where tenant inducement offers are as sweet as they come, it is important for tenants to take a step back, evaluate the offer, perform due diligence on the landlord and the space in question, both from a tangible and intangible perspective, and take steps to protect the tenant's rights in the inducements offered to ensure that they are ultimately realized. An inducement is only as good as a landlord's ability to provide it or, in the event the landlord succumbs to foreclosure, the lender's or purchaser at foreclosure's obligation to recognize those rights. Depending on the needs and desperation level of the landlord and its ability to ensure cooperation from its lender, the tenant can all but guarantee receipt of the benefit of its bargain with respect to the tenant inducements in play.

Andrew R. “Drew” Allen is a senior associate in the Atlanta office of Alston & Bird LLP. He concentrates his practice on the acquisition, financing, development, leasing and disposition of commercial real estate. He has experience representing large institutional and pension fund investors, developers, landlords and tenants of retail, office and industrial properties, and publicly traded real estate investment trusts.