How Low Can You Go?

Landlord Strategies

To eliminate or reduce the impact of these two evils, the landlord can attempt to limit the availability of these tenant options during the lease negotiation stage.

In the first situation, before agreeing to a “kick-out” right, the landlord should require the tenant to be fully operating during the test year, and fully stocked, staffed and fixtured. The tenant should be required to use reasonable efforts to maximize gross sales, including marketing the premises at a level that the tenant markets other stores in the area. The lease should also provide that if the tenant has achieved said sales level in any 12-month period prior to the test year, the termination right may not be exercised. If the tenant will not agree to this last concept, then a compromise would be that if the tenant has achieved the minimum sales threshold in any 12-month period, but not the test year, then the lease term is extended for one more year past the test year, and gross sales must be below the sales level again in the year following the original test year, in order to allow the tenant to terminate early.

If the tenant simply refuses to exercise a renewal option without a rent concession, or asks for a lower rent to extend the term, the landlord must perform adequate due diligence to determine if the tenant is really struggling in the store or is just trying to better the deal. The landlord must look at the contractual rent as compared with current market conditions and determine if there is a risk in calling the tenant's bluff. Is the renewal option rent higher than current fair market rent? Is the shopping center near capacity with other potential tenants available that will pay higher rent?

In a situation where the tenant has no right to terminate, but is threatening simply to default under the lease, the landlord must again review the tenant's financial situation and review the remedies negotiated in the lease to determine whether it is feasible for the landlord to exercise the security the landlord has if it denies the suggestion to renegotiate the business terms. Default remedies should be carefully studied. If the tenant has other stores in the same name, and those are performing well, the tenant's threats may be weakened. Can the landlord apply a security deposit or draw on a letter of credit? Is there a guaranty?

Reduction Accepted

Once the decision has been made to reduce the contractual rent, the landlord must decide on the nature of the reduction and the length of time of the reduction. Is it for a year, or the remainder of the term, or does it extend into the next renewal option? Does the landlord agree to an absolute reduction, or perhaps the reduction only serves to postpone or “defer” the amount of the reduction, and the tenant must make up the shortfall at a later date. In some situations, only additional rent (taxes and common area maintenance) is excused, while base rent remains the same as originally set forth in the lease.

In other situations, the tenant is permitted to pay only percentage rent over a $0 base, instead of a fixed minimum rent. If the tenant's base rent is reduced to a lower fixed amount, the landlord must remember similarly to reduce the breakpoint for determining percentage rent, if applicable, especially if the breakpoint was previously based on a natural break. The landlord may also provide that once rent is lowered, if the gross sales subsequently exceed some set dollar amount, indicating that the tenant has recovered, the rent reduction is terminated, and the original rent level is reinstated.

If the landlord is forced to reduce rent, it should attempt to get some kind of trade-off for this concession. A careful review of the lease may indicate several provisions that the landlord should require be used in a re-trade. Are there co-tenancy requirements that should be deleted? Should the landlord be given an early termination right for low sales? Should expansion or renewal rights be terminated? Perhaps broad-use rights or exclusives should no longer be allowed. If the tenant is requiring rent relief because it is not doing well, it should no longer have certain rights that are typically only granted to tenants paying market rent and expected to perform well.

The landlord should also consider a right to re-market the space if the tenant is receiving a rent concession that allows it to pay below market rent. The landlord should be given the right in the future to terminate the lease, or relocate the tenant, unless the tenant is willing to reinstate the original rent.

The request for a rent concession often indicates a tenant in trouble that is at risk of not performing under the lease. Therefore, as a condition to the granting of any rent reduction, the tenant should agree that the rent relief granted by the lease amendment should only remain in effect so long as the tenant does not commit an event of default, and provided that the tenant remains open to the public, fully stocked, staffed and fixtured and that the tenant uses reasonable efforts to maximize gross sales (the same requirements the landlord should have put into the lease if there were an early termination right).

If the tenant does not satisfy any of the terms of this paragraph or otherwise defaults under the lease, the rent concession terminates. To add additional strength to this requirement, the landlord might also seek to have the tenant acknowledge that the original rent payments are retroactive to the beginning of the reduced rent period if the tenant is no longer entitled to rent relief (unless the reason for termination of the rent relief is that the tenant has achieved a sufficient sales level to no longer justify the reduction).

The tenant should also agree that if within some short time period after the effective date of the lease amendment, should it file for or be put into bankruptcy, then the lease amendment containing the rent reduction should be deemed null and void. Then the lease shall be reinstated to its original terms and be deemed in full force and effect, and the landlord can file a claim for amounts due under the original lease as if the amendment had never existed.

Conclusion

While landlords should be careful to limit the circumstances in which they agree to rent reductions, doing so can often be turned into positive situations. In addition to keeping tenants in place, which tenants otherwise might terminate their leases, landlords can modify other lease provisions to be more favorable to them, and in so doing, soften the negative aspects of the concessions and come away with stronger shopping centers.

Ira Fierstein, a member of this newsletter's Board of Editors, is Co-Chair of the Leasing Practice Group and a partner in the Chicago office of Seyfarth Shaw LLP.

While most professionals are in agreement that the retail industry has recovered somewhat from the depths of the recession, there are still many retailers who are struggling to generate profits, either for their entire enterprise or for specific locations. As a result, these tenants have approached landlords to renegotiate their rent in order to lower their occupancy costs as they struggle to remain open.

Tenant Scenarios

In many instances, these tenants rely on one of the following positions to persuade the landlords to come to the table:

1. The tenant has a sales “kick-out” or “early termination” clause, and the tenant is threatening to exercise this right unless the landlord agrees to a rent concession. In a 10-year term, for example, occasionally a tenant will negotiate this in the original lease as an option that arises after the fifth lease year, if the sales during the fifth lease year do not equal or exceed some minimum threshold.'
2. The lease is coming to the end of the term, and the tenant threatens not to extend the term or exercise an option to renew unless the landlord agrees to reduce the rent in the renewal option period for less than previously negotiated in the lease, or less than the rent currently being paid.
3. The tenant has other termination rights and it is threatening to exercise one of them unless the landlord reduces the rent. For example, there might be a co-tenancy breach, or exclusive use breach or right to terminate if the landlord has exercised a relocation option.'
4. The tenant has no personal liability, has signed the lease in the name of a shell entity, and there is little security deposit. In this situation, the tenant may simply threaten to default or file bankruptcy.'

Faced with these situations, landlords must decide between the lesser of two evils: making some concession to the existing tenant or accepting vacant space in a soft market.

Landlord Strategies

To eliminate or reduce the impact of these two evils, the landlord can attempt to limit the availability of these tenant options during the lease negotiation stage.

In the first situation, before agreeing to a “kick-out” right, the landlord should require the tenant to be fully operating during the test year, and fully stocked, staffed and fixtured. The tenant should be required to use reasonable efforts to maximize gross sales, including marketing the premises at a level that the tenant markets other stores in the area. The lease should also provide that if the tenant has achieved said sales level in any 12-month period prior to the test year, the termination right may not be exercised. If the tenant will not agree to this last concept, then a compromise would be that if the tenant has achieved the minimum sales threshold in any 12-month period, but not the test year, then the lease term is extended for one more year past the test year, and gross sales must be below the sales level again in the year following the original test year, in order to allow the tenant to terminate early.

If the tenant simply refuses to exercise a renewal option without a rent concession, or asks for a lower rent to extend the term, the landlord must perform adequate due diligence to determine if the tenant is really struggling in the store or is just trying to better the deal. The landlord must look at the contractual rent as compared with current market conditions and determine if there is a risk in calling the tenant's bluff. Is the renewal option rent higher than current fair market rent? Is the shopping center near capacity with other potential tenants available that will pay higher rent?

In a situation where the tenant has no right to terminate, but is threatening simply to default under the lease, the landlord must again review the tenant's financial situation and review the remedies negotiated in the lease to determine whether it is feasible for the landlord to exercise the security the landlord has if it denies the suggestion to renegotiate the business terms. Default remedies should be carefully studied. If the tenant has other stores in the same name, and those are performing well, the tenant's threats may be weakened. Can the landlord apply a security deposit or draw on a letter of credit? Is there a guaranty?

Reduction Accepted

Once the decision has been made to reduce the contractual rent, the landlord must decide on the nature of the reduction and the length of time of the reduction. Is it for a year, or the remainder of the term, or does it extend into the next renewal option? Does the landlord agree to an absolute reduction, or perhaps the reduction only serves to postpone or “defer” the amount of the reduction, and the tenant must make up the shortfall at a later date. In some situations, only additional rent (taxes and common area maintenance) is excused, while base rent remains the same as originally set forth in the lease.

In other situations, the tenant is permitted to pay only percentage rent over a $0 base, instead of a fixed minimum rent. If the tenant's base rent is reduced to a lower fixed amount, the landlord must remember similarly to reduce the breakpoint for determining percentage rent, if applicable, especially if the breakpoint was previously based on a natural break. The landlord may also provide that once rent is lowered, if the gross sales subsequently exceed some set dollar amount, indicating that the tenant has recovered, the rent reduction is terminated, and the original rent level is reinstated.

If the landlord is forced to reduce rent, it should attempt to get some kind of trade-off for this concession. A careful review of the lease may indicate several provisions that the landlord should require be used in a re-trade. Are there co-tenancy requirements that should be deleted? Should the landlord be given an early termination right for low sales? Should expansion or renewal rights be terminated? Perhaps broad-use rights or exclusives should no longer be allowed. If the tenant is requiring rent relief because it is not doing well, it should no longer have certain rights that are typically only granted to tenants paying market rent and expected to perform well.

The landlord should also consider a right to re-market the space if the tenant is receiving a rent concession that allows it to pay below market rent. The landlord should be given the right in the future to terminate the lease, or relocate the tenant, unless the tenant is willing to reinstate the original rent.

The request for a rent concession often indicates a tenant in trouble that is at risk of not performing under the lease. Therefore, as a condition to the granting of any rent reduction, the tenant should agree that the rent relief granted by the lease amendment should only remain in effect so long as the tenant does not commit an event of default, and provided that the tenant remains open to the public, fully stocked, staffed and fixtured and that the tenant uses reasonable efforts to maximize gross sales (the same requirements the landlord should have put into the lease if there were an early termination right).

If the tenant does not satisfy any of the terms of this paragraph or otherwise defaults under the lease, the rent concession terminates. To add additional strength to this requirement, the landlord might also seek to have the tenant acknowledge that the original rent payments are retroactive to the beginning of the reduced rent period if the tenant is no longer entitled to rent relief (unless the reason for termination of the rent relief is that the tenant has achieved a sufficient sales level to no longer justify the reduction).

The tenant should also agree that if within some short time period after the effective date of the lease amendment, should it file for or be put into bankruptcy, then the lease amendment containing the rent reduction should be deemed null and void. Then the lease shall be reinstated to its original terms and be deemed in full force and effect, and the landlord can file a claim for amounts due under the original lease as if the amendment had never existed.

Conclusion

While landlords should be careful to limit the circumstances in which they agree to rent reductions, doing so can often be turned into positive situations. In addition to keeping tenants in place, which tenants otherwise might terminate their leases, landlords can modify other lease provisions to be more favorable to them, and in so doing, soften the negative aspects of the concessions and come away with stronger shopping centers.

Ira Fierstein, a member of this newsletter's Board of Editors, is Co-Chair of the Leasing Practice Group and a partner in the Chicago office of Seyfarth Shaw LLP.