The Modified Anchor Tenant in Enclosed Regional Malls

As a result of these issues, tenants negotiating their leases should anticipate the possibility of MATs taking over a department store or other anchor tenant's space, and should fully address the ways that installation of Modified Anchor Tenants could impact:

1. Co-tenancy clauses;
2. Operating costs and real estate taxes;
3. Competition within the enclosed regional mall; and
4. The retail environment of the enclosed regional mall.

Co-Tenancies

In enclosed regional malls, tenants may seek to incorporate into their leases the concept of a co-tenancy (i.e., the right to adjust the amount of rent that the tenant pays, if certain department stores or anchors and certain in-line tenants are not open for business). Typically, these co-tenancies are tied to the closure of department stores/anchors and the closure of square footage occupied by in-line tenants. With the number of potential department stores/anchors decreasing over time (i.e., there simply are not as many as there once were), landlords have sought to redefine the concept of department store/anchor by incorporating the concept of Modified Anchor Tenant into the co-tenancy provision.

While, in general, tenants would like to see higher occupancy levels at a shopping center (as opposed to closed department stores), tenants should be very careful in determining whether a Modified Anchor Tenant will be permitted to replace a department store/anchor in order to “cure” a co-tenancy violation under its lease. In particular, a tenant may seek to limit the use of a Modified Anchor Tenant in the following ways:

1. By providing that no more than one Modified Anchor Tenant will be permitted to “cure” a co-tenancy violation caused by the closure of a department store/anchor;
2. By not allowing the closure of the department store/anchor located closest to the tenant's premises to be cured by the addition of a Modified Anchor Tenant;
3. By not allowing the tenant's competitors to be included within the Modified Anchor Tenant; and
4. By making sure that the Modified Anchor Tenant occupies at least as much square footage as what is required under the tenant's lease to qualify as a department store/anchor (i.e., if the definition of a department store/anchor under the tenant's lease is that the department store/anchor must occupy at least 50,000 contiguous square feet, then the Modified Anchor Tenant must similarly occupy at least 50,000 contiguous square feet).

Since a co-tenancy provision is designed to protect a tenant's occupancy cost by adjusting its rental structure if certain conditions occur (e.g., a certain number of department stores/anchors not being open for business), the tenant should not lose sight of the fact that the substitution of in-line tenant square footage may not promote the same amount of sales and may not promote the same business environment as if the department store/anchor had been replaced by another traditional department store/anchor. Most tenants consider occupancy at an enclosed regional mall by department stores/anchors to be intrinsic to the success of the shopping center and the individual tenant's business. Therefore, a tenant should be very careful to tailor the use of a Modified Anchor Tenant to address the concerns that the tenant has based upon a co-tenancy violation.

By incorporating certain of the concepts outlined above, a tenant can restrict the loss of multiple anchors (or at least trigger the co-tenancy provision if multiple anchors are closed at the enclosed regional mall), as well as lessen the direct impact of the closure of anchors in close proximity to the tenant's premises. Further, the tenant may attempt to protect the size of anchor tenant that was originally negotiated with the landlord or contemplated in the letter of intent.

Common Area Maintenance Costs/Real Estate Taxes

Generally, department stores and anchor tenants will not pay their pro rata share of common area maintenance costs and real estate taxes. In-line tenants accept this concept because these department stores/anchors will bring customer traffic to the shopping center. In order to establish this concept in an individual tenant's lease, a landlord will deem the department store/anchor square footage to be “excluded” from the denominator used to calculate the tenant's pro rata share of common area maintenance costs and real estate taxes.

However, if a department store/anchor is replaced by a group of tenants comprising a Modified Anchor Tenant, then, conceptually, those tenants will be paying their pro rata share of common area maintenance costs and real estate taxes. If a particular tenant's lease states that department stores/anchors are excluded from the denominator used to calculate common area maintenance costs and real estate taxes and if the Modified Anchor Tenant is considered a department store/anchor for purposes of the lease, this could result in an unreasonable windfall for the landlord; the landlord will be receiving common area maintenance costs and real estate taxes from the tenants representing the Modified Anchor Tenant, but will also be receiving a “full share” of common area maintenance costs and real estate taxes from the tenants whose denominator used to calculate their pro rata share will “exclude” the square footage occupied by the Modified Anchor Tenant.

As a result, if a tenant does accept the concept of a Modified Anchor Tenant, the tenant should specifically state that the square footage of the Modified Anchor Tenant is not excluded from the denominator used to calculate the tenant's pro rata share of common area maintenance costs and real estate taxes.

Further, if tenants at an enclosed regional mall are paying common area maintenance costs based upon a fixed amount — which is subject to fixed increases (e.g., 4% annual escalations of this charge) — then, once again, a landlord may be receiving an unreasonable windfall if the landlord is collecting common-area maintenance costs from each of the tenants based upon a fixed amount with fixed increases, while at the same time collecting common-area maintenance costs from tenants that used to be excluded as department stores/anchors from paying for common-area maintenance costs. A tenant should seek to have its common-area maintenance costs adjusted if a Modified Anchor Tenant is instituted at a shopping center, in order to coincide with what “actual” common-area maintenance costs are for that particular shopping center once the Modified Anchor Tenant is added.

Competition

Tenants should be very careful to determine whether the “curing” of a co-tenancy violation by the addition of a MAT that includes competitors to the tenant's specific use will be a valid means for the landlord to cure the co-tenancy violation. Since the point and purpose of a co-tenancy provision is to implement a modified rent structure based upon vacancies at the shopping center, a tenant needs to carefully evaluate whether the addition of “competitors” is a reasonable way to solve the problem of vacancies at the shopping center.

While a tenant may have other protections under its lease pertaining to competitors being added to the shopping center (e.g., the tenant may have an “exclusive” clause under its lease that will reduce its rental obligation if competitors are added to the shopping environment), a tenant may still want to determine whether the addition of competitors is an acceptable method for curing a co-tenancy violation. A tenant may want to state that no more than one of the tenants comprising the MAT may engage in sales that are competitive with the tenant's permitted use, and that that tenant may not occupy more than a certain number of square feet of space.

Maintaining the Retail Environment of a Shopping Center

One concern a tenant should have with a landlord implementing a Modified Anchor Tenant is whether the use of the leased area comprising the Modified Anchor Tenant is “retail” in nature. Examples of non-retail uses include schools, post offices, military recruitment centers, hotels and other similar non-traditional tenants to the shopping center mix. Tenants may want to consider whether this concept is consistent with how the tenant envisioned that a co-tenancy could be cured. For instance, if a tenant is in the business of selling children's clothing, adding a post office or college to the enclosed regional mall may not be an acceptable Modified Anchor Tenant, since people attending the college or visiting the post office may not become shoppers within the retail environment.

This problem is further exacerbated if the addition of the MAT to the enclosed regional mall does not have an entrance onto the enclosed area, but rather only has an entrance to the exterior of the shopping center. This type of addition to the shopping center may have little benefit to the tenants inside, since the people entering the Modified Anchor Tenant (e.g., college or post office) may never actually enter the enclosed regional mall or create any additional customer traffic. A tenant should therefore be certain that all tenants comprising the Modified Anchor Tenant have entrances onto the enclosed regional mall and, generally, have “retail” uses associated with their tenancies.

Conclusion

By carefully analyzing the concept of the Modified Anchor Tenant, a tenant should be able to restrict some of the negatives that might flow from the departure of an anchor tenant from an enclosed regional mall, address implications that could be created by the addition of a MAT, and tailor the use of a MAT so that it still provides a benefit to the individual tenant and the landlord by increasing the occupancy at the enclosed regional mall, while at the same time limiting certain potential negatives associated with the inclusion of the MAT.

*****
Glenn A. Browne, a member of Commercial Leasing Law & Strategy's Board of Editors, is a partner in Braun, Browne & Associates, P.C., Riverwoods, IL.

As traditional department stores and so-called “anchor” tenants in enclosed regional malls are closing stores and limiting their expansion in the marketplace, landlords are seeking alternatives to the traditional department store or anchor store to occupy space in their shopping centers. (“Anchor tenants” can be defined as those selling a wide assortment of goods and occupying more than a certain number (e.g., 50,000) of contiguous square feet of floor area.) These anchor-tenant alternatives — referred to in this article as “Modified Anchor Tenants” or “MATs” — are often defined as follows: A collection of multiple tenants that in the aggregate occupy the lesser of:

1. Fifty percent (50%) of the square footage occupied by the former anchor on the first level of the enclosed mall; or
2. At least [xxx] square feet of space.

One of the key elements in this definitional term is that the MAT does not need to occupy the same square footage that the anchor tenant was supposed to occupy when the in-line tenants' leases were originally negotiated, nor does this MAT need to consist of only one tenant.

If a tenant has an existing lease that was negotiated with the understanding that a department store or other anchor store was going to be in operation within the mall, replacement of such with a Modified Anchor Tenant creates fundamental problems. After all, anchor tenants frequently lease under more favorable terms because they are the anchor.

The underlying rationale for treating an anchor tenant or a department store differently from other tenants in an enclosed regional mall is that this tenant is deemed to bring traffic to the shopping center and to create a synergy with the in-line tenants, so that shoppers obtain a cross-section of goods during their visit to the enclosed regional mall. For that reason, in-line tenants are often willing to agree that landlords will treat anchors and department stores differently, both in their contributions to operating costs and real estate taxes, and in the rights provided to these types of tenants. However, if a Modified Anchor Tenant does not need to consist of one tenant selling a varied array of goods — which replacement tenancies may or may not attract the same consumer traffic to the shopping center that all parties contemplated — in-line tenants may not be as willing to concede that these MATs should be treated differently when it comes to shared costs and landlord-granted rights.

As a result of these issues, tenants negotiating their leases should anticipate the possibility of MATs taking over a department store or other anchor tenant's space, and should fully address the ways that installation of Modified Anchor Tenants could impact:

1. Co-tenancy clauses;
2. Operating costs and real estate taxes;
3. Competition within the enclosed regional mall; and
4. The retail environment of the enclosed regional mall.

Co-Tenancies

In enclosed regional malls, tenants may seek to incorporate into their leases the concept of a co-tenancy (i.e., the right to adjust the amount of rent that the tenant pays, if certain department stores or anchors and certain in-line tenants are not open for business). Typically, these co-tenancies are tied to the closure of department stores/anchors and the closure of square footage occupied by in-line tenants. With the number of potential department stores/anchors decreasing over time (i.e., there simply are not as many as there once were), landlords have sought to redefine the concept of department store/anchor by incorporating the concept of Modified Anchor Tenant into the co-tenancy provision.

While, in general, tenants would like to see higher occupancy levels at a shopping center (as opposed to closed department stores), tenants should be very careful in determining whether a Modified Anchor Tenant will be permitted to replace a department store/anchor in order to “cure” a co-tenancy violation under its lease. In particular, a tenant may seek to limit the use of a Modified Anchor Tenant in the following ways:

1. By providing that no more than one Modified Anchor Tenant will be permitted to “cure” a co-tenancy violation caused by the closure of a department store/anchor;
2. By not allowing the closure of the department store/anchor located closest to the tenant's premises to be cured by the addition of a Modified Anchor Tenant;
3. By not allowing the tenant's competitors to be included within the Modified Anchor Tenant; and
4. By making sure that the Modified Anchor Tenant occupies at least as much square footage as what is required under the tenant's lease to qualify as a department store/anchor (i.e., if the definition of a department store/anchor under the tenant's lease is that the department store/anchor must occupy at least 50,000 contiguous square feet, then the Modified Anchor Tenant must similarly occupy at least 50,000 contiguous square feet).

Since a co-tenancy provision is designed to protect a tenant's occupancy cost by adjusting its rental structure if certain conditions occur (e.g., a certain number of department stores/anchors not being open for business), the tenant should not lose sight of the fact that the substitution of in-line tenant square footage may not promote the same amount of sales and may not promote the same business environment as if the department store/anchor had been replaced by another traditional department store/anchor. Most tenants consider occupancy at an enclosed regional mall by department stores/anchors to be intrinsic to the success of the shopping center and the individual tenant's business. Therefore, a tenant should be very careful to tailor the use of a Modified Anchor Tenant to address the concerns that the tenant has based upon a co-tenancy violation.

By incorporating certain of the concepts outlined above, a tenant can restrict the loss of multiple anchors (or at least trigger the co-tenancy provision if multiple anchors are closed at the enclosed regional mall), as well as lessen the direct impact of the closure of anchors in close proximity to the tenant's premises. Further, the tenant may attempt to protect the size of anchor tenant that was originally negotiated with the landlord or contemplated in the letter of intent.

Common Area Maintenance Costs/Real Estate Taxes

Generally, department stores and anchor tenants will not pay their pro rata share of common area maintenance costs and real estate taxes. In-line tenants accept this concept because these department stores/anchors will bring customer traffic to the shopping center. In order to establish this concept in an individual tenant's lease, a landlord will deem the department store/anchor square footage to be “excluded” from the denominator used to calculate the tenant's pro rata share of common area maintenance costs and real estate taxes.

However, if a department store/anchor is replaced by a group of tenants comprising a Modified Anchor Tenant, then, conceptually, those tenants will be paying their pro rata share of common area maintenance costs and real estate taxes. If a particular tenant's lease states that department stores/anchors are excluded from the denominator used to calculate common area maintenance costs and real estate taxes and if the Modified Anchor Tenant is considered a department store/anchor for purposes of the lease, this could result in an unreasonable windfall for the landlord; the landlord will be receiving common area maintenance costs and real estate taxes from the tenants representing the Modified Anchor Tenant, but will also be receiving a “full share” of common area maintenance costs and real estate taxes from the tenants whose denominator used to calculate their pro rata share will “exclude” the square footage occupied by the Modified Anchor Tenant.

As a result, if a tenant does accept the concept of a Modified Anchor Tenant, the tenant should specifically state that the square footage of the Modified Anchor Tenant is not excluded from the denominator used to calculate the tenant's pro rata share of common area maintenance costs and real estate taxes.

Further, if tenants at an enclosed regional mall are paying common area maintenance costs based upon a fixed amount — which is subject to fixed increases (e.g., 4% annual escalations of this charge) — then, once again, a landlord may be receiving an unreasonable windfall if the landlord is collecting common-area maintenance costs from each of the tenants based upon a fixed amount with fixed increases, while at the same time collecting common-area maintenance costs from tenants that used to be excluded as department stores/anchors from paying for common-area maintenance costs. A tenant should seek to have its common-area maintenance costs adjusted if a Modified Anchor Tenant is instituted at a shopping center, in order to coincide with what “actual” common-area maintenance costs are for that particular shopping center once the Modified Anchor Tenant is added.

Competition

Tenants should be very careful to determine whether the “curing” of a co-tenancy violation by the addition of a MAT that includes competitors to the tenant's specific use will be a valid means for the landlord to cure the co-tenancy violation. Since the point and purpose of a co-tenancy provision is to implement a modified rent structure based upon vacancies at the shopping center, a tenant needs to carefully evaluate whether the addition of “competitors” is a reasonable way to solve the problem of vacancies at the shopping center.

While a tenant may have other protections under its lease pertaining to competitors being added to the shopping center (e.g., the tenant may have an “exclusive” clause under its lease that will reduce its rental obligation if competitors are added to the shopping environment), a tenant may still want to determine whether the addition of competitors is an acceptable method for curing a co-tenancy violation. A tenant may want to state that no more than one of the tenants comprising the MAT may engage in sales that are competitive with the tenant's permitted use, and that that tenant may not occupy more than a certain number of square feet of space.

Maintaining the Retail Environment of a Shopping Center

One concern a tenant should have with a landlord implementing a Modified Anchor Tenant is whether the use of the leased area comprising the Modified Anchor Tenant is “retail” in nature. Examples of non-retail uses include schools, post offices, military recruitment centers, hotels and other similar non-traditional tenants to the shopping center mix. Tenants may want to consider whether this concept is consistent with how the tenant envisioned that a co-tenancy could be cured. For instance, if a tenant is in the business of selling children's clothing, adding a post office or college to the enclosed regional mall may not be an acceptable Modified Anchor Tenant, since people attending the college or visiting the post office may not become shoppers within the retail environment.

This problem is further exacerbated if the addition of the MAT to the enclosed regional mall does not have an entrance onto the enclosed area, but rather only has an entrance to the exterior of the shopping center. This type of addition to the shopping center may have little benefit to the tenants inside, since the people entering the Modified Anchor Tenant (e.g., college or post office) may never actually enter the enclosed regional mall or create any additional customer traffic. A tenant should therefore be certain that all tenants comprising the Modified Anchor Tenant have entrances onto the enclosed regional mall and, generally, have “retail” uses associated with their tenancies.

Conclusion

By carefully analyzing the concept of the Modified Anchor Tenant, a tenant should be able to restrict some of the negatives that might flow from the departure of an anchor tenant from an enclosed regional mall, address implications that could be created by the addition of a MAT, and tailor the use of a MAT so that it still provides a benefit to the individual tenant and the landlord by increasing the occupancy at the enclosed regional mall, while at the same time limiting certain potential negatives associated with the inclusion of the MAT.

*****
Glenn A. Browne, a member of Commercial Leasing Law & Strategy's Board of Editors, is a partner in Braun, Browne & Associates, P.C., Riverwoods, IL.