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As state and local governments rolled out measures to prevent the spread of the novel coronavirus in March, commercial landlords began getting calls for help from tenants. In an environment where social distancing has taken hold and more customers are staying home, retailers and other consumer-facing businesses are feeling the impact of decreased demand, supply-chain interruptions, and in some cases, mandatory closures.
In light of this rapidly evolving situation, here are five issues landlords should consider before negotiating concessions with commercial tenants.
Loan documents could limit tenant relief. Before agreeing to any reduction in rent or other modifications to a lease, owners should carefully review their project’s loan documents. Many documents include financial covenants that must be maintained during the term of the loan. Owners should ensure that aggregate rent reductions will not reduce net operating income to a point where financial covenant tests are tripped, triggering a default or other lender protections (such as cash management) under the loan documents. Additionally, owners need to confirm whether their loan documents permit the modification or termination of a lease, or acceptance of less rent than stipulated.
Identify opportunities. Tenants that were in financial trouble before the COVID-19 pandemic will most likely not see improvements in their condition. Assistance from the courts and law enforcement in the eviction of tenants may be limited due to COVID-19, so landlords should consider a mutual early lease termination instead of eviction. For these tenants, applying a security deposit against past due rent in accordance with the terms of the lease may make sense.
Deferment and not abatement of rent. If a landlord agrees to accept reduced rent from a tenant, it should be documented in a lease modification or forbearance agreement. This agreement should defer, not abate, the rent for a defined period. Request financial information from the tenant before agreeing to any deferral of rent. Any deferred rent and landlord costs (such as attorneys’ fees) should be repaid by the tenant in the future, either in one or more lump-sum payments or by having the deferred rent repaid over the balance of the term. Deferred rent should be accelerated and payable in full upon any default, notwithstanding the landlord’s existing remedies in the lease. Consider requesting that the tenant (or a credit-worthy parent) sign a promissory note for the deferred rent. Additionally, this is a good time to revisit tenant-friendly provisions in the lease that may cause problems with the ongoing operation of the project during this crisis, such as exclusive-use rights, co-tenancy and prohibited uses. Until an agreement has been signed permitting a tenant to defer the payment of rent, landlords should send default notices reserving their rights to tenants that fail to pay rent in breach of their leases.
Co-tenancy concerns. While most state and local governments mandated the closure of gyms and health clubs, movie theaters, bars and restaurants in the early days of the COVID-19 crisis, many retailers were already voluntarily closing stores or reducing hours. Co-tenancy provisions in retail leases provide a tenant with certain rights (including reduction or abatement of rent or termination) if a certain percentage of tenants, or certain specific tenants, are not open and operating for a specified period. Reduced hours also could trigger a co-tenancy violation. Closures for certain events, including force majeure, often do not immediately result in co-tenancy violations. However, some leases will require that landlords provide notice to tenants within a certain period of time following a force majeure event as a condition to claiming force majeure. Landlords should be mindful of co-tenancy provisions in negotiating rent reductions with tenants.
Understand effects of force majeure. Most lease agreements include a force majeure provision that suspends performance by a party upon the occurrence of certain specified events outside of a party’s control, such as a war or natural disasters. Some force majeure provisions include catch-all language for events outside of either party’s control. Courts in most jurisdictions strictly construe these provisions, so unless the provision specifically addresses pandemic or disease, a court may not agree to suspend a party’s performance absent a catch-all provision. Also, many leases specifically exclude the payment of rent or other monetary amounts under a lease from performances that may be excused due to force majeure. Landlords should consider whether force majeure clauses can provide protection from construction and delivery delays due to the COVID-19 pandemic, co-tenancy violations and the provision of services under the lease.
While landlords must protect their interests in a commercial project, the time following the COVID-19 response gives them an opportunity to strengthen their relationships with tenants by providing creative solutions that help them weather the storm. As is the case in any unforeseen event — such as a fire, tornado or earthquake — landlords, tenants and lenders must work together to achieve their common interest. That will position the project for success when business resumes.
Michael Stewart is a member at Bass, Berry & Sims in Nashville.