The following article gives a concise point of view on the issues that a Landlord will consider prior to giving a tenant a rent reduction. Of course, please contact an attorney whose primary focus is lease terminatination and rent reduction services in order to better understand the issues surrounding your specific set of facts.
As a result of the current economic downturn, many commercial tenants are finding themselves in precarious financial positions and are approaching landlords to seek rent reduction in order to survive until the economy recovers. While landlords are often hesitant to diminish their revenue stream by granting rent reduction, they may have a strong self-interest in facilitating a successful lease restructure if the tenant need is genuine. The prospect of a vacancy and its resultant effects on surrounding tenants may justify reconsideration of lease workout proposals and motivate landlords to come to the negotiating table. A landlord may wish to act promptly so as to avoid the loss of an anchor tenant or a key tenancy which triggers the exodus of other tenants, as well as the additional costs involved in replacing a tenant through brokerage fees, lease inducements and other costs.
Granting rent assistance by entering into a lease restructuring arrangement can also be an excellent opportunity for landlords to effectively regain leverage or concessions granted during the initial lease transaction, either through the claw-back of tenant rights or by obtaining additional security and rights in favour of the landlord. Therefore, landlords should consider rent reduction arrangements holistically and not just in terms of a break on rent in favour of the tenant. When determining whether or not to negotiate with a troubled tenant, there should also be consideration of the advantages a landlord can secure in exchange for its temporary concessions.
In order to be effective for both parties, rent reduction must be sufficient to avoid a future default or bankruptcy by the tenant, at least until the economy improves. Accordingly, the elements of a successful lease restructure can be numerous and complex. From the landlord’s perspective, the costs of the rent reduction must be affordable and less than the consequences of a tenant’s breach. When approached by a tenant for rent reduction, landlords should analyze whether there is any benefit to a restructuring arrangement and if there is actual need on the part of the tenant for a rent reduction. Owners should also consider whether rent reduction will have the intended effect: does the tenant have a viable business operation, or will a rent reduction simply delay the inevitable demise of the tenant.
RENT ABATEMENT VS. RENT DEFERRAL
A fundamental consideration is whether the rent reduction arrangement should be structured to allow for a temporary forgiveness of rent or merely rent deferral until the tenant can recover. While tenants prefer that some or all of the rent abate or be forgiven fully, the landlord’s inclination is to provide that a portion of the rent be deferred until a later date such that aggregate subsequent rent payments are increased. This strategy is advantageous to the landlord by allowing recapture of presently conceded rent at a later date, and by creating the appearance that the net return on the lease is not diminished. Going forward, the landlord retains the option of forgiving the deferred rent or financial concessions in exchange for timely payment or other proper performance of lease obligations by the tenant. Owners may also pursue creative solutions such as temporary conversion from base rent to percentage rent, or the deferral of non-critical management costs.
TERMINATION OF RENT REDUCTION PERIOD
From the landlord’s perspective, the rent reduction agreement should be finite and short in duration, and should expressly allow the landlord to terminate the rent assistance immediately upon default or certain circumstances such as the following: (i) transfer of the lease by assignment or subletting; (ii) disclosure of the terms of the rent reduction agreement to a third party; (iii) a corporate tenant making any distributions by way of dividends, bonuses or repayment of loans to any of its shareholders, directors or officers or anyone not at arm’s length of the client; (iv) increase to the salary or other remuneration of any of the foregoing; and/or (v) the tenant or other entity directly or indirectly lending financial assistance to or guaranteeing the debts or obligations of another entity. Rent reduction should also automatically be deemed as terminated one day prior to the tenant becoming bankrupt or filing for creditor protection so as to avoid any bankruptcy trustee obtaining the benefit of the rent reduction.
ADDITIONAL SECURITY AND ACCELERATED PAYMENTS
Keeping in mind that rent reduction is part of a larger restructuring strategy, landlords should also consider obtaining additional security.
Where the deferral of rent is significant, proactive landlords can become secured creditors by requiring the tenant to grant a security interest equal in value to the amount of the deferred/abated rent in its personal property, accounts, inventory and other assets. By registering its interest, the landlord will augment its position in bankruptcy or insolvency proceedings. Furthermore, requests by other lenders for postponement of this security will flag the landlord to claims of other secured creditors who may be lending money to the tenant. Landlords may also require the addition of an indemnifier or guarantor if there is not one in place already, or to expand the obligations of any existing covenantors.
RECAPTURE OF TENANT’S FAVOURABLE RIGHTS
Granting rent reduction to a tenant should coincide with the landlord taking back, either permanently or temporarily, rights given to the tenant during the initial lease negotiations including renewal rights, rights of first refusal, expansion rights, broad use clauses, lease termination rights, co-tenancy provisions and exclusivity clauses. The original lease deal can also be amended favourably to the landlord by extending the term of the lease and reclaiming signage rights to be used as inducement to replacement tenants.
This is also an excellent time for the landlord to couple the relief with additional landlord rights, or to impose various new restrictions such as continuous operating covenants. Landlords may also revisit previously negotiated exclusions from operating costs or eliminate year-end reconciliations and lease audit rights. Landlords can also impose new relocation obligations or demolition clauses on the tenant, or require payment of additional or increased security deposits.
In order to facilitate re-letting the space to a more reliable and solvent tenant, landlords should add a blanket right to terminate the lease at any time. This right will provide the landlord with flexibility in order to market the premises if a replacement tenant is found who is prepared to pay the full rent.
SUGGESTIONS FOR LANDLORDS
Landlords should keep in mind the following restructuring strategies while considering a request for rent reduction:
- Determine the relative bargaining positions of both the landlord and the tenant. Market conditions and trends are key in considering options, as is the tenant’s economic justification for rent reduction. Acquire knowledge of the tenant’s core business, supply and funding sources and creditworthiness. The tenant should be required to provide financial statements to the landlord regularly at set intervals in order to track the needs for rent reduction including monthly gross revenue reports.
- Consider supplementary factors such as tenant mix and the impact that dark storefronts may have on the centre and whether losing an anchor tenant may have a domino effect on the business of other tenants through the operation of co-tenancy clauses.
- Keep in mind financial or other restrictions on the landlord’s ability to modify leases, such as the need to obtain lender or partner consents to lease modifications. The landlord should be particularly attentive to the potential effects that restructuring may have on its own ability to meet debt service in co-tenancy/operating requirements of other leases.
- Develop standardized procedures for evaluating rent assistance requests. Consider forming internal committees comprised of leasing agents, property managers or financial analysts to address the inquiries. The mandate of such committees usually includes conducting credit checks, assessing inventory levels and supply sources, and reviewing the tenant’s business plan and financial statements. Often when faced with a detailed information request, the tenant without a bona fide need for relief will withdraw their request for assistance.
- Consider obtaining a release or estoppel from the tenant for any landlord defaults, omissions of payment of tenant allowances or any liability arising out of the lease prior to the restructuring arrangement.
TENANT CONSIDERATIONS Tenants should be prepared to provide a solid business basis and detailed financial information together with the relief request and should keep the following considerations in mind:
- Be cognizant of your bargaining power and vulnerabilities. Understand the market value of the premises in the centre/building in order to practically consider your options. Have a solid understanding of your financial condition and be prepared to demonstrate that while the tenant is financially threatened, it is not so greatly impaired that it will be considered a lost cause which the landlord will have little motivation to assist.
- Weigh opportunity costs. By obtaining temporary relief through a rough economic period is the tenant losing an opportunity to relocate to a better premises? Consider the likelihood that you may be able to negotiate an even better deal by delaying this request for relief. Tenants should consider whether they would be better off negotiating a lump sum lease buyout payment in exchange for termination now and seeking premises elsewhere. Also consider if there an easier exit strategy from the lease such as assignment/subletting or going dark.
- Analyze whether any landlord defaults exist and if so, how remedies may be part of the overall restructuring approach.
As the above considerations demonstrate, with a systematic and thoughtful approach, both landlords and tenants can work together to negotiate a lease restructuring and rent reduction arrangement in order to achieve a constructive resolution to a potentially undesirable tenant departure during challenging economic times.