As the COVID-19 pandemic continues to unfold, commercial landlords should act promptly to ameliorate the impact of the economic disruption on tenants. If they have not already received them, landlords will certainly receive tenant requests for rent relief and lease workouts, and even in the absence of such requests, landlords should work proactively to anticipate tenant issues.
To help landlords formulate their plans and responses, we have prepared a brief list of recommendations and best practices that landlords and property managers should consider when responding to struggling tenants:
Do your homework now:
- Know your leases. Review all leases and become familiar with provisions relating to how much term is left, force majeure, financial reporting requirements, co-tenancy, gross sales-based kick-out rights, operating covenants (and cessation rights), defaults, notice requirements and remedies (including any limitations on remedies). The review should also focus on what security enhancements are available (such as security deposits, letters of credit and personal guaranties), and when and how they can be utilized. Finally, the review should note critical provisions that can be improved for the landlord’s benefit, such as relocation rights, expansion extension options, signage rights and exclusive use provisions.
- Know your tenants. Knowing your tenants’ businesses, both financially and otherwise, will go a long way in helping you determine whether a tenant’s request is bona fide and the likelihood and timing of such tenant returning to viability. How is the tenant funded? Is the tenant creditworthy? How does the tenant’s request for relief support its larger restructuring plan? What is the tenant’s source of business, materials and revenue? What is the tenant’s core business (g., is it a personal service business that may not resume normal operations for months)? Is this a ‘problem’ tenant who you may want to terminate?
- Know your project and the market.Understand and weigh market conditions and trends as applied to the real asset. What are the prospects of backfilling vacant space? What are the owner’s own constraints when it comes to loans, financial limitations, future lease rollover and co-tenancy provisions? What is the owner’s financial equity structure? Is lender consent required prior to granting any relief? What is the likelihood of triggering recourse liability?
- Know How the Pandemic is Affecting Enforcement Rights. Owners must be able to quantify their exposure for damages resulting from tenant defaults and anticipate potential equitable defenses (g., force majeure, impossibility, frustration of purpose) that may be claimed by tenants due to the unique nature of the pandemic.
- Form a COVID-19 tenant response committee. Owners should form an internal committee comprised of property managers, leasing agents and analysts to develop uniform systems and criteria for evaluating tenant requests. Ad hocand “one-off” negotiations should generally be avoided. Consider evaluating tenant requests for relief no differently than a prospective new tenant. The internal committee should require the full panoply of a tenant’s financial information (g., financial statements, updated business plans, credit checks, sales information and operating history).
If relief is warranted:
- Consider the form and substance of the relief agreement. Relief granted can be memorialized in a new lease, an amended/restated lease, an amendment or a wavier letter. Depending on the scope of the relief, consider using an “omnibus” form. An LOI may be desirable or necessary to help frame the deal points and minimize negotiations – particularly where relief will be granted in exchange for other tenant concessions. Also, consider requiring a forbearance agreement (e.,relief and waiver of existing default are only permanent of tenant avoids future default) and/or a confession of judgment (which allows expedited judicial process for damages and possession). Be sure to include estoppel, release and strong confidentiality provisions. Owners should use the restructuring process as an opportunity to renegotiate and improve the lease for the landlord by modifying concessions that were made in a more tenant favorable cycle.
- Consider types of monetary restructuring. There are myriad ways to grant temporary relief; creativity is the only limitation. Some of the more common types of monetary restructuring include: rent deferral (with or without an extension of the term), rent forgiveness (with or without an extension of the term), temporary conversion to “percentage rent only” (or a change in the existing percentage rent obligation), a right to delay opening or cease operations, modification of the terms and/or timing of payment of TI allowances, and modification of CAM or operating costs (e., temporary conversion to a gross rent or fixed CAM structure).
- Types of non-monetary restructuring. Owners should consider whether non-monetary restructuring may be effective. Again, creativity is key: permit the tenant to subdivide or reduce space, modify or expand the permitted use clause, consolidate dark locations in a project to drive foot traffic to operating tenants, increase marketing and special events in the project, renovate common areas (g.,amenities, landscape, facades), or require quid pro quoarrangements in mixed use projects (e.g.,require fitness centers, nail salons, food shops to provide discounts to other tenants and residents) in exchange for the granting of any relief.
As always, do not hesitate to contact us should you need assistance navigating these unprecedented changes in the commercial real estate industry. CGS3 is ready to assist you in developing a comprehensive and proactive approach in responding to tenant inquiries and requests for relief, as well as other COVID-19 related management strategies. Our COVID-19 Legal Task Force – comprised of seasoned attorneys with expertise in real estate, finance, litigation, construction, tax, and creditor’s rights – is here to help guide you through this difficult process. Please also monitor our website for additional resources and publications prepared by CGS3 attorneys that relate to specific issues you may be facing.
CGS3 Insight Alerts are curated with you in mind. They deliver focused, relevant, and timely information on trending topics to our clients, colleagues, and others in the industry. Please note that they are intended for general informational purposes only, and should not be construed as legal advice for any specific situation. Always remember to contact an attorney to obtain advice with respect to a particular issue or problem.