Because of required closures and other challenges facing businesses during this pandemic, many tenants are unable to meet lease obligations and/or asking for concessions from landlords. Rather than wasting precious resources arguing about whether the tenant’s performance is excused based on force majeure, frustration of purpose or other legal concept, consider strategizing with your tenant to come to a mutually acceptable solution. When developing a working solution with your tenants, consider: What do you as landlord need at a bare minimum? What does your tenant need? Are there creative solutions to be had? What resources are available?
Develop Solutions with Your Tenants
Communicate clearly and often on the issues and possible solutions with your tenant. Two key questions to ask them are:
- How has the pandemic impacted the tenant’s business?
- What has the tenant done and what does the tenant plan to do in the future to operate a successful business?
It is your tenant’s business, so have your tenant provide a business plan including a budget and projections. Once you have the plan, devise a payment plan based on milestones for the tenant’s business success that recognizes we are in uncertain times and that plans will necessarily need to change. Require the tenant to take advantage of available and appropriate assistance programs; allow the tenant to use funds in a way that makes sense for the tenant’s business.
Also, consider CDC and other governmental health and safety requirements and guidelines; however, allow the tenant the flexibility it needs for its business. While a business may be permitted by law to re-open, your tenant may not be comfortable for safety reasons. Even if the tenant is comfortable with reopening, it may not make financial sense. A change in shelter at home or safety regulations will not necessarily translate to increased customer traffic, and for some businesses, the reduced capacity allowed may not justify the operational expenses.
Rent and Monetary Concessions
Be very specific on the treatment of the rent amounts that are not being paid when due. Communications with your tenants regarding rent payments should answer the following questions:
- Are rents being forgiven? If yes, is there a time frame?
- Amortized over the remaining lease term?
- Tacked on to the end of the term – will the term be extended?
- Do they include base rent only or all or some portion of CAM, taxes and insurance?
- Will the unpaid amounts accrue interest?
- Is there a security deposit? If so, what can and should be done with it?
- Are late charges being waived? For what period of time?
Tenant Needs Post Pandemic
Discuss with your tenant its needs, beyond payment modification, to run its business post pandemic. If more office workers stay home but good practice dictates increased physical-distancing, the ups and downs of office space size needs could be a wash. With each of your tenants, you will want to discuss:
- What are the space needs of your tenant?
- Does a retail or restaurant tenant need access to open-area space?
- Is a restaurant doing more take-out or outdoor dining?
- Does the tenant need more parking because everyone is driving solo (and there is no ride-share)? Does the tenant need less parking because the business is doing more delivery?
- Will the tenant need more frequent and thorough cleaning to meet CDC and local government guidelines?
- Does the tenant need new technology or equipment and does it have the ability (funds) to invest in it?
- Does the tenant have the flexibility under the lease that it needs to expand or contract its space or make physical alterations?
- How do the expenses attendant to these needs impact their bottom line and yours?
When creating solutions for your tenants, you will also want to consider:
- Are there lease requirements or restrictions that are hampering potential solutions (e.g. a restriction against outdoor vendor displays or outdoor restaurant seating)?
- Could the continuous use, permitted uses, exclusives, or subleasing restrictions be relaxed at least temporarily?
- What are the impacts of one tenant’s needs on other tenants? Synergies, particularly in retail, are still important.
What can your tenant offer you in exchange for a deferment of rent or other concession that has value to you? Possible options are: an extension of the lease term, the giving up of a termination right, right of first refusal and/or the relaxing of its exclusive use? Additionally, consider whether it is appropriate to require tenants to provide guaranties or collateral to show good faith commitment to the landlord, in addition to requiring them to participate in industry or government loan/assistance programs.
Risk & Insurance Considerations
As the landlord, you will need to review lease provisions on risk allocation and required insurance. In particular, you will want to be clear on the allocation of liability responsibility between landlord and tenant and as to third parties, so you can modify your indemnity and insurance provisions (and insurance coverages) as appropriate. Where appropriate, require the tenant to obtain releases from customers (and other third parties entering the premises) for the benefit of tenant, landlord and the landlord’s lender. Also, add a requirement to leases that the tenant shall comply and cause compliance with government mandates.
Summary and Action Items
Document, document, document. The best way to avoid conflict later is to communicate and clearly memorialize understandings. Recognize that more changes will be necessary, so build in flexibility and keep communications open. Additionally:
- Ask your attorney if a forbearance might make more sense than a lease modification. Make sure you build in flexibility.
- Avoid getting in the weeds with the tenant on its business plan – exerting too much control can make the landlord a partner with the tenant under the eyes of the law and endowing the landlord with all the liability that comes with that.
- Do not put every detail of the business plan in the modification agreement; it needs to be a workable document, not out of date as soon as it is written.
- Consider whether landlord and tenant should each identify more than one authorized contact person in the event of unavailability of the primary contact.
- Plan for the possibility of business failure – make sure there is an escape hatch (for the tenant and for you).
- Expect the unexpected. Have your attorney review the force majeure provision of the lease and modify if appropriate.
- Consult with your insurance agent and tax consultant regarding proposed changes to the lease. Your lender, if you have one, may need to consent (check your loan documents). Also confirm that changes conform to CCRs and zoning/land use regulations or that any waivers, exceptions or consents are obtained.
- If the tenant is a franchisor, request confirmation that tenant’s franchise requirements are met.
- If other tenants are impacted by changes for a tenant, obtain necessary consents or waivers.
- If the changes are operational, remember to keep your property manager in the loop.
In summary, rather than treating landlord/tenant negotiations as a zero sum game, recognize commonalities and aligned interests. This will go a long way towards a mutually beneficial resolution of tenant payment challenges.