Answers To Today’s Legal Questions
Top retail legal experts answer questions pertinent to retailers and owners in today’s economy.
Compiled by Lindsay Sport

Shopping Center Business recently interviewed several top retail lawyers to get a take on some common issues confronting landlords and tenants in today’s economy. SCB interviewed: Randall S. Arndt, practice coordinator of Schottenstein Zox & Dunn’s Real Estate and Land Use Practice Area; John Coyne,  partner in the Real Estate Group at Roetzel & Andress; Abe J. Schear, partner with Arnall Golden Gregory LLP; and Jeffrey J. Wild, partner and vice-chair, Real Estate & Environmental Practice Group for Benesch.

SCB: How are shopping center owners (or retailers) dealing with co-tenancy provisions in this tough leasing environment? Are retailers asked that they be enforced when broken?

Arndt: Both landlords and tenants are revisiting co-tenancy provisions. Many existing co-tenancy provisions are not being satisfied, and tenants frequently have significant remedies. To the extent tenants can receive rent abatements on account of a co-tenancy violation, tenants are taking the rent abatements. Where tenants have possession co-tenancy provisions, some retailers are not taking possession of new space on account of the possession co-tenancy requirement not being satisfied. In hindsight, many owners were too generous in granting their tenants expansive co-tenancy provisions and material remedies. The co-tenancy provision is a frequent topic of modification in lease amendments under negotiation in this environment.

Coyne: Shopping center owners mainly deal with two types of co-tenancy provisions: the inducement or opening co-tenancy provision and the ongoing co-tenancy provision. In this more challenging economic environment, shopping center owners have been focusing on identifying the inducement tenant. They want to reduce risk and need to make sure that the inducement tenant identified does in fact open according to the terms of their lease. Shopping center owners will not use just any large retailer as an inducement tenant; the tenant must have a proven track record and be financially secure.

With respect to the ongoing co-tenancy provision in leases, shopping center owners are more apprehensive of the risk of tenants filing bankruptcy and are trying to negotiate co-tenancy provision that are based on a percentage of the gross leasable area of the shopping center being occupied or leased, rather than listing particular tenant(s) that are required to be in the shopping center. The risk of listing an individual tenant is becoming more problematic in the current economic environment.

Sophisticated retailers continue to ask that co-tenancy provisions in their leases be enforced. I have not seen much of a change from the behavior of retailers with enforcement rights as a result of the economy.

Schear: Landlords are generally making sure that there are five components to co-tenancy failure: (1) that the failure continues for a period of time — perhaps 6 months or more; (2) the right to substitute tenants when dealing with named tenants; (3) a predefined decline in gross sales during the failure period; (4) that the remedy be clearly defined; and (5) that the tenant must either terminate or revert to a full rent after some period of alternative rent. Retailers are for sure very thoughtful in today’s market re co-tenancy.

Wild: Many retailers are using co-tenancy provisions as leverage in negotiations for reduced rent. Where a tenant may have the ability to terminate a lease, or pay reduced rent for a short period of time, because of a violation by a landlord of a co-tenancy provision, many tenants are instead using such breach as leverage in negotiating reduced base rent for the premises for an extended period of time. In many instances, tenants do not want to close their stores as a result of the co-tenancy violation. However, because of the current economic environment, they are taking the opportunity to lower their operating costs for an extended period of time.

SCB: Kickouts — do you see shopping center owners waiting longer to exercise this option? Are owners more willing to work with retailers than in the past?

Arndt: Landlords are not inclined to exercise kickout rights as finding a suitable replacement tenant is difficult in the current retail market. However, even if the owner does not desire to exercise its kickout rights, owners frequently use this right as leverage in negotiating lease modifications. Owners are more willing to work with retailers to address the difficult retail environment than in the past, especially where the retailer has good prospects for long term success once the economy rebounds.

Coyne: Shopping center owners are more patient before exercising their rights under kickout provisions contained in their leases. Of course, this depends on the strength of the tenant and the location of the shopping center.

Schear: Kickouts remain common, but in some ways, a 5-year deal with a 5-year option is the same as a fifth-year kickout, particularly if the option automatically exercises if a sales threshold is achieved. Landlords are drafting much better today, often refusing to allow the kickout to attach to an assignment.

Wild: Owners are definitely more willing to work with tenants now than in the past. There is a feeling by many landlords that tenants and landlords are part of a team, and must work together in order to survive in this environment. As a result, landlords are more willing to be patient in exercising kickout rights, and are trying to be proactive in their approach to their tenants. However, much of landlords’ patience is in their own best interests. If a landlord exercises a kickout, there is a good chance that they will not be able to fill the vacant space in this market, and because of the numerous rent reduction requests being requested by tenants (and granted by landlords), there is a greater chance that exercising the kickout will put the property in default of the mortgage as it may no longer satisfy the required debt to service coverage ratio. Landlords have a lot more to consider now when exercising a kickout than they have had to consider in the past.

SCB: Rent relief — are you being asked to revisit or rework leases for healthy tenants? Is this in the best interest of the owner? Are there benefits to the owner?

Arndt: Landlords have a long line of tenants out their doors asking for the landlord to revisit or rework existing leases. Even healthy tenants are being challenged in the existing retail climate. Tenants need to be well prepared when sitting down with their landlords to make their case that lease modifications are necessary. Where a tenant comes armed with sales reports showing reduced sales based on current economic conditions, together with a solid game plan to restore the tenant to a healthy condition, landlords are willing to discuss lease modifications. As landlords desire to modify other lease provisions, such as co-tenancy clauses, exclusives, restrictions and radius provisions, the shopping center owner can benefit from lease amendments and modifications as well.

Coyne: Yes, shopping center owners are being asked to revisit or rework leases from healthy tenants. Healthy tenants view the current negative economic situation as an opportunity to reduce fixed leasing costs. There are many issues that a shopping owner must review before changing any executed lease with a healthy tenant. Shopping center owners will look at their loan documents encumbering the shopping center property to determine whether or not lender approval is necessary for the lease modification. In many instances, lender review and approval is required. In addition, shopping center owners will need to review the tenant’s financial information. If the tenant is not in financial crisis, the shopping center owner will most likely not change the lease unless special circumstances exist. Similar to playing poker — the shopping center owner will be unwilling to offer rent relief to a tenant and willing to call the tenant’s bluff if the tenant does not provide hard evidence that the tenant actually is in need of rent relief. Rent relief is also a challenging issue for the shopping center owner with cap rates on the rise and asset preservation, which are central issues.

Schear: Rent relief is on a case-by-case basis, and landlords are generally requiring understandable financials, a clear case of need, the right to recapture the space from the tenant and drafting which defers rent as opposed to forgives rent.

Wild: Many healthy tenants are using the current economic environment as an excuse to request lower base rent, even though they do not need such relief. However, landlords are being very careful about how they approach each request. A landlord must satisfy themselves that the requesting tenant is in genuine trouble due to the current market, and that the rent reduction being requested will indeed help the tenant survive until the market improves. If a tenant’s sales are not heavily affected by the market, or if they have been affected by the market but granting the requested rent reduction will not get them past their troubles, then there is no reason to reduce the rent. Doing so only sets a precedent for how you will need to deal with the other tenants at the center as most tenants talk with one another. A landlord needs to be convinced that the tenant is hurting and that the relief being sought will get the tenant past these difficult times. If not, then it is not in the landlord’s or the center’s best interests.

SCB: What are retail clients asking you to do differently during the recession? Are retailers getting smarter about leases?

Arndt: Retail clients are more focused on managing their existing stores and making sure they are taking advantage of all rights under their existing leases, as opposed to negotiating new leases, during the recession. Retail clients are auditing existing leases, revisiting their rights and remedies in the event landlords are not satisfying co-tenancy and other lease provisions, and focusing on amending existing leases. Retailers are reacting to existing market conditions and learning from a market which few, if any, have previously encountered. Both retailers and shopping center owners are “getting smarter” about running their businesses in the existing economic climate and reacting to new and evolving market conditions.

Coyne: One noticeable change with retail tenants during this recession is the focus on rent structure contained in the lease. More tenants during lease negotiations are starting to request lower fixed minimum rents and higher incentive rent provisions that are tied to gross sales. This revised rent structure generally contains unnatural break points on gross sales figures that are much lower than in previous years. Sophisticated tenants continue to push the shopping center owner; however, the shopping center owner’s leverage is not as strong as it is in a vibrant economy and they are faced with both keeping the shopping center open and complying with lender requirements.

Schear: Good retailers have always been sought out, and now they are even more attractive to the landlord. Tenants are concerned regarding landlord’s ability to deliver and are focusing on timing — when the premises can (and cannot) be delivered, the penalty for non-delivery and a drop-dead rate for non-delivery. Tenants are also focused on the right to offset should the allowance not be timely paid.

Wild: Retailers are being a lot smarter about how they approach the lease negotiation process. Tenants understand that they have the leverage in this market, and they are being aggressive in how they exercise their leverage. For example, when negotiating the initial buildout provisions of leases, most tenants are being very conservative about how they approach the timelines and deadlines imposed in such provisions, and are reluctant to agree to severe penalties if they are late. In the past, tenants were under a lot of pressure to open the stores as soon as possible in order to satisfy a landlord’s co-tenancy obligations, or to open simultaneously with other tenants at the center. However, in this market, tenants have the leverage to ensure that they give themselves enough time to properly and efficiently complete the work. Completing the work as cost-effectively and efficiently as possible is extremely important to tenants in today’s market.

SCB: In what other ways are your clients asking you to help them?

Arndt: Clients are asking us to help them think creatively, to think outside of the box, and share experiences and solutions we have seen in other centers with other clients which might prove beneficial to them in the existing retail environment.

Coyne: Some shopping center owners are looking for “win-win” situations with respect to troubled tenants. For example, if a tenant is contemplating closing its doors at the shopping center, the owner may offer the tenant a modified lease term with the option of either the tenant or the owner terminating the lease after every six month period. This gives the tenant the flexibility to weather the economic downturn, and the shopping center owner the time to find a suitable replacement tenant. The goal is asset preservation and loan covenant compliance in these uncertain times. Temporary rent reduction could sometimes be appropriate.

Schear: Clients, both landlords and tenants, look to their counsel to provide best practices, and counsel today clearly needs to have an ear to the ground. The environment is truly competitive, and tenants and landlords expect timely service, accurate drafting and thoughtful negotiation.

Wild: We are being approached on a daily basis for help in structuring forbearances and workouts of loans. Many landlords do not have the experience in negotiating restructuring terms with a lender, and they do not have an understanding of the current market and what lenders are agreeing to in this market. We are being approached to give our understanding of the market, and help them negotiate terms that will give them the flexibility to survive.

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