Leases & Landlords

HOW TO: LEASE HOW TO

Lease restructuring for bars during COVID-19, and beyond.

COVID-19 hit businesses hard, with repercussions felt by national brands and independents alike. So-called “non-essential” businesses have been required to close, re-open with constraints, then close again as a second wave of COVID-19 spikes in many parts of the country.

Bars have borne the brunt of mandated closures and social distancing. In many parts of the country, bars are still not fully open or have seen a steep decline in their revenues. As a result, some bar owners have been unable to pay rent.

Remittance of Rent Landlords often claim that rent is due regardless of the circumstances. Many landlords can point to lease language indicating that the obligation to remit rent is an independent covenant, which must be fulfilled by the tenant regardless of circumstances.

Not surprisingly, some commercial tenants disagree with their landlords’ contentions and initiate litigation. But for many bar owners, litigation isn’t a viable option as the process is time consuming, expensive, and uncertain.

Restructuring the Lease In many instances, the bar owner is left with one survival strategy: restructure lease obligations through negotiations. Landlords negotiate leases all the time and are often intimately familiar with procedural and substantive issues. On the other hand, bar owners aren’t generally as familiar with substantive or procedural issues. This disparity is a barrier that bar owners will have to overcome.

It’s important to bear in mind that the changes you are contemplating can be as helpful to the landlord as they are to you.

Some bars will be unable to survive without concessions from their landlords. When a bar goes out of business, the landlord has to find a new tenant. This is a very difficult environment in which to try and fill a vacant space. There are thousands of vacancies, and a shortage of tenants vying to fill them. Moreover, before a new tenant begins to pay rent, the landlord must incur a variety of expenditures including: brokerage commissions, legal fees, landlord work, and tenant improvement allowance.

Landlords also need to contend with the time during which the premises are vacant. It can take the landlord a year or more before a new tenant leases the vacant premises. During that time, the landlord is not only deprived of rental revenue, he is responsible for satisfying obligations that are normally borne by the tenant. These include real estate taxes, common area maintenance (CAM), and insurance.

Landlords have to provide substantial concessions to retailers to transform them from prospects to tenants. Such concessions often include free months.

Co-tenancy provisions can also affect both the landlord and the tenants. Co-tenancy clauses protect tenants in the event that an anchor leaves or a certain number of in-line stores are vacant. Every tenant that leaves brings the facility closer to triggering co-tenancy rights for remaining tenants who have negotiated such protection. Retailers protected by co-tenancy are often able to pay alternative rent, for example six percent (6%) of gross sales, then terminate early if occupancy levels remain below the agreed-to threshold.

The concessions you are asking for may be dramatically less than those which the landlord would have to provide to a new tenant. So, from a purely financial vantage point, many landlords benefit from retaining an existing bar. Landlords also benefit by having a “stabilized” property.

For example, a lender may deem a temporary reduction in rent, or an abatement of several months’ rent, to be more favorable than a vacancy. Due to the expenses noted above, the vacancy may detract from the landlord’s ability to fulfill mortgage obligations to a much greater degree than the grant of relatively shortterm relief to an otherwise viable tenant. In fact, concessions granted to an otherwise viable bar tenant may not materially impact the landlord or his ability to fulfill mortgage obligations.

Look for Mutual Gains Frequently, lease negotiations descend into zero-sum games. That doesn’t have to happen. Your business may be closed or struggling under severe constraints, leaving you temporarily unable to remit rent. However, if the landlord provides you with some latitude, you might have the ability to return the favor by conferring benefits to the landlord. For example, by extending the lease.

Although you may currently be closed, there are a number of benefits that a viable bar can provide to the landlord. For example, the bar could agree to provide the landlord with a Profit Sharing Provision. Pursuant to such a provision, the landlord would be entitled to a percentage of the profits earned by you upon the sale of the business. In turn, the landlord could facilitate such a profitable sale through concessions such as making the assignment clause more lenient. The bar owner can ensure fair and equitable treatment by carefully negotiating an appropriate deductible—the minimum amount which must be exceeded before sales proceeds constitute profits.

The landlord also benefits by not having to sign a long-term lease in a very tough retail environment. The concessions you’re contemplating may pale in comparison with the lower rents that will be needed to secure a new, long-term tenant.

The Resolution of Conflict Your position should be grounded in objective criteria, not on a subjective position. There is a vast array of objective criteria that you can use to formulate and support your position, including: government mandate that you close; government mandate that you limit operations to only part of the leased premises; Executive Orders issued by the governor; cases adjudicated by a court of competent jurisdiction, interpreting similar lease language; and the economic benefits accruing to the landlord by providing the relief you are requesting.

Of course, you have to negotiate with the landlord to determine which standard will apply. By negotiating over what standard or benchmark to apply, rather than the parties’ positions, neither party has to yield to the other. Landlords and tenants can eventually agree to the application of a fair third-party standard.

Reciprocity mandates that the objective criteria selected govern both parties. So, if the landlord believes that rent should be paid regardless of the circumstances, he should fulfill his mortgage obligations regardless of the circumstances.

If the landlord says, “you are expected

to pay rent while the premises are closed,” ask the landlord how he arrived at that position. Leases are complex documents, and the cases interpreting such documents are not uniform.

Separate the People from the Problem Don’t attack your landlord. In many respects, he is in the same predicament you are. Insurance premiums, mortgage payments, property tax bills, and maintenance costs are unrelenting. Moreover, there are interest and penalties imposed on many of these obligations when they are not fulfilled on time.

Focus on overcoming challenges. For example, the bar’s inability to fulfill lease obligations due to a lack of liquidity.

Identify and seek to resolve your landlord’s problems. For example, your

landlord may not be able to grant you the relief needed without violating loan covenants. Find out what your landlord’s interests are, then work cooperatively to structure the resolution in a manner that serves your respective interests.

The first step is to analyze the situation by engaging in a variety of activities, beginning with the collection of your lease documents. The relevant provisions of your lease must then be evaluated. This step includes input from a skilled lease attorney licensed in your jurisdiction.

Consult your attorney before undertaking any action or refraining from an action (such as remitting rent on a timely basis). This includes writing to your landlord asking for relief from rental obligations. You’ll want advice tailored to your situation, including whether the initial outreach could constitute anticipatory repudiation, potentially resulting in a breach and your landlord accelerating the rent. You also want advice on issues such as whether your lease’s force majeure clause relieves the tenant of any part of the obligation to remit rent.

Nurture Your BATNA Whenever the other side is more powerful, nurture your BATNA: Best Alternative to a Negotiated Agreement. Have a plan for what you will do if you don’t reach agreement on the payment of rent for the period of mandated closure and the ensuing economic aftershocks. Make the most of the assets that you do have. Will you have your attorney submit notice to your landlord that you’re relying on the force majeure provision of the lease and claim that rent is not owing due to COVID-19?

You might have many options. Identify and curate them.

Randy Airst is CEO at Exceedant (exceedant.com), a platform for real estate owners, occupiers, lenders and investors seeking to optimize their investment in commercial real estate. Randall is also creator of COVID-19 Rent (covid19rent. com), an online lease negotiation course for tenants, landlords, and their representatives. This article does not constitute either legal or financial advice. Every situation is different and solutions must be tailored by your legal and financial advisors to fit your individual circumstances.