Entering into a retail deal, regardless of whether it involves a lease, ground lease, or pad sale, takes optimism. Each party enters into a new venture that it fully expects will be a mutual success. Unfortunately, the success of a retail enterprise relies in large part on the discretionary income of often fickle customers and, as we have recently learned, risks of a pandemic, supply chain issues, and the increasing popularity of e-commerce. The hottest concept one year may be old news the next season. Thus, the positive expectations that abound at the front end of a retail deal must be tempered with a certain degree of cynicism. Both sides need to craft exit tools, if the retail operation does not succeed. This article will address options for restructuring or, if need be, exiting a retail relationship. The discussion will focus primarily on leasing, but will also touch on arrangements where a retailer owns a pad that is part of a larger development.
The logical time to structure exit strategies occurs during initial negotiations. Generally, a landlord’s lease form contains all the bells and whistles the landlord needs to enforce the lease, but the tenant must expressly insist on provisions protecting its downside. Correspondingly, many national retailers have form leases and reciprocal easements agreements (REAs) that protect their interests, but do not offer the landlord or owner of the development viable options if the retailer experiences a downturn. The next section of this article discusses several common front-end protections the parties may discuss.
A sophisticated tenant will look for assurances that the landlord will lease and operate the center as represented, both as a condition to the tenant opening for business and to the tenant paying fixed rent throughout the lease term. The tenant will want a requisite number of the proposed anchor tenants, which are the main draw to the center, to open. The tenant will also want the balance of the center to thrive, with a minimum percentage of the small tenants open to coax customers to stay and shop. If the center does not satisfy either of these tests, the tenant will initially want relief on its rent, and eventually the right to terminate the lease.
Co-tenancy provisions pose a significant risk for the landlord. The landlord cannot guarantee that any given tenant will remain in business. Even if a lease requires the tenant to remain open and operate for business, as a practical matter, courts have routinely refused to grant landlords the remedy of specific performance for such an obligation, on the grounds that the court cannot reasonably monitor an ongoing business operation. Co-tenancy provisions can have a domino effect, where one store closing may trigger rent concessions or termination rights in a number of other leases. Thus, a wise landlord will negotiate for time to resolve a co-tenancy violation before tenant remedies come into play. The landlord will also want to tie the tenant’s remedies to damages the tenant has actually suffered because of the co-tenancy violation. For instance, there may be a co-tenancy violation in the center that does not materially impair the tenant’s sales. If the lease gives the tenant the unfettered right to pay reduced rent, the tenant may happily operate for years paying a fraction of its normal rent. This devalues the center and impairs the landlord’s ability to refinance or sell it. Further, if the tenant has an ongoing termination right because of a co-tenancy violation, no lender or purchaser will allow any credit for that lease in valuing the center. Therefore, all co-tenancy remedies need to expire at some point. Either the tenant must terminate the lease or go back to full rent. A common structure for a co-tenancy provision would therefore look something like the following:
• Landlord has X months after notice from the tenant to remedy the violation (the Cure Period);
• If the violation is not remedied within the Cure Period, the tenant thereafter pays percentage rent in lieu of fixed rent (and expense pass-throughs);
• If the co-tenancy violation continues for X months (the Cure Deadline), the tenant thereafter has the right to terminate the lease upon X months’ notice to the landlord;
• If the tenant ceases doing business in the center at any time prior to the Cure Deadline, the tenant’s remedies go away and full rent resumes;
• If the co-tenancy violation continues for X months (the Tenant Remedy Deadline), the tenant must either terminate the lease or waive its termination right and return to full rent.
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.