Five Things Landlords Need to Prepare for COVID-19’s Impact on Retail/Commercial Tenants

March 18, 2020
Firm Publication

For many commercial landlords, the calls for help from tenants began late last week as state and local governments rolled out measures to prevent the spread of the novel coronavirus (COVID-19). As social distancing becomes the norm, retailers and other consumer-facing businesses of all sizes are feeling the impact of decreased demand, supply chain interruptions, and in some cases, mandatory closures.

Below are five issues landlords should consider before negotiating concessions with commercial tenants.

  1. Tenant Relief May be Limited Under Loan Documents. Before agreeing to any reduction in rent, owners should first carefully review their project’s loan documents. Many real estate loan documents include financial covenants required to be maintained during the term of the loan. Owners should ensure that aggregate rent reductions will not reduce net operating income to a point where financial covenant tests are tripped, triggering a default and other lender protections (such as cash management) under the loan documents. Additionally, owners need to confirm whether their loan documents permit the modification or termination of a lease, or acceptance of less than the rent stipulated under a lease.
  2. Identify Opportunities. Tenants that were in trouble before the COVID-19 pandemic are unlikely to improve over the coming months. While a replacement tenant may not be immediately available, removing a problematic tenant now for cause due to a payment or operating default may be preferable to accepting less rent from the tenant only to be stuck with them again once things improve. Note that assistance from the courts and law enforcement in the eviction of tenants may be limited due to COVID-19, so landlords should consider a mutual early lease termination instead of eviction.
  3. Condition Agreement to Defer Rent. A landlord’s agreement to accept reduced rent from a tenant should be documented in a lease modification or forbearance agreement. This agreement should provide for a deferral, not an outright abatement, of rent for a defined period. Request financial information from the tenant before agreeing to any deferral of rent. Any deferred rent and landlord costs (such as attorneys’ fees) should be repaid by the tenant in the future, either in one or more lump-sum payments or by having the deferred rent amortize/burn off over the balance of the term. Deferred rent should be accelerated and payable in full upon any default, notwithstanding the landlord’s existing remedies in the lease. Consider requesting that the tenant (or a credit-worthy parent) sign a promissory note for the deferred rent. Additionally, this is an opportune time to revisit tenant-friendly provisions in the lease that may cause problems with the ongoing operation of the project during this crisis, such as exclusive use rights, co-tenancy, and prohibited uses.
  4. Co-Tenancy Concerns. While a growing number of state and local governments have mandated the closure of gyms and health clubs, movie theaters, bars and restaurants, many retailers are voluntarily closing stores or reducing hours. Co-tenancy provisions in retail leases provide a tenant with certain rights (including reduction or abatement of rent or termination) in the event a certain percentage of tenants, or certain specific tenants, are not open and operating for a specified period. Reduced hours also could trigger a co-tenancy violation.  Often closures for certain events, including force majeure, do not immediately result in co-tenancy violations.  Landlords should be mindful of co-tenancy provisions in negotiating rent reductions with tenants.
  5. Understand Effects of Force Majeure. Most lease agreements include a force majeure provision that suspends performance by a party upon the occurrence of certain specified events outside of a party’s control, such as acts of God or war. Some force majeure provisions include catch-all language for events outside of either party’s control generally. Courts in most jurisdictions will strictly construe these provisions, so, unless the provision specifically addresses pandemic or disease, a court may not agree to suspend a party’s performance absent a catch-all provision [see a full analysis of the effect of Force Majeure provisions here].   Also, many leases specifically exclude the payment of rent or other monetary amounts under a lease from performances that may be excused due to force majeure. Landlords should consider whether force majeure can provide protection from construction and delivery delays due to COVID-19, co-tenancy violations and the provision of services under the lease.

While landlords must protect their interests in a commercial project, the coming months provide an opportunity for landlords to strengthen their relationships with tenants by providing creative solutions to help tenants weather this storm. As is the case in any unforeseen event – such as a fire, tornado or earthquake – landlords, tenants and lenders must work together to achieve their common interest of positioning the project for successes when things inevitably normalize.

If you have questions about dealing with tenants during this unprecedented time, please contact the author.