Just work with me: When is it a good idea to keep working with a defaulting tenant?
How many times (even during a robust market) have landlords considered and perhaps acted on a tenant’s request to grant them abatement, deferrals and other concessions in order to preserve the relationship, avoid vacancy, make their lender happy and keep the rent coming in? More often than you might imagine. Although there are clearly self-interests on both sides in the decision to allow the tenant to pay partial rent or defer overdue amounts under the lease, often landlords and tenants enter into such discussions with the best intentions for all involved. Yet, even the most benevolent agreements can lead to negative consequences down the road. A landlord approached by a tenant with a request to vary from the terms of the lease agreement has a number of primary considerations to take into account before continuing this conversation:
1. How long has the tenant been in business at the premises?
2. What do the tenant’s gross sales look like?
3. What plans does the tenant have for maintaining or increasing sales?
4. How valuable is the tenant’s continued presence to the shopping center, industrial park or office building to the image or viability of the asset?
5. What are the current and long term plans for the property?
6. Is landlord considering refinancing its debt, any redevelopment or perhaps selling the project?
7. What is the effect of a forbearance or deferment on overall cash flow?
8. What is the status of the debt on the property?
Assuming that after putting all this together the landlord is comfortable moving forward with a discussion about the request for a change in the rent and other payment terms in the lease, the parties should try to come up with a framework for addressing the landlord’s concerns and tenant’s needs. But be careful!
Consider this example: A mid-sized shopping center anchor is four months behind in minimum rent and is slow paying. Taxes, Insurance & Common Area Maintenance (TICAM) explains that it is experiencing operational difficulties and reduced cash flow. The tenant has a plan that specifically addresses how it is going to address and solve these issues, but part of that involves an abatement or reduction in rent for a period of time, with an agreement to amortize the past due amounts in future rent payments. The landlord’s cash flow at the center is strong and its lender is generally happy with the status of the loan and the asset.
However, the landlord has plans for refinancing the loan to allow for an expansion of the center in the next year, possibly requiring a relocation of the tenant. Landlord finds a short-term abatement and a year of reduced rent agreeable to allow the tenant to continue operating and producing cash flow for the center. The parties shake hands on the deal and the landlord gives the tenant free rent for four months and then begins accepting lower rent.
After a year, the tenant returns and tells the landlord that it still is having cash flow problems and simply cannot start paying full rent and an additional amortized payment to repay the reduced/unpaid amounts as well. In the meantime, landlord is halfway through negotiations to expand the center and finds that its lender is going to require that this tenant pay off all of the past due amounts immediately and start paying full rent or the loan will not be approved. The landlord demands the tenant honor its agreement. The tenant refuses and says its lawyer has advised that the landlord has “waived” the requirement of payment of the full contract rent and the payment of past due amounts. When the landlord reiterates its demand, the tenant responds that it has no other choice but to shut its doors in two months.
Could this situation have been prevented? Maybe and maybe not… The common law and/or statutes in most states provide that long term acceptance of a change of terms of a contract by a party can result in a legal waiver or estoppel preventing the party from enforcing the original terms of the lease. In extreme cases, this can also result in a permanent change to such terms for the remainder of the term. However, in many states, courts have upheld the right of commercial parties to enforce anti-waiver provisions that would preserve the original contract terms at the end of the abatement/reduced rent period. So, how could the landlord protect itself in the situation described above?
Solutions and Preventative Measures
Certainly there is no magic answer to address all of the problems that arose in this example, but here are a few thoughts on what the parties could have done:
1. The lease should contain a strong and specific anti-waiver provision, as well as robust remedies for tenant default;
2. The parties should document their discussions and final terms of agreement into a written lease amendment, including a clear recitation that the original contract terms will remain in full force and effect;
3. The amendment should include additional security for landlord to insure performance including one or more of the following: a) cross- corporate or personal guaranties; b) perfected security interest in favor of the landlord in tenant’s trade fixtures, equipment, accounts etc.; and c) letter of credit for the total amount of free and reduced rent plus any past due amounts as of the time of the agreement.
4. Don’t fall asleep! Monitor the status and viability of the tenant’s business during the abatement/reduced rent period. The first indication that the tenant is not back on track should not be an email from the tenant in response to a demand for proper performance.
This article originally appeared in the Fall 2015 edition of Paradigm, a Primerus publication.