Real Estate

Landlord and Tenant Considerations When Negotiating Economic Concessions in Commercial Leases

Landlords and tenants enter into leases with the expectation that the document which they execute will govern their relationship throughout the term of the lease. However, shifting economic realities may move a tenant to pursue some form of relief from the terms of the lease. It is important to note that while this may initially appear to be a negative for the leasing relationship, it can also prove to be an opportunity for both parties. In order to fully realize these opportunities, there are several considerations landlords and tenants should evaluate.

The starting point for lease modification would naturally be the lease document itself. Both parties should be mindful of the original lease negotiations. Each party likely made concessions during that process, and if a tenant introduces the idea of modifying a provision of the lease (for example, the rent), it is appropriate for the parties to discuss the possibility of other revisions to the lease. Therefore, once a landlord learns of a tenant’s proposal to alter the economic terms of the lease, the landlord should consider which currently unfavorable terms could be modified to make an amended lease more palatable, such as the elimination of a tenant’s early termination right, renewal option, expansion right or other preferential rights or adding restrictions on tenant’s use of the premises. Likewise, before a tenant approaches the landlord for a concession such as rent reduction or abatement, that tenant should “think ahead” and try to anticipate what other favorable terms of the lease could be affected and balance the benefits and drawbacks to each scenario.

Next, the parties must consider the terms of the proposed economic concessions. This can come in many forms, the most common being rent abatement, rent reduction, and space reduction. In these conversations, the landlord and tenant must each have a realistic view of the value of the tenant’s lease. A tenant with a poor payment history or extended financial hardship will have a weak bargaining position. Conversely, during an economic market in which landlords are having difficulty finding new tenants to fill vacant spaces, tenants may have notably increased bargaining power.

While the proposed concession is intended to benefit the tenant, it may lead to opportunities for the landlord to reconfigure its balance of occupied and vacant space. The landlord may wish to reduce a tenant’s space or relocate a tenant to another (perhaps less marketable) location in the project in order to free up the relinquished space to be remarketed or “bundled” together with other space, creating the ability to lease to a larger full-floor/full-building tenant. Each party may also be well served in such discussions to do the other side’s homework for them in advance, including analysis of market rents, the net value of any rental adjustments and any other analysis which may help streamline negotiations.

Once a tenant asks for an economic concession, the landlord is justified in asking to examine the tenant’s financials. An open review of tenant financials will not only help the landlord determine whether to give a concession, but also help determine the amount of any concession. It is also common for such a landlord to then require continued periodic reviews of the tenant’s financials. The parties
should also address other cost saving methods available to the tenant. It will hurt a tenant’s bargaining position if it cannot show evidence that it has taken steps to reduce costs in other areas. The landlord should also take this opportunity to re-evaluate the security the tenant has given to secure its obligations and whether some modification is justified, such as the addition of a personal guaranty or additional security deposit.

Economic recovery by the tenant may trigger the end of any concession provided. In the event of rent concessions, the parties must then consider the concept of recapture. Landlords may expect the tenant to reimburse them for any rent that is forgiven. Once a balance of expectations is considered, the parties should evaluate the multiple options for recapture, such as a simple increase in the base rent at such later time as the parties reasonably project, or, for retail tenants, the addition of, or increase in, percentage rent. Because percentage rent is dependent upon tenant sales, the parties may need to manipulate the breakpoint calculation in order to guarantee repayments.

Finally, there are several issues outside the confines of the actual lease document that both parties must consider when negotiating economic concessions in the lease. First, one or both parties may be subject to loan agreements, and should seek all necessary lender approvals for modifications. Second, a landlord may want to request a waiver of all tenant claims against landlord arising prior to the effective date of the amendment via the inclusion of “estoppel” representations from such tenant. It stands to reason that a landlord that gives relief to a struggling tenant should not fear claims from a matter arising before such relief and the amendment giving tenant its economic concession. Third, any concession should be deemed terminated upon the filing of bankruptcy by a tenant in order to attempt to have the bankruptcy court consider the lease on its original terms during such process.

When tenants face difficult financial times, it is often necessary for tenants and landlords to work together to find a mutually beneficial concession which relieves the tenant’s burden while also adequately addressing the concerns of the landlord. So long as the parties carefully consider the full range of issues involved with such concessions, it can be an important step to securing a positive and sustained economic relationship between the landlord and tenant.

By Jeff Mosteller and Brian H. Baker

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