commercial real estate · Malls · Retail leases · Shopping Center

Just how bad can that cotenancy provision be?

Coronavirus is laying bare deficiencies that exist in lease language. We are currently working on a still very successful regional mall. Its one vacant anchor is slated for redevelopment. The owner had never had a large portfolio, so did not have the benefit of seeing the evolution of lease language and, as a result, has absorbed hundreds of thousands of dollars per year. But the specific issue at hand are some of the cotenancy provisions.

Specifically, around the time of the great recession, most landlord added conditions to their cotenancy provisions – conditions related to sales. Something along the lines of “if there are less than 3 department stores or less than 75% of the non-department store GLA operating, and the tenant’s sales during the six month period after the failure are less than 80% of the tenant’s sales in the prior year.” This added the condition that a tenant show that it had been affected. In the case of coronavirus, very few categories were not impacted, so this may not have been an issue.

However, one condition that has existed in the industry for years is a period of failure. If fewer than three department stores “are operating for more than six months,” or if less than 75% of the in-line GLA is “operating for more than nine months,” or some other time period or combination of time periods, the “period of failure” is in the vast majority of cotenancy provisions. However, not one cotenancy provision at this property had any period of wait.

Further, there are typically exceptions to cotenancy provisions for causes outside of the landlord’s control – such as government mandated shutdowns and, believe it or not, pandemics. However, in the case of one particular lease, the tenant negotiated “for any reason whatsoever.” That, indeed, is a rare add to a lease. So, this tenant could go to alternate rent – 6% of sales in lieu of minimum rent only, plus continue to pay its share of Additional Rent – immediately.

However, in the case of that particular lease, the tenant managed to tie in its operating covenant to its cotenancy. So, if few than three department stores, or less than 75% of the GLA is operating for any reason, the tenant may cease operating – 6% of sales plus additional rent.  Many tenants do negotiate the right to cease operating during a cotenancy failure, but if they choose that option, they continue to pay full rents. This particular lease did not have that requirement.  So, because the tenant could pay alternate rent IMMEDIATELY upon a failure FOR ANY REASON WHATSOEVER, and the tenant was NOT REQUIRED TO OPERATE, the tenant could immediately pay 6% of zero sales, or $0, but continue paying its Additional Rent.

However, as I mentioned, the vacant department store is slated for redevelopment and has been for about 15 months (as the redevelopment goes through the approval process). So, the landlord had converted some of the tenants’ rent to Gross Rents (including this tenant’s) during this redevelopment period. Gross Rent – meaning no Additional Rent.

So, to answer the question, just how bad can a cotenancy provision be?

The tenant goes on Alternate Rent immediately (with no wait period) upon the existence of a Cotenancy Failure (for any reason whatsoever). The tenant’s Alternate Rent is 6% of Sales plus Additional Rent, but the tenant is not required to operate, and the tenant is not required to pay any Additional Rent. The tenant is not required to operate. The tenant is not required to pay Minimum Rent. The tenant is not required to pay Additional Rent.

That’s about as bad as it gets when it comes to cotenancies.

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