I AM NEGOTIATING WITH A TENANT THAT DOESN’T WANT TO OPERATE CONTINUOUSLY – NOW WHAT?
By: Dan Villalpando
When negotiating shopping center leases, landlords sometimes come across tenants that have enough bargaining power to simply say “no” when they are told that they will be expected to operate continuously for the full length of the term. For these tenants, if sales are not meeting expectations, it may make economic sense to close for business and continue paying rent, rather than pay the additional costs associated with running the store (payroll, merchandise, advertising, etc.). Tenants who are not willing to agree to continuously operate sometimes argue to the landlord that their primary obligation should be to pay rent on a monthly basis, and that closing shop should be immaterial to the landlord so long as the rent is paid. Apart from arguing that those tenants may generate foot traffic for other merchants, and that a shopping center with a lot of empty spaces will likely be less attractive to shoppers than one that is fully leased, what does a landlord do to protect itself if an otherwise attractive tenant insists on not being required to operate, or, put another way, on the right to be able to “go dark”?
For starters, the landlord should consider the following:
Require the tenant to at least open for one day. Although the tenant may not agree to operate continuously, it should agree to open for at least one day, fully fixturized, staffed and stocked with merchandise. This may not seem like much, but a tenant that is required to spend the time and money to get a store in a position to open and operate, even for one day, is probably less likely to close after opening its doors, at least for a while.
Make sure the tenant is required to perform all of its other obligations under the lease. Even if it gives up on requiring the tenant be open continuously, the landlord should make sure that the tenant is still obligated to perform its other obligations under the lease, regardless of whether or not the tenant’s store is open for business. Paying rent (including operating costs, taxes and insurance) is an obvious requirement, but the tenant should also be obligated to perform its maintenance obligations under the lease. Just because the premises are closed does not mean that they should look shoddy or run down from the exterior, which could potentially drive away customers from the remainder of the shopping center. Also, it makes sense to allow a tenant to “go dark” only if it is not then in default of its other obligations under the lease. The right to close should be viewed as a “benefit” to the tenant, and should only be exercisable if the tenant is, for example, current on its rent.
Give yourself the right to “recapture” the premises. One general rule that landlords should try to live by is that, for a landlord, it is of utmost importance to “control the real estate”. With that in mind, a savvy landlord will want to negotiate the right to “recapture” the premises (essentially, to terminate the lease with the tenant) if the tenant is closed for business for an extended period of time (i.e., 60 days or more). The landlord’s “recapture” right should be ongoing, unless the tenant re-opens for business. The landlord will most likely exercise its recapture right only if it has another viable tenant, or thinks it can quickly find one. The amount of time a tenant needs to be closed before the landlord can “recapture” is negotiable, but a basic recapture right should be a starting point in the negotiations.
Don’t let a tenant’s right to “go dark” impact the economics of your deal. A tenant’s right to close for business may seem innocuous enough, but it could have far reaching effects on other sections of the lease. For example, if the tenant has the right elsewhere in the lease to pay modified rent (i.e., 5% of its gross sales in lieu of contract rent) because of a landlord misstep due to a co-tenancy failure or failure to adequately maintain a critical component of the shopping center, it may suddenly have the right to pay nothing, because a closed space generates no gross sales. In this case, the landlord will want to come up with an alternative “modified rent” mechanism to make sure that the tenant is not off the hook for its rent payment just because it is closed for business. This type of potential pitfall could have a dramatic impact on the landlord’s bottom line and the landlord’s leverage against a tenant who has “gone dark,” and thus should be carefully considered.
The foregoing addresses what a landlord should do if it has to grant a tenant the right to “go dark” to get a lease signed. Of course, the starting point for the landlord should be a requirement that the tenant operate continuously throughout the lease term (subject to industry standard closures for holidays, casualty, condemnation, etc.). However, if a tenant is insistent on the right to close for business, the landlord should try to address as many of the foregoing issues as possible in the letter of intent stage (optimally), or in the lease itself.
This article discusses just a few basic points that arise in retail lease operating covenant negotiations. There are other nuances and complications that may arise in this context, and the Retail Team at Cox, Castle & Nicholson LLP is made up of experts in navigating these issues.
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