What We’ve Learned: Considerations for Landlords When Negotiating
Key Retail Lease Provisions Following Covid
Since the onset of the Covid-19 pandemic (“Covid”), the commercial real estate world has been upended. In the negotiation of almost all new retail leases, tenants (whether traditional retailers, restaurants, exercise-related facilities or theaters) have been requesting very specific lease changes reflecting their desire to address ever-changing Covid-related governmental restrictions.
Prior to Covid, virtually every retail lease contained force majeure provisions which, arguably, could be interpreted to apply to governmental restrictions relating to pandemics. However, almost all of these provisions also expressly provided that the payment of rent and additional charges by the tenant would not be excused by force majeure events. Nevertheless, for many reasons, many retail landlords have provided some economic relief to retailers most affected by Covid. This relief has often taken the form of base rent deferral for a defined period of time.
Although retail leasing has declined considerably since Covid, when negotiating new leases, retailers (especially restaurants and exercise-related facilities) are now commonly requesting a variety of new lease provisions to protect them from Covid-related restrictions and closures. The most common of these new lease provisions can be broken down into the following six categories.
1. Construction Requirements. Once the landlord has delivered the premises to the tenant, the tenant does not want to have the obligation to build out its space until it knows that certain governmental restrictions have been lifted with respect to its use. For example, a gym or restaurant may not want to start construction of its tenant improvements until it knows that it can operate without significant capacity restrictions. In such a situation, the landlord may want a “put right” if the tenant has not commenced construction within a defined period of time, such as six months. In this case, at the end of the six-month period, the tenant would be obligated to commence construction of its tenant improvements or landlord would have the right to terminate the lease. A termination may leave the landlord vulnerable if its build-out of the space has a number of items that are specific to the tenant’s use. In this case, the landlord may seek reimbursement from the tenant for these items if it terminates the lease.
2. Dedicated Short-Term Parking for Pick-Up and Delivery. Many retail tenants now require a few parking spaces in front of their premises dedicated to short-term parking for pick-up and delivery. During Covid, pick-up and delivery of both food and goods have been essential for restaurants and retailers. Landlords usually do not have a problem with this request as long as the spaces are set aside as non-exclusive so as not to violate existing leases or CC&Rs (which typically require that all parking spaces be utilized on a non-exclusive basis), the landlord is not required to monitor or enforce the short-term nature of the designated spaces, and the tenant pays the cost for such signs.
3. Opening Requirements. If significant Covid restrictions are in place when the tenant is required to open for business from the premises, the tenant will want the right to elect not to open until such restrictions are lifted. However, the landlord will want the tenant to open if the restrictions are not too onerous. For example, if a restaurant is able to operate for in-store dining at 50% capacity, the landlord will want the restaurant to be required to open at that level. If the tenant agrees that it will open in this situation, in lieu of the stated base rent set forth in the lease, it will want the right to pay a percentage of its gross sales as base rent for as long as the capacity restriction remains in effect, although it will generally agree to pay its share of taxes, insurance and common area expenses. Most landlords will agree to such an arrangement since they much prefer to have a tenant operating from space in its shopping center than the space being “dark.” At such time that the capacity restrictions are lifted, the landlord will expect the tenant to pay the fixed base rent set forth in the lease in lieu of a payment based on a percentage of gross sales.
4. Impact on Operating Retail Businesses. Many retail tenants will attempt to negotiate provisions in their leases providing that, if a Covid-related governmental restriction is imposed on their business after they have opened from substantially all of their premises, they will have the right to close or pay base rent based upon a percentage of its gross sales. Landlords will want to incentivize such tenants to stay open for business despite the restrictions for many reasons. First and foremost, it is important for the synergy of the shopping center. Secondly, it allows the landlord to continue to receive some rent and 100% of tenant’s share of taxes, insurance and common area expenses.
The landlord may attempt to negotiate a provision that limits the tenant’s right to pay base rent based upon gross sales (or other type of alternate rent) if the tenant’s gross sales do not decline by more than an agreed percentage due to the Covid-related governmental restrictions. Although this is a fair request, it may be met with resistance by a tenant that argues that its sales would have increased much more significantly but for the Covid restrictions.
In addition, if Covid restrictions require a retail tenant to be closed from all or substantially all of its premises, the tenant may prefer to close from all of its premises and have all of its base rent and additional rent abated. If the landlord agrees to such an abatement it should attempt to have the abated rent deferred and paid over a one-year period commencing a few months after tenant is once again able to operate for business from a material portion of the premises – after all, it is not the landlord’s fault that the tenant is not able to operate and the tenant contractually agreed to the rent for an agreed period of time. In addition, the landlord will usually require the tenant to continue to pay its share of taxes, insurance and common area expenses during all closures. All of these items will be subject to negotiation based upon the relative bargaining strengths of the parties.
Finally, some parties may agree to extend the term of the lease for periods during which the tenant has the right to abate or defer base rent due to Covid restrictions.
5. Termination Rights. Tenants may attempt to negotiate termination rights in their leases if Covid restrictions prevent them from operating in material portions of their premises for lengthy periods of time, ranging anywhere from six to 18 months. Landlords will strongly resist providing tenants with termination rights based upon the argument that they have already provided the tenant with reduced rental obligations that will last for the length of any material Covid restrictions. However, if the landlord does provide the tenant with a termination right, it should require that the tenant reimburse it for the then unamortized costs of any brokerage commission and/or tenant improvement allowance paid by landlord in connection with the lease transaction.
6. Force Majeure. Force majeure provisions in many new retail leases will now provide that a force majeure event includes a “virus, disease, pandemic, epidemic, or other health emergency, and all governmental restrictions relating thereto.” Landlords should continue to provide in the force majeure provision that a force majeure event does not excuse the tenant’s payment of rent and its share of taxes, insurance and common area expenses. It should also require that tenant provide it with written notice of any force majeure event within a short-defined period of time following the force majeure event (e.g., 5 days). However, the force majeure provision in a retail lease will now need to be subject to the specific Covid-relief provisions of the lease addressed above.
We are certainly living in a new world due to Covid. Many retail tenants are still aggressively looking for new locations. Some see the current economic climate as an opportunity to enter certain markets or shopping centers that were previously unavailable. Covid has created a new paradigm for retail lease negotiations. Landlords will need to be creative in addressing Covid related circumstances if they are going to be successful in their future lease negotiations.