Get 10 Protections When Restructuring Lease of Percentage Rent Tenant

Offering any tenant rent relief is inherently risky.

Like so many landlords these days, you may be considering restructuring your lease to aid a percentage rent tenant that’s struggling to stay afloat. While avoiding a vacancy by helping the tenant stay in business is clearly in your interest, attorneys also preach prudence to landlords who engage in percentage rent lease restructuring. One seasoned Southern California attorney recommends a restructuring approach that he says has enabled his own shopping center landlord clients to:

• Maximize the rental income they stand to receive should the tenant turn its business around;
• End the lease if the tenant continues to struggle and a more promising prospect enters the picture; and
• Retain key legal and business protections for all post-restructuring scenarios.

Even in cases where a struggling tenant wasn’t able to turn things around, the restructuring arrangement at least enabled the landlord to maintain a rent-paying tenant in the premises over a significant period during which the space would have likely otherwise been vacant. Here’s a briefing on this strategy along with a Model Agreement containing 10 key protections that you can use to implement it with your own percentage rent tenants.

How the Restructuring Strategy Works

Offering any tenant rent relief is inherently risky. From a landlord’s perspective, balance and flexibility are the keys to managing the risks. And that’s what the Southern California attorney’s approach provides. The way it works: The landlord and tenant sign an agreement to temporarily reduce the tenant’s minimum rent for a predetermined period. The tenant continues to pay percentage rent during this so-called “relief period.” However, there’s a revised breakpoint at which percentage rent kicks in that’s based on the reduced minimum rent figure. The landlord also has the right to change the rate of percentage rent during the relief period.

In addition, the arrangement gives the landlord maximum flexibility to end not only rent relief but also the underlying lease. This protects the landlord in case the tenant remains in financial distress and the opportunity to replace it with a more promising prospect arises.

10 THINGS TO INCLUDE IN RESTRUCTURING AGREEMENT

There are 10 things a lease restructuring arrangement with a percentage rent tenant must address.

1. The Relief Period

The relief period, or specified amount of time during which the tenant is entitled to pay the lower percentage rent, should typically range from one to two years. “You want to give the tenant a fair opportunity to make it work without locking yourself in for too long a period,” the attorney explains [Agreement, par. 1].

2. Landlord Right to End Relief Period Immediately

In addition, you should reserve the right to end the relief period early and thereby require the tenant to pay the rent provided for in the original lease before the restructuring agreement commenced in certain situations. Get the right to terminate the relief period immediately when and if the tenant:

• Defaults on the restructured lease agreement;
• Assigns the lease;
• Becomes bankrupt or insolvent; or
• Discloses the restructured lease deal to others—most landlords want to keep the existence and terms of restructured lease deals strictly confidential lest other tenants seek similar concessions for themselves [Agreement, par. 5(a)(i)].

3. Landlord Right to End Relief Period on 30 Days’ Notice

For extra protection, get the right to end the relief period for any reason on 30 days’ notice. This way you’ll have leverage over a tenant that’s meeting its obligations under the restructuring agreement and lease but engages in some action or omission that you deem objectionable even though it’s not technically a violation [Agreement, par. 5(a)(ii)].

4. Landlord Right to Collect Foregone Rent Upon Early Termination

In the event you do decide to end the relief period early, you should be able to require the tenant to immediately pay the rent you’ve foregone during the relief period—a.k.a., “relief arrears”—up to that point. As a practical matter, tenants will probably be unable to make good on the relief arrears upon your early termination. However, simply having the right to demand the arrears increases your leverage over the tenant to collect whatever money that’s collectable at that point [Agreement, par. 5(b)].

5. Percentage Rent Rate During Relief Period

The restructuring agreement should specify how much percentage rent the tenant must pay during the relief period [Agreement, par. 3]. The landlord can give the tenant an extra boost by lowering the rate. But the landlord may benefit by raising the percentage rent rate.

Example: A lease requires the tenant to pay percentage rent of 3 percent of its gross sales over $10,000 per month. During the relief period, the landlord requires the tenant to pay 5 percent of its gross sales over a new breakpoint of $8,000. If the tenant’s sales are strong enough and the percentage rent rate is high enough, the landlord may actually end up collecting more rent during the relief period than it would’ve collected under the original lease payment terms. The landlord wants to be sure it can keep that money and not have to refund it to the tenant in the fairly unlikely event that this scenario comes to pass [Agreement, par. 6].

6. Minimum Rent After Relief Period

Percentage rent leases typically require tenants to pay a specific minimum amount of rent each month. The restructuring agreement should list the minimum rent, both during and after the relief period. The conventional approach is to reduce the minimum rent during the relief period and restore it to its original amount after the relief period ends. But there are other possibilities. One is for the landlord to give itself the right to increase the minimum rent above the original amount over a set period after the restructuring arrangement ends to compensate it for the rent it gave up during the relief period [Agreement, par. 5(b)].

Example: A tenant’s minimum monthly rent before restructuring was $10,000. The restructuring agreement provides for a two-year relief period with a minimum rent of $8,000 but also gives the landlord the right to increase the minimum rent to $12,000 over two years after the relief period to recoup the rent it gave up. Of course, landlords will need to be in a strong bargaining position to command this concession from a tenant.

7. Landlord Right to End Lease Upon 60 Days’ Notice

Even if the restructuring works out well and the tenant keeps its obligations under the deal, there’s always the chance that the landlord finds somebody even better who’s ready, willing, and able to pay more for the space. Accordingly, negotiate for the right to end not only the restructuring agreement but also the underlying lease early for any reason upon 60 days’ written notice. Reserving early termination rights can be presented to the tenant as part of the cost of rent relief [Agreement, par. 9].

Our Model Agreement also requires the tenant to pay all of the relief arrears accrued until early termination, but tenants may push back on this [Agreement, par. 5(a)(i)(4) and 5(b)].

8. Ban on Financial Diversions by Tenant During Relief Period

You should restructure percentage rent only if you’re sure that the tenant will act in good faith to maximize its sales and what it pays you each month. Accordingly, it’s advisable to ban the tenant from engaging in other business activities and ventures that divert money it could be using to pay full rent, such as:

• Lending money or financial assistance to other companies;
• Opening new stores or ventures;
• Making distributions such as paying dividends to shareholders; or
• Handing out lavish bonuses or raises to its officers, directors, shareholders, or other principals [Agreement, par. 7].

9. Tenant Duty to Pay Landlord’s Legal Expenses

Landlords may incur significant expenses in negotiating, drafting, and executing a restructured lease agreement. It’s not unreasonable to require tenants to reimburse you for those expenses [Agreement, par. 10].

10. Agreement Binding on Landlord’s But Not Tenant’s Successors & Assigns

One of the dangers of lease restructuring is that the tenant will seek to transfer the concessions to a third party, such as a corporation that acquires its business. That’s why landlords should include language in the agreement that makes it clear that the concessions are personal to the tenant and may not be assigned to third parties while not impairing the landlord’s own right to transfer the agreement to its successors and assigns [Agreement, par. 12].