Limit Tenant's Cotenancy Remedies After It Returns to Full Rent

If you own or operate a shopping center, your strong retail tenants typically demand and get an “operating” or “ongoing” cotenancy clause in their leases. This clause gives a tenant certain remedies, such as a rent abatement, if one or more major or anchor stores or a set percentage of the center's gross leasable area (GLA) occupied by smaller stores close or go dark during the lease term and aren't replaced within a specified time period. You don't want the tenant's remedies—especially, a rent abatement—to continue indefinitely if you can't find a replacement for the closed or dark tenants. So, leases typically require a tenant to fish or cut bait—that is, choose to either return to paying full rent or terminate the lease—at a set point in time (for example, 12 months from the start of the cotenancy violation).

But if your operating cotenancy clause is like many we've seen, it may have this loophole: It doesn't adequately address what happens to the tenant's cotenancy remedies after the tenant returns to paying full rent. That could be a big problem if you can't cure—that is, fix—the old cotenancy violation. Immediately after the tenant returns to paying full rent, it could argue that the continuing violation has triggered its remedies under the cotenancy clause yet again and claim that it's entitled to another rent abatement.

To prevent that from happening, add two protections to your operating cotenancy clause, says Toronto attorney Stephen J. Messinger. These protections will let a tenant that returns to full rent apply the cotenancy clause only to new cotenancy violations and certain continuing cotenancy violations that meet specific conditions. There's a Model Lease Clause that includes those protections on p. 3 that you can adapt and use in your lease.

Put Two Protections in Cotenancy Clause

Ideally, you'd like the cotenancy clause to become void after the tenant decides to return to full rent, but a tenant won't agree to that, says Messinger. The tenant will demand that the cotenancy clause remain in effect for the rest of the lease term, even though the tenant has returned to paying full rent. That's why it's important that your lease, like our Model Lease Clause, include two key protections.

Note that our Model Lease Clause uses the defined terms “Major Store Violation” and “Small Store Violation” to describe the two types of cotenancy violations covered by a typical cotenancy clause. You'll need to define these terms elsewhere in your lease. A “Major Store Violation” typically occurs when, for more than a set number of consecutive days, fewer than a set number of stores of at least a certain size (typically, anchor tenants) are open and operating at your center—for example, when, for more than 90 consecutive days, fewer than two stores of 50,000 square feet or more are open and operating.

A “Small Store Violation” occurs when, for more than a set number of consecutive days, less than a set percentage of the center's GLA devoted to smaller stores is open and operating at your center—for example, when for more than 90 consecutive days, less than 65 percent of the GLA devoted to stores smaller than 50,000 square feet is open and operating.

Cotenancy clause applies to new—not existing—major store violations. Make it clear in your lease that when the tenant returns to paying full rent, the cotenancy clause will apply to subsequent, new cotenancy violations—both major store and small store violations—but not to major store violations in existence when the tenant returned to paying full rent and continuing thereafter, says Messinger.

For example, suppose you cure a major store violation after the tenant returns to full rent. An anchor tenant then closes its store, causing a new major store violation. The tenant can resort to its remedies under the cotenancy clause. But suppose you don't cure a major store violation during the time the tenant gets a rent abatement. The tenant resumes paying full rent, and a few months later, another anchor store closes. The closing of the anchor store is simply a continuation of the uncured major store violation. So, the tenant couldn't resort to its remedies under the cotenancy clause.

Cotenancy clause applies to existing small store violation only if conditions met. If you can't cure a small store violation by the time a tenant chooses to return to full rent, the tenant will want the right to resort to its cotenancy remedies if the existing small store violation worsens, Messinger notes. After all, it doesn't want to be the only store operating in a dark center.

To protect your interests, let the tenant resort to a cotenancy remedy only if the existing small store violation remains uncured and the percentage of the center's GLA devoted to small stores that are open and operating at the time the tenant returns to full rent decreases by more than, say, 10 percentage points (known as the “Minimum Threshold” in our Model Lease Clause) for a significant amount of time—say, for six consecutive months, advises Messinger. And state that the only cotenancy remedy available in this situation is for the tenant to elect to terminate its lease, he says. You don't want the tenant to have the right to abate its rent in this situation; otherwise, you'll have to accept an abated rent for as long as another 12 months.

Give the tenant only a brief time (say, 60 days after the consecutive six-month period expires) to exercise its termination right. If the tenant exercises its termination right, the lease will terminate at a set time—say, 90 days—after the date of the tenant's termination notice. But give yourself an out if things improve. Get the right to cancel the termination if, during that 90-day period, the percentage of the center's GLA devoted to small stores that are open and operating increases to at least the same level as when the tenant returned to full rent, says Messinger.

Example: Assume the lease says a small store violation occurs when less than 65 percent of the center's GLA devoted to small stores is open and operating. At the time the tenant chooses to return to full rent, the small store violation continues to exist because only 62 percent of the center's GLA devoted to smaller stores is open and operating. At some later point, your center's occupancy worsens, so that for a consecutive six-month period only 48 percent of the center's GLA devoted to small stores is open and operating.

At the end of that six-month period, the tenant may exercise its termination right because, for more than a consecutive six-month period, the center's GLA devoted to small stores that are open and operating dropped by more than 10 percentage points. The tenant chooses to exercise its termination right. But during the 90-day period before the lease terminates, you rent to a few small stores so that 62 percent of the center's GLA devoted to smaller stores is now open and operating. As a result of your reaching the GLA level in effect when the tenant returned to full rent, the tenant's termination right is cancelled. The tenant can neither terminate the lease nor abate its rent.

Practical Pointer: A savvy tenant may demand that your right to cancel its termination right be limited to a situation in which the small store violation is completely cured, not just that it increases to at least the Minimum Threshold level, notes Messinger. That is, the percentage of the center's GLA devoted to small stores that are open and operating must increase to at least 65 percent in the example above—not 62 percent—for you to cancel its termination right. If the tenant has a lot of negotiating power, you may have to give in to its demand, he says.

CLLI Source

Stephen J. Messinger, Esq.: Partner, Minden Gross LLP, West Toronto, ON.