Phase In Operating Cotenancy Clause if Center Has Many Vacancies

Issue to Negotiate

A prospective retail tenant demands that you add an operating cotenancy clause to its lease, so that it could, for example, pay a percentage of gross sales instead of minimum rent and percentage rent if less than a certain number of anchors or a certain percentage of the smaller store spaces are operating. If your center has many vacancies (whether because it's new or undergoing major renovations, or it has been hit hard by tenant bankruptcies and vacancies), should you give in to the tenant's demand?

Owner's View

If your center already has vacancy problems, you don't want to give in to the tenant's demand for an operating cotenancy clause. It's not fair to impose the tough requirements of such a clause on you when the tenant knows going into the lease that the center has vacancy problems—but still chooses to sign a lease for space at the center, notes Chicago attorney Ellen B. Friedler. And with vacant space already a problem, you may be in violation of the operating cotenancy clause's requirements at the start of the lease. Then you'll have to contend with not just the vacancies but with the tenant's being able to exercise its remedies in the cotenancy clause against you. The resulting loss of rent, plus the existing vacancies, could end up sinking your center, she warns.

Tenant's View

The tenant will say that it understands that you need time to fill—or refill—your center. But it will argue that it needs to protect itself if you can't do this. Without an operating cotenancy clause, the tenant risks paying a lot of rent to stay at an undesirable location.

Compromise: Increase Requirements over Time

If you're willing to compromise with the tenant, Friedler suggests using this approach: Agree to give the tenant an operating cotenancy, but rather than agreeing to satisfy tough requirements right off the bat (particularly since you probably won't meet them), set out less onerous requirements to satisfy at the start of the lease. Give yourself time to lease up the center by gradually increasing the cotenancy requirements over time, she says. This way, the tenant winds up getting the full protection it wants, while you get time to fill up the vacant spaces without having to worry about the tenant's exercising its cotenancy remedies, she explains.

Tenants that are aware of the vacancy situation at the center and still choose to sign the lease will often accept this “ramping up” of the requirements, says Friedler.

Example: Suppose the tenant wants an operating cotenancy clause that requires that 65 percent of non-major stores must be open and operating at the center. If your center is being renovated and is only 50 percent leased, you can compromise with the tenant by agreeing that during the first year of the lease, only 45 percent of non-major stores must be open and operating. Then in year two, 55 percent of non-major stores must be open and operating. In year three, increase the percentage to 65 percent of the non-major stores.

Add Lease Language

You can use this compromise by adding the following language to your lease's operating cotenancy clause, says Friedler: CLLI0069

Model Lease Language

a. For purposes of this Paragraph [insert #], the “Non-Major Stores Operating Requirement” shall be deemed to be met if the Required Percentage (as defined in paragraph b below) of the gross leasable area of the Shopping Center (excluding the gross leasable area occupied by Major Stores) is open and operating.

b. For purposes of this Clause, the phrase “Required Percentage” shall mean:

(i)[insert #]% for the first lease year;

(ii)[insert #]% for the second lease year; and

(iii)[insert #]% for each lease year thereafter throughout the Lease Term.

CLLI Source

Ellen B. Friedler, Esq.: Partner, Neal, Gerber & Eisenberg LLP, 2 N. LaSalle St., Ste. 2200, Chicago, IL 60602; (312) 269-5242; efriedler@ngelaw.com.