Tenant Leasing Illustrated July 2020 Cats and Dogs and Future COVID Leases

Hello,

At some point soon, we will all get back to “normal” (whatever that may ultimately mean) and leasing and subleasing will move forward. When that happens, tenants and landlords will need to figure out how COVID-19 or other pandemics should be addressed in future leases.

In today’s issue, we provide seven suggestions regarding how to handle a pandemic when structuring a new commercial lease.

Sincerely,

Alan Katz
Mintz & Gold LLP

Cats and Dogs and Future Covid Leases
Everybody seems to be getting a COVID-19 dog.

At one point it was impossible to find toilet paper, now exercise equipment, bicycles and yes, puppies, have gone missing.

Our son Noah and his roommates, ever the contrarians, have adopted a kitten (see too adorable pictures below).

Naturally, that led to naming suggestions from his siblings. So far, Luke Skywhisker, Cat-shis Clay, Purrrrrnest Hemingway and Meow Zedong seem to be leading the pack.

But Noah and his roomies should realize that cats are not dogs.

Jason Gay, WSJ sportswriter, no doubt bored with no sports to cover, looked at sheltering at home from the perspective of a dog and a cat.

Your cat (sort of) loves you but has had enough and wants you out of her house and back to work.

Your dog, on the other hand, is more concerned with public health and also all the extra walks, fetch and company. She is thinking you should never go back to work.

To the relief of your cat and disappointment of your dog, office and retail tenants are starting to reopen.

Yet it may be a long time until we truly get past the virus and even then getting back to normal may not be so normal.

There will be large differences by region, since a suburban office park is more manageable than a city skyscraper.

Many office tenants may find that their workers prefer stay-at-home flexibility and that they can survive with less expensive space. Many retail tenants will require substantial changes in the leasing cost structure.

Commercial tenants are now trying to figure this all out and eventually leasing and subleasing will move forward.

How should COVID-19 or other pandemics be addressed in future leases?

Tenants will want a better resolution under their leases in the event of a resurgence or another pandemic and no tenant will want its lease to commence when restricted by a pandemic.

Some clients have proposed rewriting the force majeure provisions of their leases to excuse the payment of rent.

Nice idea from the tenant’s perspective, but landlords have mortgages, operating expenses and taxes to pay and are unlikely to agree.

Naturally, what can be achieved will be based on leverage and generally only larger tenants will be able to make substantial structural revisions since landlords will object to anything that interferes with the payment of rent.

Landlords are also more likely to be sympathetic to retail tenants who cannot operate without being open for business (or tenants in similar situations who cannot run their businesses remotely, such as dentists or exhibition spaces).

Still, all tenants should be discussing these issues with their attorneys and brokers as we navigate new circumstances.

Make sure you are not barking up the wrong pandemic tree on your next lease and channel your inner Winston Purr-chill by considering the following seven suggestions:

  • Swing for the fences. Although a long shot, you could try revising the force majeure provision and provide that if you cannot open your business at the beginning of the term or must close your business during the term due to a pandemic or related governmental order, you will be under no duty to stay open, pay rent or perform any construction or repair obligations during the pandemic (even if begun but not completed). You may need to include a termination right for both parties if the pandemic restrictions are not lifted by a certain period of time.
  • Address commencement date. With a new lease you should be able to negotiate a push back of your commencement date if COVID-19 or a future pandemic does not allow you to open. Particularly in today’s climate, tenants have greater leverage on a new lease and this is not unreasonable.
  • Focus on build out. The build out of your space may be delayed by breaks in the supply chain or contractor delays.
    • If your landlord is providing a turnkey build out, it will require extensions for pandemic related delays but make sure this does not result in holdover charges in your current space. These pandemic extensions should be narrowly drafted with an outside “fail safe” date by which you can terminate the lease if the work is not completed.
    • If you are responsible for the construction, be sure that you are entitled to extensions so that you do not have to pay rent on space you cannot yet use or do not lose anticipated “free rent” (again with an outside termination date).
  • Real Estate Tax Base Year. We have previously discussed how your base year should reflect a fully stabilized and assessed building (i.e., not be artificially low), a concern if your building might experience reduced occupancy because of COVID-19. If the potential increase in value once the building occupancy recovers is not reflected in your base year, you will have exposure for large future real estate tax escalations. There are methods to set the base year once the building is fully assessed or to tie increases to comparable buildings.
  • Consider deferment. A deferment of some rent with payment over an extended time period may be the most equitable solution to a pandemic today and in the future. Provide that if at any time during the term there is an ongoing pandemic that causes you to be unable to operate your business and you actually vacate (a constructive eviction standard used in abatement clauses), then you may defer your rent for some period of time, possibly with an interest factor. This structure has not to date been subject to negotiation and it is unclear how landlords will respond, but this is certainly an avenue worth pursuing.
    • The amount of deferred rent will need to be negotiated (e.g., three, six or even twelve months).
    • You will need to determine whether the deferral covers all of your rent or some percentage of rent (e.g. 75%, 50%). You also might defer fixed rent but agree to remain obligated to pay escalation rent (operating expenses, CAM and/or real estate taxes) to cover your landlord’s fixed costs.
    • You will need to determine the repayment of the deferred rent, e.g., deferred until the end of the term or perhaps amortized over some period of time once the pandemic is under control and your business is back up and running.
  • Percentage Rent. Provide that during a pandemic that prevents you from operating your retail business that you will pay percentage rent (i.e., based on a percentage of your gross receipts) in lieu of fixed rent. Retail tenants in shopping centers generally pay the bulk of their rent on a percentage basis and perhaps this should be true under all circumstances for street retail too. This arrangement makes the landlord something of a “partner” and would make your rent line up with your revenue.
  • Broadly define “pandemic restriction”. In all of the scenarios outlined above, you should cover as many situations as possible that might adversely affect your business including a pandemic that (i) requires or recommends that employees of non-essential businesses stay at home and not be physically present in offices in your geographic area, (ii) limits the number of persons that can be physically present in any office or building or that can otherwise congregate in public spaces, (iii) limits public transportation or other traffic or movement of people in, to or from your office or (iv) otherwise restricts or advises against the movement or congregation of groups of persons.

Noah and his roomies seem to be leaning toward “Mookie” as the name for their new housemate (I hold myself responsible for making my own kids Mets fans). I was kind of partial to Feline Dion. Any of our readers truly bored enough to have made it this far in the newsletter may have enough time on their hands to suggest better names than Mookie. Let us know and the winning entry will win, well, the satisfaction of knowing they have saved an innocent a young kitten from a lifetime of bad Mets jokes. Considering the suggestions above may also save you from another pandemic nightmare under your next lease.