Restructuring When Leases Falter

Restructuring When Leases Falter

“These are the times that try men’s souls,” wrote Thomas Paine, beginning 1776’s influential The Crisis.  It’s a sentiment painfully familiar to  both Landlords and Tenants, whose patience, good humor, and financial wherewithal have been sorely tested lately.  Despite everyone’s best intentions, in times like these, some Tenants can’t pay their current, contractual rents, based as they are on projections from an earlier, more robust economic environment.  As a result, a Tenant will sometimes seek to restructure his commercial lease, resulting for at least some period in a lower rent.  If a lease restructuring becomes necessary, how does a Tenant go about it, and what can he expect?  Should a Landlord agree, and if so, what should he require?  After all, a deal is a deal, trying times or not.

 

            Consider the motivation of each.  A Tenant’s goal is, well, survival, at least in the short run.  Sure, Tenants don’t get into a retail business, be it burgers, bagels, or bicycles, to break even.  But given the grisly alternative – default, legal pursuit of personal assets, and sometimes bankruptcy – just getting by in recessionary periods is clearly preferable to outright failure.  For Landlords, the goal is largely the same as always:  securing a rent-paying Tenant.  Neither do Landlords get into their business to give spaces away and create negative cash flow.  No one, including every Landlord I know, likes working for free.  But a sudden and disruptive vacancy costs time and money, and sucks life and energy from a shopping center, weakening the entire enterprise.  If a Tenant’s business is salvageable, it’s frequently in the Landlord’s interest to help through the lean times.  What to do?

 

            First, the Tenant should notify the Landlord in writing that his business is faltering through no fault of his own, and request to renegotiate lease terms.  Here the Tenant must demonstrate real, actual need, and not merely a desire to pay less (there are plenty of opportunists afoot, seeking to exploit Landlords’ economic vulnerabilities, perceived or real).  The Tenant will need to provide:  1) relevant financial statements for at least the past couple years, showing the business’ erosion; 2) evidence of a robust marketing plan, indicating the Tenant’s efforts to succeed; 3) a restructuring plan describing what the Tenant will do differently to make the business successful again; and 4) whatever else the Landlord may require to properly consider, and hopefully agree to, the restructuring. 

 

The Tenant should be as specific as possible:  what kind of concession does he seek, structured in what manner, for how long, and why?  It’s not enough to simply cry, help!  The Tenant should think it through, and tell the Landlord with the greatest specificity what he needs to be successful again.  With that information, the Landlord will gauge the Tenant’s long-term viability and decide what, if anything, to do to help rehabilitate the Tenant’s business.  That’s the Landlord’s goal:  a reasonable expectation that, by temporarily reducing his return on investment, he’s securing a more stable long-term Tenant. 

 

The Landlord can, and should, have requirements of his own, and the Tenant should expect and be prepared to give up something in return for the Landlord’s forbearance.  The Landlord may require that any abated rent is paid back, likely through higher rents at some future point, or the addition of percentage rent, where a certain percentage of profits is paid in addition to the base (per square foot) rent.  The Landlord may seek to remove any special lease provisions, like an exclusive right to operate a certain type of business or restrictions applying to other businesses, to remove a previously agreed upon option period, adjust a future base rent, or to shorten or lengthen the lease.  But the Landlord will want something, and properly so.

 

A Tenant’s earnestness is vital.  No Landlord in his right mind would restructure a deal if the Tenant is simply tired, disinterested, uncreative, or insufficiently hardworking.  I have seen Landlords show real flexibility and even kindness to earnest, hardworking Tenants nonetheless struggling to make a go of it, and real teeth to lazy, insufficiently engaged Tenants who want to make their own shortcomings the Landlord’s problem, too.  Good for the Landlord, on both counts, and good for the earnest Tenant, working like the dickens in what for most of us is the most challenging economic environment of our lives. 

           

 

            David S. Redmond is a Retail Sales and Leasing Associate at Divaris Real Estate and a member of the Virginia Beach Planning Commission.

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