© 1992
by Jay B. ltkowitz, Esq. and Barry Gottlieb, Esq.
It is hardly a secret that the commercial real estate market is more depressed
than it has been in many years. This is the result of many factors, chief among
them being the present depressed condition of the New York State economy and the
glut of commercial space in many locations (notably New York City). The
condition of the real estate market has obviously enhanced the bargaining power
of commercial tenants in a variety of situations. It has affected relations
between landlords and tenants at mid-lease, and at the end of a lease, whether
or not the lease contains a renewal option. Moreover, market conditions have
affected the balance of power between landlord and tenant, both where the tenant
is financially distressed and where the tenant is in sound financial health.
The situation where the term of the lease is nearing expiration and the landlord
wishes to keep the tenant on is the situation where the tenant's bargaining
power is the strongest, whether or not the lease contains a renewal/extension
option. If the lease was negotiated when the commercial rental market was much
stronger, any renewal option is apt to offer the tenant the right to renew on
terms considerably less favorable than the terms the tenant could obtain if it
vacated at the end of its term and leased new space from a different landlord.
Obviously, in such a situation, the landlord's insistence on renewal according
to the terms contained in the lease will result in the tenant's decision not to
renew but to depart. So the net result is as if there were no renewal option at
all: the lease is about to expire, and if the landlord wants to keep the tenant
the landlord must offer the tenant a renewal or new lease that essentially
matches the terms the tenant could obtain from a different landlord. Of course,
each situation is different. A tenant's decision whether or not to stay on in
present space under terms that are reasonable (if not optimal) under present
market conditions may involve considerations other than simply the size of the
tenant's monthly rent obligation under the new or renewed lease: the location of
the present space, the costs, monetary and otherwise, of relocating, etc. And
there is also the human factor; where the relations between tenant and landlord
under the about-to-expire lease have consistently been good, and the landlord
has demonstrated a desire to accommodate and assist the tenant when minor
problems or needs have arisen, the tenant will be more inclined to stay with its
present landlord, all other things being approximately equal.
The present state of the commercial real estate market has also increased the
frequency and character of mid-lease renegotiations. If the present difficult
economic climate has caused the tenant's business to fall off considerably, the
tenant may no longer be able to pay the rent that it previously agreed to and
was able to pay. At that point, one of two scenarios is likely to occur. The
tenant, in arrears, may approach the landlord and ask for a renegotiation of the
lease, claiming that it can no longer meet the financial obligations it agreed
to earlier on. Or the tenant's failure to pay rent may cause the landlord to
commence a summary non-payment proceeding against the tenant, seeking recovery
of possession and as much of the arrears as possible. In either event, the stage
is set for a renegotiation of the lease in the middle of the term.
In the bargaining between landlord and tenant in connection with the possible
renegotiation of an ongoing lease, the landlord should insist early on that the
tenant produce current financials to support its claim of financial distress.
Once the landlord is satisfied that the tenant honestly can no longer meet its
leasehold obligations, various considerations will inform the landlord's
decision as to whether and how to amend the lease in the tenant's favor. If the
subject premises are retail space, the landlord may be motivated to grant
significant concessions to keep the tenant because empty retail space looks bad
and invites vandalism. Moreover, in a property consisting of many different
retail spaces, the loss of one tenant (particularly a major tenant) may
adversely affect the sales of remaining tenants (by reducing overall customer
traffic), thereby creating further difficulty for other tenants who are
themselves struggling, and discouraging prospective tenants of other spaces in
the same property from taking space. The financial strength of the landlord, and
the size of the landlord's tax and mortgage obligations for the property in
which the subject premises are located, are also relevant considerations; if the
landlord can itself ill afford an interruption of its cash flow, it may be
inclined to accommodate a financially distressed tenant in the hopes of
receiving a reduced but steady rental income, rather than risk collecting no
rent at all for an indeterminate period of time, and having to incur additional
expenses in simply trying to re-let. Once again, specific situations differ;
even in today's market, the landlord may, under particular circumstances, expect
to be able to re-let without great delay or expense. If so, the landlord will
have less incentive to accommodate a troubled tenant. The size and consistency
of the rent payments that the landlord could reasonably expect pursuant to a new
lease with a new tenant (assuming such a tenant could be found without undue
difficulty) would also obviously have a bearing.
There are ancillary factors bearing on a landlord's decision to renegotiate an
ongoing lease with a financially insecure tenant. The troubled tenant may years
before have deposited hefty security with the landlord, and if the security is
by and large intact, the landlord may deem it wiser to cut its losses, let go of
the tenant and partially recoup its loss by taking the tenant's security. Also,
if the tenant's obligations under the lease are guaranteed by a natural person
whose assets can be reached without undue difficulty, the landlord may decide to
hold the tenant to the original lease and sue the guarantor for the rent
payments which the tenant cannot make.
Of course it is not only the financially troubled tenant which may seek to
renegotiate its lease in mid-term; a strong tenant, aware that it is paying
above-market rates, may seek revision of its lease as a condition of continuing
its leasehold. Here, the tenant has leverage because dependable tenants are at a
premium, and the landlord may prefer a reduced but steady payment from a given
tenant to suing the same tenant after the tenant has broken its lease and
vacated - particularly if the tenant is a shell corporation from which assets
may disappear literally overnight. Once again, special circumstances may be
present. Does the tenant have a colorable claim that the landlord has materially
breached the lease, to the tenant's financial detriment? The landlord may prefer
to give the tenant a reduced rent if a lawsuit against the tenant for breaking
the lease will engender a valid and substantial counterclaim or independent
action against the landlord, or the assertion by the tenant of meritorious
affirmative defenses. (Of course, if the tenant does in fact have meritorious
claims against the landlord, the landlord should attempt to obtain a waiver of
such claims in return for a mid-lease renegotiation financially favorable to the
tenant.)
Where the tenant in good financial health seeks a mid-term reduction in its rent
because of changed market conditions, the landlord may be better advised to give
the tenant a long term rent concession rather than a simple reduction in rent.
The rent concession provision should specify that if the tenant defaults in the
timely payment of any charge of minimum or additional rent, the amount of the
rent concession shall immediately become due and owing to the landlord as
additional rent. This is an entirely reasonable negotiating point; the
landlord's agreement in principle to reduce the rent in such a situation is
premised on the expectation that this is a strong tenant which will be willing
and able to pay the adjusted rent throughout the remaining term of the lease; if
the tenant thereafter defaults in its obligation to pay the reduced rent timely
and dependably, it has forfeited its right to the reduction in rent, and
therefore the provision granting the rent reduction should permit the rent
reduction to be nullified if the tenant does not hold up its side of the
bargain.
It should be noted that whether a lease renewal is being negotiated or a lease
in mid-term is being renegotiated, if the landlord deems it necessary to make
substantial concessions to the tenant, the landlord may still be able to salvage
something of value. The chief topic in any such negotiation is likely to be
money in the most direct sense: the size of the tenant's rental obligation.
However, there are other aspects of a lease that may also be important to a
landlord. Negotiating a renewal or mid-term changes in the lease may give the
landlord the opportunity to seek and obtain changes in provisions of the lease
which do not relate directly to the size of the rental obligation, in return for
rent concessions or reductions. For instance, the landlord may want a clause
limiting the tenant's time to contest rent escalations, or increasing the
minimum rent and/or security upon the tenant's subletting the premises or
assigning the lease; if the landlord is prepared to make major monetary
concessions to the tenant, it is entirely appropriate for the landlord to ask
for seemingly minor changes in non-rent-related provisions of the lease.
Accordingly, in preparing for such negotiations, a landlord should review the
lease (with counsel) to determine what the landlord might desire and receive in
return for a reduction in the tenant's rental obligations. If the tenant's
entire focus is the size of its monthly rent bill, it may be willing to change
or add some non-monetary provisions.
The present condition of the rental market for commercial real estate poses a
challenge to the real estate/landlord-tenant bar. For tenants' attorneys, it is
a golden opportunity to materially improve the situation of clients who lease
commercial space. For landlords' attorneys, the challenge is to lessen the
unavoidable negative effects of present market conditions on their clients,
through competent and creative legal counseling, until there is a marked
improvement in those market conditions. When that improvement will occur, of
course, cannot easily be predicted.
Publications
Mid-Term Renegotiations and End-of-Term Renewal Negotiations of Commercial
Leases
INTRODUCTION
END-OF-TERM NEGOTIATIONS
MID-LEASE RE-NEGOTIATIONS
The Financially Distressed Tenant
The Financially Secure Tenant
Concessions to Landlord
CONCLUSION