Office Lease Resolution Strategies for a COVID-19 World
- Aug 19, 2020
The COVID-19 crisis has reshaped what it means to “go to the office.” Although most office tenants continued to pay rent at the beginning of the pandemic, many tenants are now reevaluating their ability to pay for space that few, if any, people are using. As a result, rent relief requests and workouts are surging. With this in mind, office landlords should carefully consider the following best practices while navigating these uncertain times.
Carefully review the lease
Evaluating any rent relief request must start with a review of applicable lease language. Most well-drafted leases will not allow tenants to withhold rent because of pandemics or other force majeure events, giving landlords leverage. However, tenants enjoy various legal arguments to avoid paying rent despite unfavorable lease language, so landlords should not overplay their hands without consulting counsel.
Determine if the tenant is an essential business
Each state defines “essential businesses” that can remain open despite lockdowns differently. Landlords should familiarize themselves with essential business categories and be cautious before granting rent relief to an essential business largely unaffected by the pandemic.
Request financials and insurance
Most well-drafted leases require a tenant to periodically provide the landlord with details about its finances. Landlords should invoke such reporting requirements before considering rent relief requests. Even if a lease does not explicitly require such disclosures and because the tenant is requesting a lease concession, a landlord should condition rent relief upon receipt of financial information from the tenant and any guarantor. In addition, landlords should consider requesting updated business plans, credit checks, and sales information.
This financial information will dictate whether rent relief is warranted. Rent relief should not be granted to tenants that can pay their rent. On the other end of the spectrum, tenants unlikely to survive the recession should not be granted rent relief.
Landlords should also request copies of any business interruption insurance policies carried by tenants. Such policies generally exclude risks associated with pandemics, but tenants that have pandemic protection should rely on their insurance for financial assistance.
Rent deferment versus abatement
If rent relief is warranted, landlords should generally defer rent due rather than abate (i.e., forgive) the rent. Deferred rent should be repaid under a payment schedule that takes into consideration the tenant’s current and expected economic viability. To minimize collection risk, tenants on shaky economic footing should not be given long periods of time to repay deferred rent.
Some tenants are requesting reductions in reimbursable operating expenses, arguing they are not using the space, so such expenses should be lowered. Landlords should remind tenants that although occupancy is down, taxes and insurance costs remain the same, and increased cleaning costs are being incurred. Any reduction in operating expenses will ultimately be reflected in the annual expense reconciliation process.
Consider workout solutions other than rent relief
Landlords may employ strategies other than rent relief to help ailing tenants. For example, tenants may be permitted to reduce their premises or relocate to cheaper space. Operating expense reimbursements can be restructured or eliminated. For tenants in the process of moving, allowances can be increased or rent commencement dates extended.
Concessions to landlords
The landlord should evaluate the lease concessions it wants in return for any rent relief granted. Tenants should waive legal defenses to the enforcement of the lease arising from the pandemic and related government intervention. Landlords may require tenants to post an additional security deposit or provide a personal guaranty or letter of credit to secure future lease obligations.
Many landlords are requiring more robust financial reporting provisions. Importantly, tenants can be asked to waive existing lease termination rights, extension or expansion options, signage rights, parking rights, exclusive use covenants, operating expense caps or other rights that adversely impact landlords’ operations and leasing efforts. Many landlords require tenants to extend lease terms and waive all known and unknown claims against the landlord.
It is important to remember that landlords providing rent relief to tenants should get something in return. Rent relief amendments are an opportunity to “fix” leases, making them more favorable to landlords in the long term.
Rent relief amendments should require tenants to seek available government financial incentives, and tenants should be required to use such funds to pay deferred rent to the extent permitted by law.
All communications with tenants must emphasize that any rent relief is conditioned upon the full execution of a lease amendment. Some landlords even require tenants to sign pre-negotiation agreements before entertaining serious rent relief discussions. All rent relief and landlord concessions should be documented in a lease amendment.
If granting rent deferment, landlords should consult with counsel to minimize the risk that deferred rent receives unfavorable treatment in any bankruptcy proceedings. Similarly, counsel should be consulted for any waiver of tenant rights and remedies.
Many real estate loans require landlords to obtain lender approval of lease amendments, particularly lease amendments that affect rent due. Landlords should confirm lender approval rights, if any.
Beware of discrimination
In considering rent relief requests, landlords should not discriminate against tenants based on their—or their employees’—race, age, gender or other protected status. The rent relief evaluation process should be uniform across the tenant base.
The pandemic is unprecedented in so many ways, making it difficult to handicap how courts and juries will react to landlord-tenant disputes in the years to come. Landlords should be reasonable with tenants, recognizing that the economic fallout of COVID-19 is a shared problem. Piggish landlords and well-heeled tenants looking to capitalize on the pandemic to obtain rent relief will unlikely be treated warmly by courts seeking just results.
Landlords will be well-served helping viable tenants survive the pandemic while focusing on collection efforts against those tenants unlikely to make it through the recession. Employing the best practices referenced above will help landlords navigate mounting rent relief requests in an effective, strategic manner.
Specializing in the acquisition, development, financing, leasing and disposition of commercial real estate assets, Fernando Landa is a partner in the real estate and workout groups of Crosbie, Gliner, Schiffman, Southard & Swanson (CGS3), a commercial real estate law firm.