Staying Power: Negotiating Lease Amendments During COVID-19
This article is based upon several Model Documents addressing commercial lease negotiations, just a few of the more than 70,000 resources available in Practical Law.
Whether due to floods, tornadoes, hurricanes, or rioting, major business disruptions happen. COVID-19 is but the most recent — and most widespread — example. As businesses everywhere learn to navigate the serious, long-term business challenges imposed by COVID-19, many are evaluating whether and how to renegotiate the terms of their lease.
Some businesses have experienced unforeseen revenue declines and are in danger of defaulting on their leases. Other businesses are finding the shift to remote work has radically changed their needs for office space and are attempting to renegotiate or break their leases.
The tenant's perspective
Though going to court is always an option, landlords and property managers are often willing to discuss amendments to a lease before resorting to litigation.
If anything, the circumstances forced upon landlords and tenants during the COVID-19 pandemic have put tenants in a stronger negotiating position than usual. Finding new tenants in some areas has become almost impossible during the pandemic and going to court is difficult when the courts are closed or governments have imposed moratoria on eviction actions. The existing tenant may well be the only game in town.
Still, commercial real estate leases tend to favor landlords and every market and legal jurisdiction is different. Any general counsel assessing the company's options would be wise to retain a real estate attorney who is familiar with the local real estate market and court system and can assist with negotiations — and litigation if necessary. Fostering a relationship with a local real estate broker is also advisable because they are likely to know which concessions tenants are able to get within that market.
The landlord’s perspective
Most landlords have financed the purchase of their properties, so when a tenant fails to pay rent, the landlord is essentially forced to pay the mortgage on the property out of its own pocket. During negotiations, then, the landlord’s primary concerns are maximizing the rent stream and avoiding defaulting on their own loans.
Most landlords would rather avoid the trouble and expense of finding a new tenant or going to court — but then again, most landlords are no strangers to a court of law and are not shy about pressing their legal rights, especially if the tenant makes demands that are unworkable for the landlord.
Review the lease
The tenant's options vary, depending on the circumstances of the business and the willingness (or ability) of the landlord to renegotiate, but they all begin with a close reading of the lease itself. The tenant needs to understand what its current obligations are so that it can assess what amendments need to be made.
Similarly, the tenant should understand any rights it may have under the lease. For example, the lease may give the tenant valuable termination or renewal rights that can become bargaining chips or the lease’s force majeure clause may contain language that excuses or delays the tenant’s obligations, providing useful leverage.
Assuming the business doesn’t actually want to break its lease and just wants a reduction in rent or some other type of concession to allow the tenant to continue with business, the most important thing for a tenant to do is open up a line of communication with their landlord or property manager.
Although a phone call might be a useful first step, the tenant should draft a pre-negotiation letter or term sheet that explains how the business is being affected by COVID-19 restrictions, what outcome the tenant is looking for — rent reduction, space reduction, permission to sub-lease, etc. — and how the business plans to continue generating revenue.
The goal of a pre-negotiation letter is to establish communication and lay the foundation for future discussion. The letter itself should contain specifics that include:
- Precisely how COVID-19 is affecting the business. Examples would be revenue losses from shut-downs, lack of foot traffic, inability to deliver services, or moving to a mobile workforce.
- What the business has done so far to mitigate revenue losses.
- A general indication of the concessions the tenant is seeking.
- Steps the business plans to take in order to minimize the time necessary to restore its ability to pay rent in full.
- An invitation to discuss the matter further.
Once the letter is sent, the landlord may or may not be willing to negotiate. If the landlord is willing, the landlord’s lawyer will likely respond with a letter defining the nature and purpose of the discussion. That way, a framework for negotiations is established.
The landlord will usually ensure that matters under discussion are non-binding unless and until a new agreement is signed. This means that it is important for the tenant to continue meeting the rent obligation (to the extent possible) until a new agreement or lease amendment is signed. The tenant remains bound by the existing lease and most commercial leases do not excuse a tenant from paying rent even if the business is forced to close.
If a landlord is open to modifications of the current lease, the next step for tenants is to determine what the goals of the negotiation should be and what an acceptable outcome might look like.
The following is by no means a comprehensive list of possible options to consider, because commercial real estate law is full of nuances and exceptions that may or may not apply in any given circumstance. The following are some of the most common points of negotiation.
During the COVID-19 pandemic, landlords may be open to a partial reduction, or even a full abatement, of the rent while stay-at-home orders and other restrictions continue to impact the business. Replacing a tenant can be time consuming and expensive for landlords, so temporarily reducing a tenant’s rent is often the most cost-effective option.
Landlords are also more likely to respond favorably to tenants that have not missed any prior rent payments, as well as businesses that have a solid plan to quickly regain their footing and resume paying rent in full.
Rent deferral differs from reduction or abatement in that the tenant still has to pay rent, but the payment is delayed or deferred to a later time. The deferral can take many forms — a lump sum, gradually increased payments over time, or an extension of the lease — but during COVID-19, deferral can give a tenant time to weather the pandemic without reneging on their rent obligations.
Most commercial leases contain some provision allowing the tenant to sublease its premises with the landlord's permission. Negotiating for expanded rights to sublease some or all of the premises may permit businesses to potentially relieve themselves of some of their lease costs while also ensuring that the landlord receives the rents due to them.
Landlords may be concerned that the tenant will compete with the landlord's own efforts to find other tenants, so there will likely be some negotiation as to how much flexibility the tenant should have. However, if a business cannot sustain itself and the lease can’t be broken, subleasing may be a viable option that gives both parties a reasonable way forward.
Different businesses have been impacted by the pandemic in dramatically different ways. Many businesses cannot operate their business at all and have no use for their premises. For some, a more mobile workforce has significantly reduced their need for office space. For others, the need for ample room to social distance has increased their need for office space. Some fields, such as medical offices or warehouses, have substantially increased space needs.
Either way, if optimizing the business’s current space to meet its future needs is a priority, a number of issues may arise. Costs associated with converting a space for safe social distancing, additional operating expenses for COVID-related sanitation, the need to sub-lease a portion of the space — all are issues that may need to be discussed.
Find out what concessions, if any, tenants in the same building have negotiated and research the general rent-reduction trends at properties in the immediate area. Again, a local real estate broker can help identify market trends and other factors that may strengthen a tenant’s negotiating position.
On balance, real estate contract law favors landlords unless the language in a contract — such as an applicable force majeure clause — specifically addresses the situation facing the tenant. To keep the matter out of court, tenants should be honest with their landlord about the business’s economic situation, negotiate in good faith, and come prepared with a plan that includes best- and worst-case scenarios.
The eventual solution may be a blend of solutions and arriving at an acceptable compromise may depend upon a deep understanding of the local real estate market and business climate.
Therefore, whatever course negotiations take, it’s essential for GCs to consult a local real-estate attorney for help and guidance in understanding all the possible obstacles, as well as the opportunities available to overcome them.