Legal Insight Special Section
By Jeremy Syz
It is late on a Friday afternoon. You have been dealing with month-end collections all week and are looking forward to the weekend to get out of town. After a knock at your office door, your bookkeeper steps in, looking more frantic than usual.
Times have been tough, but he has always managed to find a way to make your suppliers, vendors and creditors happy. Something tells you this time is different. “Boss,” he says, “our rent is due next week. We don’t have the money. We can’t pay.”
For many tenants, the inability to pay the rent may seem like the end of the road for the business. However, in many cases, all is not lost. Just as business owners continue to face financial hardship, the same is true for landlords. Indeed, in many markets, simply having tenants who occupy a space and bring customers to a commercial property is now at a premium.
Five years ago, landlords had the upper hand, and swiftly moved to evict tenants who failed to pay rent. Today, landlords are often willing to work with existing tenants and keep them in place to avoid the prospect of darkened store fronts and empty parking lots. Landlords are also more eager to avoid costs associated with finding a new tenant, negotiating a new lease, and paying for brokerage commissions and tenant improvements, not to mention the cost and uncertainty associated with an empty space until a new tenant is found.
A cash-strapped tenant may find that its landlord is willing to help keep it in place, even if that means making concessions under the lease. For a tenant who foresees an impending inability to make rent payments, there may be options to keep the lights on and the doors open.
Setting the Stage
Before a tenant approaches a landlord to discuss modifications to a lease, the tenant should first closely examine its own financial capacity and assess the long-term viability of its business. Lease concessions are a moot point if the tenant’s business simply isn’t going to survive. However, if the tenant is merely experiencing short-term cash flow problems, but otherwise has a viable business, a tenant is well advised to focus on its business fundamentals, the reputation and integrity of its owners, and its motivation to return the business to profitability.
By affirmatively seeking to prove to a landlord that a tenant and its business is deserving of concessions, a landlord may be convinced that the tenant is worth immediate rent relief or other lease concessions.
As an opening salvo, a tenant may want to consider reducing the size of the leased premises, along with a commensurate reduction in rent. This proposition is most appropriate for a tenant whose business has experienced a contraction that is not expected to reverse soon. A tenant may be well-served to “right-size” its space to reflect its current requirements. Just as baby boomers move from four-bedroom homes into two-bedroom condos, so too should a commercial tenant consider renting space that fits its business model and demand.
Because customizing office spaces in modern commercial buildings can be done with relative ease and little expense, this may be an attractive alternative to both the landlord and the tenant alike. Alternatively, a tenant whose lease requires the business to be open during specified times could explore the possibility of reducing the required hours of operation to profitable times, thus reducing overhead costs.
While at first blush, a cash-strapped tenant may balk at providing the landlord with additional collateral, often a tenant may be able to do so with a minimal additional outlay of cash.
One method by which a tenant may be able to provide additional collateral is to offer the landlord a security interest in the tenant’s property. Unlike many states, Colorado does not grant the landlord a statutory or common law lien on the tenant’s property. Rather, this lien must be expressly granted, and many leases do not contain such a provision.
Depending on the type of lease, and the extent of the tenant’s property, this type of security interest can potentially be of great value to the landlord. Particularly for equipment-intensive businesses, granting the landlord a security interest in the tenant’s equipment, fixtures and other business property may allow the landlord to hasten the transition of the space upon a future default by the tenant.
Depending on the tenant’s type of business, this could allow the landlord to offer a new tenant “turn-key” premises, with all of the equipment and fixtures necessary to operate a business. While the upfront cost to the tenant to provide this security interest is minimal, a tenant will want to carefully describe the collateral and avoid giving the landlord a security interest in more collateral than is intended.
Often, commercial leases will not address the ownership of tenant improvements, and whether the tenant or landlord owns those improvements. An opportunity exists for the tenant when there is ambiguity in this respect. If the lease does not provide that leasehold improvements are the property of the landlord upon installation, the tenant’s creditors may have the ability to place a lien on those improvements.
A landlord does not want to find itself in the position that the tenant’s judgment creditor has a lien on the tenant improvements. Therefore, a tenant may consider offering the landlord an amendment to the lease that provides that the tenant improvements are the landlord’s property, thus eliminating the potential that the landlord’s building could become subject to a lien by the tenant’s creditor.
A tenant’s owner may also consider offering a personal guaranty of the tenant’s lease obligations if it has not already been required to do so. A defaulting tenant is only as valuable as the assets it owns, and then only after a successful lawsuit by the landlord seeking to enforce the tenant’s obligations under the lease. However, if the tenant’s owner has assets of its own other than the business, a tenant’s owner may be able to offer the landlord a guaranty of the tenant’s obligations under the lease.
To reduce the risks associated with this guaranty, the party offering the guaranty will want to carefully negotiate the terms. Reducing potential exposure under a guaranty can be accomplished in a number of ways, such as limiting the obligations that are guaranteed, requiring the guaranty to “burn off” upon the occurrence of specified events, such as when the tenant meets certain financial thresholds, or after the tenant has timely paid rent for a specified period. A tenant contemplating a guaranty may also want to consider offering a larger security deposit in exchange for a reduction in rent, thereby providing the landlord with additional security while minimizing potential exposure under the lease.
The tenant may also consider requesting that rent be paid in either longer or shorter intervals. While monthly rent payments are standard, there is nothing that requires this to be the case. For example, a tenant may be able to negotiate for a rent deferral period in exchange for longer periods of prepaid rent thereafter, thus giving a tenant additional working capital to make it through a particularly difficult period.
Alternatively, a tenant may be able to negotiate a reduction in rent in exchange for shorter rent periods, such as weekly or bi-weekly payments. A tenant should be aware, however, that a landlord may be precluded from agreeing to these terms by the landlord’s lender, who typically prohibit the landlord from collecting rent more than one month in advance or reducing rent without the lender’s consent.
A tenant may also explore the possibility of offering the landlord a stake in the tenant’s success. A landlord may be willing to offer significant concessions if the tenant offers the landlord either an equity stake in the tenant’s business or rent measured by a percentage of the tenant’s future revenues. Of course, the value of either of these propositions will depend on the likelihood of the tenant’s success. It is therefore to the tenant’s advantage to demonstrate to the landlord how the tenant’s business is likely to succeed if the landlord offers the tenant current rent concessions.
A struggling tenant may also be able to negotiate additional flexibility in the assignment and subletting provisions of a lease. Typically, a lease will provide that a tenant may not assign or sublet without the landlord’s prior consent. Having the ability to assign or sublet a lease to a viable business may give a struggling tenant an “out.” A landlord will likely be more receptive to these provisions if the subtenant is required to prove its financial capacity and meet certain financial thresholds. However, for a struggling tenant, the ability to sublet may greatly reduce the potential exposure under the lease.
The goal of any negotiation with a landlord is to keep a tenant in its space until it can emerge from a temporary cash flow shortfall. A tenant is well advised to carefully prepare for this negotiation to be able to paint itself in the best possible light, to determine the critical lease terms to be negotiated, and to figure out what the tenant may be able to offer in return for the landlord’s concessions. The success of this negotiation may determine whether or not the tenant is able to keep the lights on and the doors open.