On Monday, the Seattle City Council passed Resolution 31940 calling on Governor Jay Inslee, federal legislators, and the Trump administration to impose an immediate moratorium on residential and commercial rent and mortgage payments. This resolution brings to boil an issue with which many commercial landlords (particularly of non-essential retail, restaurant, and office space) have grappled for weeks – how to provide practical relief to their tenants facing government-imposed restrictions on travel and business while continuing to meet their own financial and operational responsibilities. Below are strategies, from a general leasing perspective, that every commercial landlord should consider when navigating these uncharted waters.
Rent Deferment vs. Rent Abatement. As a result of government-mandated social distancing measures, and closures for businesses deemed to be non-essential, many tenants do not currently have the income stream to meet their rent payment obligations, and have turned to their landlords for temporary relief. This relief usually takes the form of a rent abatement or a rent deferment and, in either case, a landlord will need to determine to what extent rent abatement or rent deferment will extend to sums other than fixed, minimum base rent.
Relief in the form of rent abatement is akin to a “free” rent concession that a landlord will often use to incentivize a tenant to enter into a new lease or to negotiate a lengthy extension; in this scenario, the “free” rent that a tenant enjoys for the first few months of a lease term is not repaid by a tenant except in the event of a default or early termination. Similarly, in the current environment, a landlord may agree to abate rent for the period of time that a tenant is unable to operate its business due to government-mandated “stay-at-home” orders or the like, with the tenant having no obligation to repay the abated sum unless it otherwise defaults under the terms of the lease. This form of relief may be more appropriate for tenants who were already in distress prior to any government-mandated social distancing or closures went into effect, or for tenants that may have been financially sound before the outbreak of COVID-19 but for whom repayment would, as a practical matter, be impossible even after the virus subsides and normal business operations resume. For those tenants, one or two months of abated rent may go a long way towards withstanding these unprecedented times and re-opening for business once governments lift their orders mandating closures.
On the other hand, relief in the form of rent deferment requires the landlord and tenant to negotiate not only the period of time during which rent will be deferred, but also the period of time that the tenant will have after the deferment period to repay the deferred amount. To the extent possible, the frequency of repayment (e.g., monthly, bi-monthly, or in one lump-sum), and whether interest will be charged on the deferred amount, should be agreed upon in writing at the outset.
Whether the rent abatement or rent deferment approach is selected, landlords should set clear expectations with respect to the following:
- In the context of a triple-net lease, what rental obligations are being abated or deferred? While a landlord may be amenable to an abatement or deferment of fixed, minimum base rent, it may not be amenable to extending the same relief to a tenant’s obligations with common-area expenses, taxes, or insurance, as the landlord will need to continue to keep its property in a good and safe condition, pay its real property taxes, and keep its buildings and other improvements insured (whether or not its tenants are open for business).
- How much rent is being abated or deferred? In some cases, landlords may feel the need to abate or defer 100% of rent payable, while other landlords may feel comfortable abating or deferring 50% or some other percentage of the rent payable.
- What remedies are available if there is a separate and distinct default by the tenant under the lease during the period that rent is being abated or deferred? What remedies are available if, in the context of a rent deferment arrangement, a tenant fails to make any regularly scheduled repayment installment? Most landlords will want to include some sort of option to accelerate the sums abated or deferred, if nothing else as a continued incentive to its tenant to remain current on its overall lease obligations.
Security Deposits. In the event a landlord agrees to abate or defer the payment of rent, to what extent can a landlord rely upon a security deposit to make itself whole? The answer to this question depends in large part on the language of the lease. Many leases provide that a landlord may draw upon a security deposit in the event that the landlord incurs costs to cure a tenant default. In these situations, landlords should take caution in drawing upon a security deposit, particularly if the agreement reached with a tenant does not characterize the tenant’s payment of a lesser amount of rent (or, in the case of a complete rent abatement, tenant’s option not to pay any rental amounts at all) as a payment default acknowledged, but waived, by landlord.
Ratification of Lease Terms. In exchange for providing relief, commercial landlords should consider whether to require a commercial tenant to ratify the terms of a lease and acknowledge that no default by the landlord currently exists under the lease. While it is vitally important that we, as an industry, find creative and practical solutions to help both landlords and tenants weather this storm, the relief requested in many instances is substantial, and, accordingly, landlords should use the relief provided to protect themselves from future claims by tenants.
Documentation. Finally, and perhaps most importantly, landlords should ensure that the agreement for relief reached with their tenants is reduced to writing and otherwise complies with the terms of the lease. At its very core, the relief discussed above is simply a lease modification, the concepts of which have undoubtedly been used countless times to provide relief to a struggling tenant well before the global pandemic in which we now find ourselves. To that end, the agreement you reach with your tenant should be reflected in an amendment to their lease. We understand, however, that the current strains on society make it such that a lease amendment may not be the most efficient or practical solution. Whether in the form of an amendment, letter, or other instrument, there are several major documentation goals that landlords should keep in mind:
- Any relief agreed upon with your tenant should be reduced to writing, and that writing should be signed by both landlord and tenant. If a landlord desires to deliver its terms to its tenant in a letter, that letter should, at a minimum, (i) provide a space for tenant to sign, acknowledging its agreement to the terms of the letter, and (ii) include a time period by which landlord will require tenant to acknowledge and return the letter (e.g., tenant must sign and return the letter within two business days after receipt thereof).
- The letter should include clear integration language, providing that any prior discussions, negotiations, or understandings, either oral or written, have been reduced to what is set forth within the four corners of the letter.
- Landlords should review the notice provisions of each lease carefully to ensure that any documentation is delivered in strict compliance with what the lease provides. For many leases, electronic delivery of notices is not an option; this would not prohibit the delivery of a courtesy notice by e-mail, but landlords should nonetheless deliver any letter or other documentation by whatever means is required by the terms of the lease. Please note, however, that this requirement should be distinguished from what the letter provides as a means of acceptance. It is prudent for a landlord to include language within the letter or other documentation providing that the tenant’s acknowledgment may be returned to landlord via e-mail; while that does not alleviate any hassle with respect to the initial delivery of the letter, it surely creates a more efficient means to ensure that tenant’s acceptance of your offer of relief is secured in a timely fashion.
- Finally, landlords should consider adding language prohibiting tenant from sharing the existence, terms, amount, conditions, provisions, and details of any agreement for relief with other tenants. While it is the case that the current crisis has permeated every corner of society, landlords will want to do their best to address these requests for relief on a case-by-case basis, and do not want to lose leverage with one tenant based on the deal they negotiated with that tenant’s neighbor the day before.
As is the case with much of our world today, the commercial leasing landscape is changing at a rapid pace. We will be sure to keep you updated on developments in this area, but, in the interim, we are ready and willing to help you with negotiating and/or documenting practical and efficient solutions with your tenants.