Any business entering into a lease agreement understands that there may be difficult times down the road which could impact their ability to pay their monthly rent. Of course, if the business seems to be in financial trouble, usually the writing’s on the wall long before rent payments become an issue, giving the company time to switch gears and prepare for their next move.
Unfortunately, COVID-19 didn’t allow time for preparation. The virus came in like a bull in a china shop, and in a matter of weeks, it completely changed the financial outlook for thousands of once financially-stable businesses. Now, struggling to pay rent, these companies are finding themselves in default, and sometimes facing a legal battle with their landlord.
Major Companies Facing Hard Times
Businesses suffering from the fallout of COVID-19 are in good company. According to The Wall Street Journal, many big names have been failing to pay all or some of their rent since April, the height of the coronavirus outbreak. These companies include Dick’s Sporting Goods, Burlington Coat Factory, Petco, Louis Vuitton, Victoria’s Secret, Staples, and fitness chain Equinox.
The report states that while many landlords are willing to work with smaller local businesses that have limited cash and have experienced a loss in revenue due to their customers being quarantined, they’re often less forgiving with large corporate tenants who they believe to have cash or access to capital and are taking advantage of the situation to avoid paying rent.
Many property owners are also not buying into the force majeure argument, which amounts to tenants claiming the coronavirus was an “Act of God,” similar to a natural disaster, and thus outside their control and preventing them from meeting their contractual obligations.
Next Steps for CRE Tenants
COVID-19 hasn’t hurt just brick-and-mortar retail stores; with federal, state, and local governments ordering business shutdowns and social and travel restrictions, it has impacted other CRE sectors, such as office, hospitality, restaurant, personal services, entertainment, and construction. With their finances in a pinch, what are these businesses to do?
Liquidation and Bankruptcy
Commercial tenants that have decided to go out of business permanently must consider each of the following:
Turnover of the space to the landlord
Damage to and restoration of the leased premises
Settlement of unpaid present and future rent obligations
Many of these tenants will ultimately liquidate their businesses to meet their debt obligations. Others may seek bankruptcy protection, although the Bankruptcy Code states that a tenant is generally required to pay all rent in arrears, which can be difficult if COVID-19 has already brought the business to its knees.
For tenants that are still fully or partially operating but lacking in funds, landlords may consider a lease concession request. These concessions can work in a number of ways:
Rent Relief: Deferral of base rent or all rent including operating expenses and real estate taxes.
Rent Repayment: Creating a repayment schedule for deferred rent.
Tenant Assurances: An arrangement that addresses a tenant’s obligations in which they must report to the landlord an ongoing financial condition, operating status, and any financial assistance they’ve received from the government.
Third-Party Consents: Arranging lease modifications and rent relief by way of lenders.
Lease Concession Considerations
For businesses that expect to weather the COVID-19 crisis, lease concessions are the way to go. Of course, negotiating them will depend upon numerous legal, practical, and financial issues:
Critical Lease Terms. These terms address matters of co-tenancy, early termination, recapture or surrender of space rights, renewal options, and force majeure.
Outlook of the Tenant’s Business. If a tenant is expecting a resurgence in business when the coronavirus crisis comes to an end, they may be able to work with their landlord to devise a payment plan for rent (and arrears) in the future.
Access to Government Relief Programs. Tenants and their landlords should take a look at loans, grants, and other benefits available to them. There’s more to learn here:
CARES Act Reference Guide
Avoiding Default through Tenant Representation
Not all landlords are understanding or forgiving regardless of the situation, and no business is immune to legal action. Just recently, a New York commercial landlord sued The Gap Inc. in Manhattan federal court over their failure to pay rent on a Midtown retail space during the COVID-19 pandemic. The complaint states that The Gap owed just two monthly payments.
Sadly, many other businesses may be in a similar situation. But, when the matter is taken to court, it can be a lengthy and expensive process. For some companies, space disposition may be the best way to go.