Dirt Dictionary: C Is for Co-Tenancy
Jeffrey Margolis Jan. 8, 2014, 7 a.m.
There is a special symbiotic relationship between shopping center landlords and tenants, with each looking to the other to promote the “product.” The same holds true for the tenant and other tenants of the shopping center. Let’s look at one unique-to-retail hot-button benchmark: co-tenancy clauses.
Co-tenancy: Tenant’s obligations (especially rent) are subject to the opening/operating of other key tenants in the shopping center; lease stipulates that a reduced rent or no rent be paid until an agreed-upon percentage of the center’s gross leasable area (GLA) or some particular key tenants, are open and operating and continue to operate during the lease term. The concept is that without the co-tenants bringing traffic to the shopping center, the tenant will suffer an economic loss.
The thinking behind co-tenancy has to do with the natural grouping of certain kinds of retailers to satisfy shoppers’ needs for a certain type of merchandise, or conversely the retailer’s need to be with others with similar lines of merchandise and price points, to attract customers.
Co-tenancy clauses are usually drafted in connection with newly constructed shopping centers and cover two distinct time periods—the grand opening and ongoing operations. As to the grand opening, the requirement is that the landlord has signed leases covering a certain percentage of the GLA, or leases with certain major or key tenants. Details are negotiated, but we note here special situations where, for example, the pizza place simply cannot successfully operate unless and until the adjacent movie theater is up and running.
The well-drafted tenant’s clause will also require that the named co-tenants continue to operate full tilt after the mall has opened.
Lastly, remedies. These clauses are often heavily negotiated, with the landlord seeking to limit remedies and the tenant looking for the gamut of remedies from rent abatement all the way up to cancellation. To be fair, there’s a balancing required: a landlord will say “Don’t blame me; I’m trying my best to get this center fully leased.” The tenant says “I need certain other key tenants to open and operate or I’m unlikely to make a living here.” As to opening, the tenant will ask for the right not to open, or if it does open to be on some re-programmed rent: just minimum rent charges for example, no percentage rent. Or the tenant is relieved of its obligation to pay common charges and even minimum rent is jettisoned and replaced by a straight percentage of sales.
Where there is no percentage rent (reserved or in the offing) the landlord can simply agree to take a rather steep chop off the fixed rent. The landlord, looking to tie any of these remedies to a verifiable loss, may also insist on a sales percentage decline test, with the tenant getting relief only if it can show verifiable damages. As to post-opening relief, some tenants may negotiate a “go dark” clause whereby it need not operate if co-tenancy criteria are not met. Of course, the ultimate remedy–lease termination–is totally abhorrent for so many reasons, that the landlord will strenuously resist it. For example, the landlord seeks to avoid a domino effect where with the closing of each store others tumble down in a row. (And these clauses are anathema to lenders looking for cash flow certainty.) So if a failure of certain key tenants to open is grounds for lease termination, the landlord will insist that he have a year or more to satisfy the requirement.
Practice pointer: if Tenant duly terminates the lease it may seek reimbursement from landlord for its unamortized tenant improvements.
Jeff Margolis is founding principal of the Margolis Law Firm in New York City, where he specializes in dirt law—buying, selling and leasing. Follow Jeff via RSS firstname.lastname@example.org