By Kathleen Bertero
The economy has put commercial landlords in a difficult situation. Rent payment defaults are at an all-time high, prospective tenants are few, and even those are seeking "killer deals." For a landlord needing cash, lockouts and lease terminations will not do. Thus, workouts and restructured leases are increasingly attractive.
Restructure is a modification of the terms of a lease that is not in default, or a lease that is in default but that can perform under the lease if lease terms are adjusted.
Workout is an agreed-upon exit strategy for a defaulting tenant that no adjustment can help.
If the cause of default is beyond the tenant's reasonable control but the adverse circumstances are likely to change within the foreseeable future, a landlord may consider restructuring the business deal. If mismanagement by the tenant is the reason for default and the landlord is confident that unwise behavior can change, then a restructured deal may be the way to go.
Most of today's tenant defaults are centered on financial distress. When a financial default occurs, the landlord must demand current financial information from the tenant. If the tenant is not forthcoming with this information, then neither a restructure nor a workout approach makes much sense, and the landlord should proceed directly to enforcement action. Some tenants who ask for relief are well-capitalized companies that do not really need relief but are exploiting the current environment as a negotiation tool. There is no reason to negotiate with them. But if a tenant has simply hit a rough patch and is capable of meeting its future lease obligations, then the financials will serve as a basis for a restructured business deal. If long-term financial capability is not there but the tenant has some ability to financially transition out of the premises, an exit strategy in a workout agreement can be developed. If the tenant has no remaining financial means, a landlord must act quickly to recover the premises either by mutual agreement or eviction. Neither a restructure nor a workout approach will succeed if a landlord does not trust and have confidence in a tenant's ability to perform its obligations. If trust is gone, trying to reach any agreement is a waste of time.
Real estate decisions are always driven by supply and demand. If there is demand for the premises, the landlord has less incentive to deal with a nonperforming tenant than in a situation where vacancy rates are high and there are few prospects for the space.
A restructure deal will be reflected in an amendment to the lease. It will typically:
- Specify each event of default;
- Specify what the tenant must to do to cure each default;
- Specify the consequences of any failure to cure (e.g., terminated lease, a stipulated judgment for damages, or restitution of the premises)
- Identify all changes in basic lease business terms (e.g., revised base rent, payment schedule, lease term);
- Include additional security for tenant's lease performance (e.g., personal guarantee; letter of credit);
- Address and resolve any landlord defaults alleged by tenant;
- Modify tenant notice of default and cure rights; and
- Include a reservation of rights and remedies by the landlord should the tenant fail to perform.
Both parties should understand that this agreement is also intended by the landlord to establish a clear path toward a remedial action (i.e., litigation), should it become necessary.
A workout deal will be reflected in a stand-alone agreement. It will include:
- New lease termination date;
- Tenant's agreement to vacate by a certain date;
- Stipulated judgment of restitution of the premises should tenant fail to vacate;
- Payment of some up-front money;
- A schedule of payments during the remaining occupancy and afterward, as agreed;
- A stipulated judgment for damages should tenant fail to make any agreed-upon payments;
- Actions the tenant must take prior to surrender that are not provided for in the lease (e.g., removal of tenant improvements);
- A mutual waiver of claims (effective upon tenant's full performance of the workout agreement);
- Reservation of rights and remedies by the landlord should tenant fail to perform its obligations under the workout agreement.
Landlords are doing their part to ease the financial impact to tenants in our struggling economy. Property owners are cutting costs left and right, with the goal of saving money for tenants, who will then be better able to pay rent. No one benefits when leases are terminated, obligations are not honored, and valuable space stands vacant. Ideally, landlords and tenants are not adversaries but reasonable parties working toward satisfactory resolutions.