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.
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.