US Commercial Tenant Rent Deferral Agreements: Checklist and Considerations
Due to the economic impact of COVID-19 and the ensuing government actions (including various forced closure and stay-at-home orders), many commercial tenants are requesting that their landlords provide rent relief through either deferral or forgiveness. The following checklist provides a framework to assess and process such requests with respect to office, retail, and industrial properties.
I. Pre-negotiation Agreements
Prior to engaging in rent relief negotiations, a landlord should require the requesting tenant to both make the request in writing and execute a pre-negotiation agreement. The primary purpose of a pre‑negotiation agreement is to preserve the landlord’s rights and remedies under the lease. Landlords should consider including the following provisions in their pre‑negotiation agreements: (i) a provision preserving the landlord’s rights and remedies under the lease; (ii) a provision confirming that the lease will only be modified pursuant to a written, executed amendment to the lease; (iii) a provision allowing the landlord to discuss the tenant’s financial condition with the tenant’s accountants, lenders, and creditors; (iv) a provision that all information to be provided by the tenant in connection with the negotiation will be complete and accurate in all material respects; (v) a provision confirming that the landlord is not in default under the lease; (vi) a provision releasing the landlord from any claims the tenant may have under or relating to the lease or for the landlord’s failure to enter into an agreement; (vii) a provision confirming the lease is in full force and effect; (viii) a confidentiality provision, wherein the tenant agrees to keep all discussions confidential; and (ix) a representation by the tenant that it has not engaged a broker in connection with the rent deferral negotiation, including an agreement by the tenant to indemnify the landlord against any claims made by any broker claiming to have been engaged by the tenant.
II. Landlord’s Due Diligence
After execution of a pre-negotiation agreement, the landlord should request that the tenant provide documentation that will aid the landlord in assessing both the tenant’s current financial condition and the risks associated with granting a rent deferral. Such documentation should include the following: (i) the tenant’s and, if applicable, the lease guarantor’s financial statements for the preceding two years and monthly operating statements for the 2020 calendar year; (ii) the tenant’s business plan detailing the impact of COVID-19 on the tenant’s business and revenues—including, for retail tenants, a sales forecast for the balance of the year—and a strategy for mitigating these impacts (provided that the landlord acknowledges that it is very difficult for any tenant to predict or forecast sales or the impact of mitigation efforts given that no one knows the full impact of the COVID-19 crisis); (iii) the tenant’s specific request for the rent deferral it is requesting; (iv) what additional security or collateral the tenant is willing to provide; and (v) whether the tenant has applied for and received PPP funds or other loans or insurance proceeds in connection with pandemic. Additionally, the landlord should request: (a) in the event that tenant is subleasing the space to third parties, documentation evidencing the extent to which the subtenant(s) are paying rent; and (b) in the event the tenant is a co-working or executive suite operator, reports detailing their current occupancy threshold in the premises and documentation evidencing the extent to which their clients or members are paying rent. If the property is encumbered with a mortgage, the loan documents need to be examined in order to determine whether lender consent is required in order to agree to a tenant’s rent deferral request and whether granting such rent deferrals will impact any of the covenants in the loan documents (e.g., debt service ratio).
III. Considerations on Whether to Offer Rent Deferral
Along with the aforementioned documentation, landlords should consider all relevant factors in their analysis of whether to grant the tenant rent relief. Factors may vary by tenant and project, but examples of general applicability are listed below.
A. Tenant’s Risk of Insolvency
In the landlord’s analysis, it should consider that nearly every tenant will be at risk of insolvency to some degree, as COVID-19 is a “mass event,” and the landlord should weigh the costs and benefits (as well as the likelihood) of finding a replacement tenant, factoring the current rental value of the space in the current economic climate and any anticipated leasing costs. Additionally, the landlord should consider (i) the tenant’s history of defaults or late payment of rent, (ii) the tenant’s risk of insolvency if rent deferral is not provided, (iii) the tenant’s risk of insolvency if the rent deferral is provided, (iv) whether rent deferral will result in the landlord collecting more rent in the long term, (v) whether the short-term rent is the landlord’s best opportunity to collect rent, and (vi) whether the tenant was at risk of insolvency prior to COVID‑19.
B. Retail and Restaurant Tenants
In evaluating whether to grant deferral to retail and restaurant tenants, the landlord should (i) consider that retail and restaurant tenants have likely suffered, at least initially, a greater impact than office and industrial tenants and are therefore in the most immediate need of rental deferral (particularly the “mom and pop” retailers and restaurants); (ii) evaluate any “co-tenancy,” continuous operations, and “go dark” provisions; (iii) consider whether the retail or restaurant tenant is considered an amenity to the property (e.g., a restaurant in an office building) and therefore whether its continued operation is more important to the project; and (iv) consider whether it would be better in the long run to provide rent deferral to a limited number of tenants to prevent their closure rather than creating numerous vacancies in a shopping center and possibly triggering cascading abatement or closure rights under other tenants’ leases (if such leases have co-tenancy clauses).
C. Miscellaneous Considerations
Additionally, the landlord should consider (i) whether the tenant is an essential business and is operating at or near full capacity with the ability of employees to work remotely and continue operations and (ii) whether the tenant will collect under its business interruptions insurance as a result of COVID-19. (With the latter, the landlord should realize that, in the absence of legislative action to force insurers to cover business interruption claims for small businesses (seven states are currently considering such legislation), the ability of a tenant to collect such insurance will be dependent on the exact terms of its policy, and it may take a long time to receive insurance proceeds.)
IV. Rent Relief Provisions
If the landlord decides to grant rent relief to the tenant, the landlord should customize the deferral to provide the appropriate level of relief to the tenant by considering and adjusting the following:
A. The length of the deferral period. The market appears to be currently in the range of 30 to 90 days.
B. The length of the payback period. The market appears to vary widely on this point. Some landlords are requesting tenants pay back the deferred rent by the end of 2020, while others are agreeing to amortize the deferred rent over the balance of the remaining lease term. If the tenant receives a PPP loan from the SBA under the CARES Act, the landlord and the tenant may decide to agree that the payback period be accelerated so that the tenant can make a claim for forgiveness (i.e., so that the rent will have been paid within the eight-week period provided for in the CARES Act). However, the landlord should account for the fact that there is a 25 percent cap on the use of tangible PPP loan proceeds for non-payroll expenses such as rent, mortgage interest, and utilities.
C. The interest charged on the deferred rent, if any. The determination of whether to charge interest may change based on the length of the deferral period, with longer deferral periods leaning toward charging interest.
D. Whether only base rent or whether both base and additional rent are deferred. To the extent possible, the landlord should attempt to at least recover operating expenses during the deferral period in order to limit the amount the landlord must pay out of pocket for its fixed costs. In the event the landlord is required to fund reserves for taxes and insurances under its mortgage, then the landlord should ensure that it will have sufficient operating revenue to meet these reserve requirements. Despite any deferral of additional rent, the tenant should remain responsible for any utilities, parking, or other services the tenant directly consumes (e.g., after-hours HVAC). If the additional rent is also deferred, then the lease amendment should reflect how the reconciliation of operating expenses will occur for the 2020 calendar year if the deferred amount is based on estimates of operating expenses and the actual operating expenses end up different.
E. Whether to apply tenant’s security deposit towards rent. To the extent the landlord is holding a cash security deposit, the parties may agree that the landlord can apply such deposit toward the next installment of rent and then require the tenant to replenish the security deposit at a later date. This option allows the landlord to mitigate the impact that rent deferral will have on its cash flow.
F. Whether to request additional security. As consideration for granting rent relief, the landlord should consider whether it is appropriate to request additional collateral in order to backstop the tenant’s obligations under the lease (or, at a minimum, to backstop the payback of the deferred rent). The additional collateral may be in the form of an additional security deposit, lease guaranty, or letter of credit.
G. Whether to lower a retail tenant’s breakpoint until such tenant pays back the deferred rent. Lowering the breakpoint incentivizes the tenant to pay back the deferred rent as soon as its sales begin improving. If a retail tenant is not required to pay percentage rent by its lease, then introducing percentage rent may be a way to ensure that the landlord is repaid the deferred rent as sales rebound.
H. Other provisions. In addition to provisions governing the rent deferral, the landlord should consider including the following provisions, as appropriate, in its rent deferral amendments: (i) modifications to the force majeure definition both to ensure that payment of rent and financial obligations are carved out of force majeure and to establish whether certain obligations of the landlord (e.g., construction obligations) should be tolled due to the COVID-19 pandemic and similar future epidemics; (ii) a provision revising the definition of eminent domain in the lease to both limit eminent domain to physical takings (excluding regulatory takings) and make a distinction between temporary and permanent takings; (iii) a provision allowing the landlord to restrict access to the building (without damages or abatement) in case of an emergency, public health crisis, or other health/safety issue; (iv) a provision revising the utility and essential service interruption clauses to remove any liability of the landlord for shutting down the premises for emergencies, public health crises, or other health/safety issues; (v) an estoppel provision wherein the tenant confirms that there are no existing landlord defaults and no rights of offset or credits; (vi) an extension of the lease term as consideration for the rent deferment (generally equivalent to the deferral rent period); (vii) a provision suspending future disbursements of allowances until the tenant repays the deferred rent or is in full occupancy of the premises; (viii) a provision conditioning the landlord’s consent to any future alterations on the tenant paying all outstanding deferred rent; (ix) a provision providing that upon any tenant default under the lease, the outstanding balance of deferred rent shall be subject to acceleration; (x) a provision requiring the tenant to provide monthly sales and operating statements and other financial statements upon the landlord’s request, with a provision providing that if the tenant’s sales or revenues hit certain thresholds, the tenant will be required to pay the deferred rent on an accelerated basis; (xi) a provision revising the exclusions to operating costs to ensure that any COVID-19-related costs (e.g., extra janitorial costs for deep cleaning or costs for an industrial hygienist) will be passed through to tenant; (xii) if the tenant elects to sublet or assign the lease with respect to the majority of the premises, a provision conditioning the landlord’s consent to such assignment or sublease on the tenant paying the outstanding deferred rent; (xiii) a provision requiring any subtenants in the premises to pay the sublease rent directly to the landlord, with the tenant’s rent obligations being offset against any such sublease rent the landlord collects; (xiv) if the lease has a non-cumulative cap on controllable operating costs, a provision revising or suspending any non-cumulative cap on controllable operating costs for the 2020 and 2021 calendar years, as forced closure and stay-at-home orders will likely sharply decrease operating costs for the 2020 year, which would result in the non-cumulative cap on costs being triggered in the 2021 calendar year (additionally, if janitorial services are included as part of controllable costs, the landlord might consider redefining such costs to be non-controllable, as the landlord may have increased cleaning expenses going forward, including, but not limited to, the costs of deep cleaning and the costs of hiring industrial hygienists to track the paths of infected individuals); (xv) if the lease contains a cancellation or termination option, a provision providing that, as a condition for exercising such option, the tenant pay any deferred rent; (xvi) an acknowledgement by the tenant that it has accepted the premises in its as-is condition and that the landlord has no further obligation to improve the premises or provide any allowances with respect thereto; (xvii) a provision waiving any preferential rights that the tenant may have in the lease; (xviii) in the event the parties did not execute a pre-negotiation agreement, a statement addressing those items that would have been addressed in the pre-negotiation agreement (e.g., that the tenant is to maintain the confidentiality of any rent deferral); (xix) a reservation of landlord’s rights; and (xx) a provision waiving the tenant’s claims of force majeure/abatement as a result of COVID-19 so that the tenant does not receive rent deferral and then subsequently argue for abatement for the same event.
V. If the Landlord Decides Against Granting Rent Relief
If the factors weigh against granting rent relief, and the tenant actually materially defaults in its payment of rent, the landlord should consider terminating the lease and drawing down on any letters of credit or applying security deposits that are on hand prior to the tenant filing bankruptcy. In the event a tenant files for bankruptcy prior to the landlord drawing upon a letter of credit or applying the tenant’s security deposit, then the landlord must consider the implications of the automatic stay and consult with a bankruptcy attorney before taking such actions. In the event the landlord elects to put a tenant in default and apply any lease security, then the landlord should consider any local eviction moratoria and other similar mandates to determine whether they prohibit such action(s).
Conclusion
The above recommendations provide a broad framework for considering and responding to rent deferral requests, but each rent deferral request will require a careful analysis of the specific tenant lease, project, and related issues, and each rent deferral amendment must be tailored accordingly. Therefore, landlords should consult their attorneys in crafting the appropriate documentation related to such requests, including the pre-negotiation agreement, financial questionnaires, rent deferral amendment, or other responses to tenants.
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