Landlord and Tenant Considerations when Negotiating Rent Concessions

Landlords and tenants enter into leases with the expectation that the document which they execute will govern their relationship throughout the term of the lease. Economic realities, such as the current recession, often require tenants to pursue some form of relief from the initial terms of the lease. It is important to remember that while this may appear to be a negative for the relationship, it can also prove to be an opportunity for both parties. In order to fully realize these opportunities, there are several considerations landlords and tenants should evaluate.

Where to Start

The starting point for any negotiation about modifying a lease would naturally be the lease itself. Both parties should not only be aware of what the current lease provides, but should also be mindful of the negotiation process that gave rise to the current lease. Each party likely made concessions during the original negotiation, and if a tenant introduces the idea of modifying the rent, it is appropriate for the parties to discuss other revisions to the lease. Therefore, before a tenant approaches the landlord for a rent reduction or abatement, that tenant should anticipate what other favorable terms of the lease could be effected and balance the benefits and drawbacks to each scenario. Likewise, once a landlord learns of a tenant’s proposal to alter the economic terms of the lease, the landlord should consider which currently unfavorable terms could be modified to make an amended lease more palatable, such as the elimination of a tenant’s early termination right or adding restrictions on tenant’s use of the premises.

Next, the parties must consider the terms of the proposed economic concession. This can come in many forms, the most common being rent abatement, rent reduction, and space reduction. In considering the form and amount of any concession, both the landlord and tenant must have a realistic view of how valuable the tenant’s lease is to the landlord’s business. A tenant that has a history of late or partial payments, or has experienced extended financial hardship, will not be in as good of a bargaining position as a traditionally stable tenant. Conversely, during an economic market in which landlords are having difficulty finding new tenants to fill vacant spaces, tenants will have notably increased bargaining power.

Proceed with Caution

Once a tenant asks for an economic concession, the landlord is justified in asking to examine their financials. An open review of tenant financials will not only help the landlord determine whether to give a concession, but also help determine the amount of any concession. The parties should be aware of the multitude of cost saving methods available to the tenant. It will hurt a tenant’s bargaining position if it cannot show evidence that it has taken steps to reduce costs in other areas. Generally, it will make sense for both parties if the concession is proportionate to the financial impact of tenant’s downturn. For example, if a retail tenant has seen a 25% reduction in sales, it would likely stand to reason that a temporary abatement of 25% of its rent would help the tenant survive this period. It is also common for a landlord to continue a periodic review of the tenant’s financials, as a recovery by the tenant should often trigger the end of any concession provided.

Seeking Recapture

The parties must also consider the concept of recapture. Most landlords will expect the tenant to reimburse them for any rent that is forgiven. It is important for landlords to remember, however, that it does not benefit them to recapture a concession too rapidly; such requirements could prove to be a crushing financial obligation on a tenant that landlord deemed worth helping during lean financial times. Once such a balance of expectations is considered, the parties should evaluate the multiple options for recapture. One such option is a simple increase in the base rent. As stated above, it is often important to make any such increase gradual over time in order to ensure that tenant can meet the additional burden. Another option for retail tenants is the addition of or increase in percentage rent. Because this form of repayment is dependant upon tenant sales, it is less reliable to ensure full recapture. Landlords and tenants may need to manipulate the breakpoint calculation in order to guarantee repayments by percentage rent.

Outside Considerations

Finally, there are several other issues both parties must consider when negotiating economic concessions in the lease. Generally one or both parties will be operating under a loan agreement to finance its operations. Landlord must ensure that a given concession will not breach its loan agreement and seek all necessary lender approvals for modifications to the lease. Similarly, tenants’ lenders may need to approve changes to their leases. Another consideration is that of prior liability. A landlord can often request a waiver of all tenant claims against landlord arising prior to the effective date of the amendment. It stands to reason that a landlord that gives relief to a struggling tenant should not need to fear litigation on a matter arising before such relief. A final issue that faces many struggling tenants is that of bankruptcy. Section 365 of the United States Bankruptcy Code allows a tenant to either assume or reject a current lease. An assumed lease can be significantly altered by the bankruptcy court. A rejected lease has restrictions on any claim which can be sought by a landlord creditor. Therefore, any concession should be deemed terminated upon the filing of bankruptcy by a tenant in order to attempt to have the bankruptcy court consider the lease on its original terms during such process. Such provision would also make the lease more attractive to any potential assignee in a tenant’s bankruptcy.
When tenants face difficult financial times, it is often necessary for tenants and landlords to work together to find a mutually beneficial concession which relieves the tenant’s burden.

So long as the parties carefully consider the full range of issues involved with such concessions, it can be an important step to securing a positive economic relationship between the landlord and tenant.