Buying Time: Rent Relief Agreements - International Law Office

Introduction
Preliminary Considerations
Rent Abatement v Rent Deferral
Termination of Rent Relief Period
Additional Security and Accelerated Payments
Recapture of Tenant's Favourable Rights
Suggestions for Landlords
Tenant Considerations

Introduction

As a result of the current economic downturn, many commercial tenants are finding themselves in precarious financial positions and are approaching landlords to seek rent relief in order to survive until the economy recovers. While landlords are often hesitant to diminish their revenue stream by granting rent relief, they may have a strong self-interest in facilitating a successful lease restructure if the tenant's need is genuine. The prospect of a vacancy and its resultant effects on surrounding tenants may justify reconsideration of lease workout proposals and motivate landlords to come to the negotiating table. A landlord may wish to act promptly so as to avoid the loss of an anchor tenant or a key tenancy which may trigger the exodus of other tenants, as well as the additional costs involved in replacing a tenant through brokerage fees, lease inducements and other costs.

Granting rent assistance by entering into a lease restructuring arrangement can also be an excellent opportunity for landlords to regain effectively leverage or concessions granted during the initial lease transaction, either through the claw-back of tenant rights or by obtaining additional security and rights in favour of the landlord. Therefore, landlords should consider rent relief arrangements holistically and not just in terms of a break in rent in favour of the tenant. When determining whether to negotiate with a troubled tenant, there should also be consideration of the advantages that a landlord can secure in exchange for its temporary concessions.

Preliminary Considerations

In order to be effective for both parties, rent relief must be sufficient to avoid a future default or bankruptcy by the tenant, at least until the economy improves. Accordingly, the elements of a successful lease restructure can be numerous and complex. From the landlord's perspective, the costs of the rent reduction must be affordable and less than the consequences of a tenant's breach. When approached by a tenant for rent relief, landlords should analyze whether:

• there is any benefit to a restructuring arrangement;
• there is actual need on the part of the tenant for a rent reduction; and
• rent relief will have the intended effect (ie, whether the tenant has a viable business operation or whether a rent reduction will simply delay the inevitable demise of the tenant).

Rent Abatement v Rent Deferral

A fundamental consideration is whether the rent relief arrangement should be structured to allow for a temporary forgiveness of rent or merely rent deferral until the tenant can recover. While tenants prefer that some or all of the rent abate or be forgiven fully, the landlord's inclination is to provide that a portion of the rent be deferred until a later date, such that aggregate subsequent rent payments are increased. This strategy is advantageous to the landlord by allowing recapture of conceded rent at a later date and by creating the appearance that the net return on the lease is not diminished. Going forward, the landlord retains the option of forgiving the deferred rent or financial concessions in exchange for timely payment or other proper performance of lease obligations by the tenant. Owners may also pursue creative solutions such as temporary conversion from base rent to percentage rent, or the deferral of non-critical management costs.

Termination of Rent Relief Period

From the landlord's perspective, the rent relief agreement should be finite and short in duration, and should expressly allow the landlord to terminate the rent assistance immediately upon default or certain circumstances, for example:

• transfer of the lease by assignment or sub-letting;
• disclosure of the terms of the rent relief agreement to a third party;
• a corporate tenant making any distributions by way of dividends, bonuses or repayment of loans to any of its shareholders, directors or officers or anyone not at arm's length;
• increase to the salary or other remuneration of any of the foregoing; and
• the tenant or other entity directly or indirectly lending financial assistance to or guaranteeing the debts or obligations of another entity.

Rent relief should also automatically be deemed as terminated one day prior to the tenant becoming bankrupt or filing for creditor protection so as to avoid any bankruptcy trustee obtaining the benefit of the rent relief.

Additional Security and Accelerated Payments

Keeping in mind that rent relief is part of a larger restructuring strategy, landlords should also consider obtaining additional security.

Where the deferral of rent is significant, proactive landlords can become secured creditors by requiring the tenant to grant a security interest equal in value to the amount of the deferred or abated rent in its personal property, accounts, inventory and other assets. By registering its interest, the landlord will augment its position in the bankruptcy or insolvency proceedings. Furthermore, requests by other lenders for postponement of this security will alert the landlord to the claims of other secured creditors that may be lending money to the tenant. Landlords may also require the addition of an indemnifier or guarantor if there is not one in place already, or the expansion of the obligations of any existing covenantors.

Recapture of Tenant's Favourable Rights

Granting rent relief to a tenant should coincide with the landlord taking back, either permanently or temporarily, rights given to the tenant during the initial lease negotiations, including:

• renewal rights;
• rights of first refusal;
• expansion rights;
• broad use clauses;
• lease termination rights;
• co-tenancy provisions; and
• exclusivity clauses.

The original lease deal can also be amended favourably for the landlord by extending the term of the lease and reclaiming signage rights to be used as an inducement for replacement tenants.

This is also an excellent time for the landlord to couple the relief with additional landlord rights or impose various new restrictions such as continuous operating covenants. Landlords may also revisit previously negotiated exclusions from operating costs or eliminate year-end reconciliations and lease audit rights. Landlords can also impose new relocation obligations or demolition clauses on the tenant, or require payment of additional or increased security deposits.

In order to facilitate re-letting the space to a more reliable and solvent tenant, landlords should add a blanket right to terminate the lease at any time. This right will provide the landlord with flexibility in order to market the premises if a replacement tenant is found that is prepared to pay the full rent.

Suggestions for Landlords

Landlords should keep in mind the following restructuring strategies while considering a request for rent relief:

• Determine the relative bargaining positions of both the landlord and the tenant. Market conditions and trends are key in considering options, as is the tenant's economic justification for rent relief. Acquire knowledge of the tenant's core business, supply and funding sources and creditworthiness. The tenant should be required to provide financial statements to the landlord regularly at set intervals in order to track the needs for rent relief, including monthly gross revenue reports.
• Consider supplementary factors such as tenant mix and the impact that dark storefronts may have on the centre, and whether losing an anchor tenant may have a domino effect on the business of other tenants through the operation of co-tenancy clauses.
• Keep in mind financial or other restrictions on the landlord's ability to modify leases, such as the need to obtain lender or partner consents to lease modifications. The landlord should be particularly attentive to the potential effects that restructuring may have on its own ability to meet debt service in co-tenancy or operating requirements of other leases.
• Develop standardized procedures for evaluating rent assistance requests. Consider forming internal committees comprising leasing agents, property managers or financial analysts to address the inquiries. The mandate of such committees usually includes conducting credit checks, assessing inventory levels and supply sources, and reviewing the tenant's business plan and financial statements. Often when faced with a detailed information request, a tenant without a genuine need for relief will withdraw its request for assistance.

Consider obtaining a release or estoppel from the tenant for any landlord defaults, omissions of payment of tenant allowances or any liability arising out of the lease prior to the restructuring arrangement.

Tenant Considerations

Tenants should be prepared to provide a solid business basis and detailed financial information together with the relief request and should keep the following considerations in mind:

• Be cognizant of the tenant's bargaining power and vulnerabilities. Understand the market value of the premises in the centre or building in order to consider the tenant's options. Have a solid understanding of the tenant's financial condition and be prepared to demonstrate that while the tenant is financially threatened, it is not so greatly impaired that it will be considered a lost cause which the landlord will have little motivation to assist.
• Weigh opportunity costs. By obtaining temporary relief through a rough economic period, is the tenant losing an opportunity to relocate to a better premises? Consider the likelihood that the tenant may be able to negotiate an even better deal by delaying this request for relief. Tenants should consider whether they would be better off negotiating a lump-sum lease buy-out payment in exchange for termination now and seeking premises elsewhere. Also consider whether there is an easier exit strategy from the lease, such as assignment or sub-letting or going dark (for further details please see "Tenant Exit Strategies").
• Analyze whether any landlord defaults exist and, if so, how remedies may be part of the overall restructuring approach.

As the above considerations demonstrate, with a systematic and thoughtful approach, both landlords and tenants can work together to negotiate a lease restructuring and rent relief arrangement in order to achieve a constructive resolution to a potentially undesirable tenant departure during challenging economic times.

For further information on this topic please contact Jennifer Williams at Blake Cassels & Graydon LLP by telephone (+1 604 631 3300) or by fax (+1 604 631 3309) or by email (jennifer.williams@blakes.com).