By: Allison Behjani
COVID-19 Stay Home Directives and governmental closures of non-essential businesses have led to leasing crises in both the commercial retail and office spaces. Tenants continue to struggle with crippling losses in sales or other revenue streams and have either requested rent relief from their landlords, or, in some cases, have simply informed landlords that they have no intention to pay rent for at least April, and perhaps even into the foreseeable future. In turn, most landlords are in the unenviable position of defaulting on their mortgage loans as a result of the tenant default. Landlords either face an inability to make the mortgage loan payments or, even still, are plagued by numerous financial covenant defaults under the loan documents. The following summarizes (I) some of the key issues to consider for both landlords and tenants during the pandemic; as well as (II) proposed ways legal services may help.
I. Issues to be Considered
Rent Deferral Rather than Rent Relief
An eviction action is always a consideration. In most instances, however, the parties are interested in coming to a solution in which the tenant remains in occupancy of the premises under the lease. In doing so, it must be remembered that no two situations are the same, and that pressures weighing on landlords as well as tenants in different situations may necessitate different outcomes. With that being said, a tenant may request a complete waiver of rent during the pendency of any government closure, and possibly beyond as well. Instead of a waiver of rent, tenants and landlords ought to consider a deferment of rent. With a deferral of rent, the tenant would not pay some portion (or possibly any) rent during the period of deferral (possibly up to three months, or longer in extraordinary cases), but must ultimately pay the deferred rent to the landlord after the tenant opens for business, whether as a lump sum payment or over a negotiated extension of the term of the lease, an amortization of the deferred rent over a period of time (up to the remaining existing term), or over some other mutually agreeable time frame. These solutions give tenants the relief they seek while preserving the value of the lease for the landlord and ensuring the landlord ultimately will be paid all the rent it is owed.
In considering a rent relief or rent deferral proposal, the landlord may request to see the tenant’s (and any guarantor’s) financials, request reports of sales or other income streams, request proof of any insurance that may cover the tenant’s losses, and may request any updates on SBA assistance that the tenant has applied for or received. The length of the deferral, the amount of the deferred rent, and the period in which the deferred rent is to be repaid, could depend upon the information provided by the tenant, as the COVID-19 pandemic is having an impact upon businesses in different ways and varying degrees. Care should also be taken with respect to whether the rent deferral applies to common area expenses (including but not limited to property taxes) or parking fees.
Landlords and tenants may also use as a negotiation chip the “go dark” provision in a retail lease. In other words, the landlord may defer rent, but still require the tenant to keep the space lit and the shopping center looking attractive. In addition, for tenants with so-called “co-tenancy” clauses allowing tenants to cease operating or to pay reduced rent if a large anchor tenant(s) cease(s) operating in a the center, in exchange for a landlord’s agreement to defer rent, the rights under a “co-tenancy” clause may properly be waived by a tenant during the pendency of any closure caused by the pandemic.
Landlord Lender Issues
As mentioned above, a failure of the tenant to pay rent will, in most every event, affect the landlord’s mortgage loan secured by the property negatively. Even if the landlord can still make its payments, the default by the tenant, or multiple tenants in the same center or building, may constitute a breach of a financial covenant. Before considering any rent deferment or rent relief proposal from a tenant, a landlord ought to consider requesting permission from its lender especially if the square footage of the lease constitutes a “major lease” under the loan documents. Now is not the time to “do now and ask for forgiveness later.” Anecdotal experience suggests that lenders are working with their borrowers.
Emergency Tenant Loans
Ray Quinney & Nebeker has published other articles on the availability of SBA relief loans under the CARES Act. Please see: Economic Relief for Employers Under the CARES Act, Utah Leads Together Small Business Loan Program: What You Should Know, and SBA Administration Releases Guidance on Paycheck Protection Program
The loans are issued by local banks, backed by the SBA, and are specifically available for business expenses, including rent. Tenants may find them useful. Unfortunately, the loans do not appear to be available for large or national tenants as they are not small businesses.
II. Legal Documentation and Assistance
Documentation of Agreements
Prior to any negotiation between the landlord and the tenant, the parties may want to enter into a type of pre-negotiation letter agreement whereby the parties agree that neither party waives any rights during the negotiation. If, after negotiation, the landlord and the tenant are able to reach an agreement, the documentation of the rent deferral agreement may be done one of two ways. First, the parties could enter into a standard amendment to the lease. This would be most appropriate in the event of rent deferral, percentage rental increase, or extension of the term. Second, the parties could enter into a side letter documenting the new agreement. This approach has its advantages, particularly in the case of a short term rent payment deferral only, in that it gets the job done quickly. The downside is that the letter would constitute a lease document that may be forgotten, not disclosed to the buyer if the property is sold down the line, or may run afoul of loan document requirements.
If the tenant does not request a deferment of rent, but rather just doesn’t pay, a landlord should strongly consider sending a default letter. The default letter will, likely, force the parties into negotiation. A simple failure of the landlord to do anything while the tenant continues to default on its rent obligations may result in a waiver of rights. Similarly, a tenant should not just continue to default on its rent obligations hoping that the landlord will understand. Significant default interest and late penalties will accrue. An upfront negotiation with any ultimate agreement documented in writing signed by both parties, is best.
If both parties cannot come to an agreement, or if the landlord has determined that there is little possibility that the tenant may ever be able to reopen or pay the rent in the future, the landlord ought to consider proceeding with an eviction action. Currently, Utah state courts are open, but it is unclear whether eviction hearings constitute “mission critical” cases defined in the current standing order of the Utah Supreme Court, or if the hearing may be subject to delay. Also, we are seeing courts in other states that are under stay home orders delaying eviction proceedings. As of the date of publication, Utah is not under a stay home order, but care should be taken to closely monitor government orders in the coming weeks. Please note that this article only deals with commercial leases. Most states, including Utah, have imposed a moratorium on residential evictions. Likewise, the federal government has placed a moratorium on evictions in buildings secured by loans backed by HUD, Fannie Mae or Freddie Mac. If you would like more information or advice on those situations, we would be happy to assist.
Ray Quinney & Nebeker Resources:
Again, COVID-19 has brought with it an unprecedented and unexpected surge in tenant defaults in the payment of rent. Ray Quinney & Nebeker is ready, willing and able to assist both tenants and landlords in all legal issues, including the documentation of the agreements listed above. Please reach out to our COVID-19 response team’s real estate expert, Allison Behjani, at (801) 323-3306, who will guide you to the correct person on our team.