For the most part, commercial leases during the early days of strip centers and shopping malls used to be fairly simple and concise agreements. Even as late as the 1960s and 1970s, it was uncommon for retail leases to span more than 15 pages of essential provisions. But leases, like life itself, have become more complicated.
Since the boom of national retail in 1980s and 1990s, national retailers increasingly insisted on using their own forms of lease, or at the very least, incorporating tenant-friendly provisions typically not found in landlord-generated forms.
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Co-Tenancy Provisions
One tenant-friendly concept that rose to prominence during this period is the co-tenancy provision. This article attempts to explain why national retail tenants often insist on incorporating this concept into their leases and offers some suggestions to landlords who want to avoid potential disasters.
Co-tenancy provisions typically fall into one of two categories, opening co-tenancy and ongoing co-tenancy (sometimes called operating co-tenancy).
Opening Co-Tenancy
Opening co-tenancy provisions are usually only incorporated into leases for new shopping centers (or shopping centers under re-development), and they provide a tenant with the right to delay its opening until certain key tenants (an anchor, for instance) or tenants occupying a certain threshold number of leasable area in the shopping center (sometime expressed as a percentage) are open and operating. Often, these provisions will allow a tenant to open despite the co-tenancy not being fulfilled, but at a reduced rental rate. Sometimes, these provisions even allow a tenant to terminate its lease if the co-tenancy threshold is not met by a certain deadline.
Ongoing Co-Tenancy
Ongoing co-tenancy provisions usually have similar co-tenancy conditions as opening co-tenancy provisions (key tenants, a threshold of operating tenants), but the tenant remedy is typically limited to a reduction in rent payable until the co-tenancy condition is satisfied, and, if the condition is not satisfied by a specified deadline, the right to terminate the lease. The tenant rationale for these provisions should be obvious: although retailers generally strive to be the first to market in most instances, no tenant wants to be a pioneer in a shopping center, operating alone without any other tenants generating traffic.
Landlord Considerations
A landlord can usually evaluate the co-tenancy conditions of an opening co-tenancy provision with a certain amount of confidence. It knows what leases it has in the works, and can gauge the probability and estimate the timeline for those tenants eventually opening in the shopping center.
But evaluating ongoing co-tenancy conditions is a considerably harder, if not impossible, task. Because in retail, the future is unwritten. Trends are informative, but not certain. Further compounding this issue is that many national tenant leases span terms of ten years or more, an incredible amount of time for anyone without a working crystal ball to predict.
Beyond typical general economic trends (such as recessions) and consumer preferences (like the relegation of the department store), there are acute occurrences (like COVID closure mandates) that can trigger co-tenancy clauses. None of these events are within a landlord’s control.
So, what can a landlord do to minimize the impact of these powerful provisions, when the landlord itself is often powerless from triggering their operation? Here are a few suggestions:
- Limit the term of an ongoing co-tenancy provision to a more succinct period of time within the original term (and only to the original term, if the tenant has the option to extend the term).
- Make sure that your lease’s force majeure provision will prevent a trigger to the co-tenancy provision if other tenants of the shopping center are required to close due to government mandate (pandemic or otherwise). Most national tenants are asking for pandemic-related provisions that allow for reduced rent during government-mandated closures, so landlords need to ensure that they are protected during the same eventuality.
- Require that the tenant itself is open and operating to take the benefit of a co-tenancy provision. If the rationale behind a co-tenancy provision is to compensate a tenant for reduced shopping center traffic, then that tenant should be required to be open to receive this benefit. Some landlords are successful in negotiating language that requires a tenant to provide evidence of reduced sales during the period of the co-tenancy deficiency in order to receive a rent reduction.
- Don’t include areas outside of landlord’s property within the scope of the co-tenancy. Often, retail developments are owned by multiple, independent parties. Tenants operating in areas outside of a landlord’s ownership and control should not be included in the co-tenancy provision, as a landlord has no control over these leases. Here’s a disastrous example: Landlord agrees that Mega Lo Mart, which is located on a portion of the shopping center it does not own, is a required tenant in a co-tenancy provision. Mega Lo Mart decides that it wants to relocate and offers its landlord a substantial termination fee to reduce its term by a number of years, and its landlord agrees. Within months, Mega Lo Mart closes its doors in the development, triggering the co-tenancy clause, and our unfortunate landlord had absolutely no say in the process. Don’t let this happen to you.
- Landlords should require some flexibility when drafting co-tenancy provisions. Landlords need the ability to mitigate co-tenancy penalties (and damage to tenant) by receiving credit for providing replacement tenants. Additionally, landlords should consider the potential for providing replacement tenants for certain spaces (a 75,000 square foot Mega Lo Mart, for example), and whether they would benefit from a provision that would allow them to replace such a tenant with several smaller tenants, instead of requiring a one-for-one replacement. Such a provision is especially important in what will likely be the last days of the large department store.
There are countless more instances and eventualities that a landlord should consider when negotiating this type of provision. And after spending much of my legal career negotiating (and sometimes litigating) over them, there’s much more to say on the subject (I’m really fun at parties).
So, if you have a potential tenant that is insisting that one be included in its lease, I recommend that you contact me or another qualified real estate attorney to assist you.
