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Of virus and rents: Can commercial lease renegotiation can help float tenants and owners?

5 options for commercial lease renegotiation

1. Full or partial rent abatement — for base rent, common area mainenance (CAM) payment, or both, and for an agreed-upon period of time or based on the tenant’s ongoing financial situation.

2. Full or partial rent deferral, to be repaid in installments, at the end of the lease term, or some other agreed-upon time, or which could be converted to a promissory note, with or without security.

3. Application of the security deposit to cover some or all of the deferred rent. Be careful of local ordinances that might prohibit replenishment of the deposit until the crisis is over.

4. Enhanced lease guarantees.

5. Full lease renegotiation, including term, rent, size of space under lease, etc.

Source: Lerman Law Partners

The second round of business shutdowns in California and other states because of the coronavirus pandemic is setting the table for more tough discussions between commercial tenants and landlords as both face significant revenue loses. Gov. Gavin Newsom on July 14 ordered that indoor dining close back down and nonessential businesses to stop using their office space, as COVID-19 cases were rising above than state-directed thresholds in dozens of counties, including Marin, Sonoma, Napa and Solano.

A month earlier, Newsom allowed restaurants to reopen indoors under COVID-19 safety precautions.

Depth of the business pain

On restaurants alone, the results of the on-again, off-again shutdowns has been devastating. In the first half of July, the new round of shut-downs across the country lead nearly 100,000 restaurants to cease operating, according to the National Restaurant Association. Rabobank projects that independent restaurants alone will account for nearly 60,000 business failures in the U.S. in the next year

Soon after the state’s first shelter-in-place closed restaurant dining rooms, theaters, malls and nonessential shops and offices in North Bay counties and across California four months ago, talks began between tenants and property owners. Tenants faced having to pay landlords for rent and other expenses at the beginning of April, and landlords faced payments to property tax authorities on April 10.

While California and counties have enacted protections for renters to not be evicted for nonpayment during the governor’s declared coronavirus emergency, first issued March 4, such moratoriums for commercial tenants have varied.

Marin County let its commercial eviction ban lapse in June, but state courts continue not allow court summons for unlawful detainer — failure to pay rent — until 90 days after the order is lifted.

However, property owners can still sue tenants for monetary damages from nonpayment, but that’s a risky undertaking, with so many businesses teetering on insolvency right now, according to Jeff Lerman, whose San Rafael-based Lerman Law Partners represents commercial tenants and landlords.

“Even though the restrictions on evicting the tenant have taken away an important arrow in the quiver of landlords, they do still have the leverage of being able to get the tenants’ attention by saying, ‘Look, we either have to sit down and figure this out, for your failure to respond leaves me no choice, or I'm going to have to go ahead and sue you for the rent.”

Can your lease ‘force majeure’ the issue?

Real estate attorneys have been closely examining lease language in the past four months to find out whether the documents have a force majeure clause, which allows for changing the obligations for performance based on an “act of God” like an earthquake. While form leases can include such clauses, they may not have “magic language” that can apply in a situation like the COVID-19 shutdowns, Lerman said.

“The kind of language that will improve your argument that you’re not in breach for not paying rent is to expand the force majeure to cover an epidemic or quarantine, a disruption of the labor force, national emergency, act/order/requirement of a government authority or ‘other similar causes beyond the control of both parties,’” he said.

After the public safety power shut-offs by Pacific Gas & Electric Co. that left businesses darkened in much of the North Bay for days last fall, leases up for renewal are being reevaluated to make sure force majeure clauses are properly worded to account for acts by a utility, according to Lerman.

Cost of evicting a nonpaying tenant

Problem is, kicking out a tenant for nonpayment would leave the space vacant, with costly prospects for filing it again, according to Tom Laugero, a partner of commercial real estate brokerage Keegan & Coppin Co. Inc., who specializes in retail properties.

“What are you going to do? You're going to evict somebody for not paying the rent? Because you got nobody to step into there to take the space,” Laugero said. “So if you throw them out, you're looking at six months or a year to retenant and the cost of (setting up) a new operator and (agent) commissions and everything else. If it’s salvageable, you try to salvage your tenancy.”

A common approach by owners of North Bay retail properties, depending on whether the tenants are sole proprietorships, franchisees or other types of businesses has been 30-, 60- or 90-day deferral or abatement of full or partial rent payments, commonly pushing those payments into 2021 and amortizing them interest-free over 12 months, according to Laugero.

5 options for commercial lease renegotiation

1. Full or partial rent abatement — for base rent, common area mainenance (CAM) payment, or both, and for an agreed-upon period of time or based on the tenant’s ongoing financial situation.

2. Full or partial rent deferral, to be repaid in installments, at the end of the lease term, or some other agreed-upon time, or which could be converted to a promissory note, with or without security.

3. Application of the security deposit to cover some or all of the deferred rent. Be careful of local ordinances that might prohibit replenishment of the deposit until the crisis is over.

4. Enhanced lease guarantees.

5. Full lease renegotiation, including term, rent, size of space under lease, etc.

Source: Lerman Law Partners

These arrangements, including “blend and extend” agreements to add the repayment months to the end of a lease term, usually require that the tenants continue to pay occupancy expenses, which for retail commonly are common area maintenance as well as taxes and insurance on the property.

And if a new tenant may be found, it can take a while to get them in place to start generating what revenue they can, Laugero said. In September, he brokered deals for a couple of restaurants to fill vacancies in the Santa Rosa Marketplace regional center, anchored by Costco Wholesale, but tenant-improvement building permits that normally take 90 days took until late June to be able to move in, because of reduced city staff availability during the pandemic.

Sacramento attempts to force commercial lease renegotiation

State legislators have attempted to craft a fix for businesses.State Sens. Scott Wiener, D-San Francisco, and Lena Gonzalez, D-Long Beach, introduced Senate Bill 939, first designed to ban evictions of small businesses and nonprofit organizations for the duration of the COVID-19 health emergency.

The bill was amended a few times to force renegotiation of leases if revenue dropped over 40% because of the shutdowns and operating capacity fell by more than 25% and to allow the tenant to cancel the lease if a new agreement wasn’t reached in 30 days.

SB 939 failed to pass the Senate Judiciary Committee on June 18.

“California faces the very real prospect of a mass extinction event for small businesses and nonprofits — a result that will undermine our economic recovery and inflict countless boarded up storefronts on our neighborhoods,” Wiener and Gonzalez said in a joint statement. “SB 939 was a good faith effort to help them survive.”

Before you renegotiate, prenegotiate

Part of that good-faith effort between tenant and property owner involves understanding the situation both are in, and the landlord should figure out why the tenant isn’t paying rent, Lerman said.

He has seen tenants who can’t pay the rent and tenants that are taking advantage of the economic crisis to not pay rent. That’s why he’s advising property owners to craft a prenegotiation agreement that provides tenants certainty and mental relief and landlords the reassurance that the help is truly needed and there’s a plan for payment.

“The last thing a landlord wants to do is spend the time, money and effort going through a negotiation and reaching a compromise with a tenant, only to find out … that the tenant has hired a lawyer and is now suing the landlord for some breach of the lease that that they claim arose before they signed off on this agreement,” Lerman said. “As a landlord, you're being asked to basically renegotiate the lease in favor of the tenant.”

One of the most important provisions of these prenegotiation agreements, beyond a requirement for the tenant to document the severity of the financial situation, is a statement the tenant agrees to in writing that the landlord hasn’t failed to perform — “defaulted” — on its obligations, Lerman said.

“If the tenant thinks the landlord is in default or is in breach, then that should be part of the conversation,” he said.

Another key provision for the prenegotiation agreement is confidentiality, particularly for multitenant commercial properties such as a shopping center or office building.

“If you cut a deal with one of your tenants, you don’t’ want that tenant talking to the other tenants and telling the other tenants what you did, what they got, what you’ve given up,” Lerman said. “And I guarantee you that tenants talk.”

Jeff Quackenbush (jquackenbush@busjrnl.com, 707-521-4256) covers wine, construction and real estate.

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