While there may be no obvious reasons to do so, renegotiating the terms of an existing lease can make sense for both landlord and tenant – especially in difficult economic times where a tenant may be struggling to make ends meet. In this case, it may be wiser for a landlord to accept less rent, temporarily, than to force a tenant into economic ruin by insisting on the original terms of the deal. This article will highlight some of the options to consider, as well as some points to keep in mind when renegotiating a commercial lease.
The most commonly sought amendment in lease renegotiations is a reduction in rent. However, a rent reduction can be combined with other amendments which, over the remaining term of the lease, would be designed to minimize the economic loss to a landlord. The landlord could agree to a reduction or abatement of rent for a certain period of time in exchange for an extension of the lease during which rent would be increased allowing the landlord to recapture some or all of the foregone rent.
A landlord could also take the opposite approach by agreeing to a rent reduction along with revising the lease to a month-to-month term. This allows a landlord to still earn some income yet is in a position to terminate the lease in short order should a more able tenant be found.
A landlord may also consider changing the rent structure from that of a fixed rent to a percentage rent. This would alleviate some of the stress on the tenant during a slow sales period while allowing the landlord to recover higher rents when tenant sales revive. However, this requires more management on the part of the landlord, and the landlord must often rely on statements regarding sales prepared by the tenant.
A tenant may also want to take advantage of an economic slowdown to renovate the premises. A landlord may consider a reduction or abatement of minimum rent during renovations in return for the benefit of improving the premises.
The renegotiation of rent also provides the landlord with the opportunity to request additional security from the tenant. As such, a landlord may consider asking for an indemnity or guarantee from the principal or principals of the tenant, or increasing the limits of an existing guarantee. A landlord may also go so far as to ask that the principal(s) support the guarantee with a collateral mortgage against properties owned by the principal(s).
More sophisticated landlords and tenants may consider a cash security deposit or a letter of credit securing the performance of the tenant’s rental obligations. However, both forms of security have their advantages and disadvantages. Letters of credit are easier to deal with and less expensive for the tenant, but have finite terms and often must be renewed from year to year. Cash security deposits held by the landlord are more accessible by the landlord, but form part of the estate of a bankrupt tenant. As such, the trustee in bankruptcy could require the landlord to pay over the security deposit.
A landlord may also require the tenant to provide the landlord with a security interest over the personal property of the tenant. However, to be perfected, such interests usually must be registered with the appropriate personal property registry and must be monitored for renewals. In addition, the tenant’s lender will invariably require postponement of landlords' security interest. Nonetheless, a general security agreement may still be worthwhile for a landlord especially where there is significant value in the tenant’s personal property.
Partial Surrender of Premises
Rather than reducing the rental rate, a landlord and tenant may simply reduce the amount of space that the tenant is leasing. However, this is of little use to a landlord unless the surrendered space is marketable and the landlord has another party ready to lease the surrendered space. Any agreement to surrender space should also take into account the costs to the landlord to re-demise the space.
Before agreeing to any amendments, the landlord must consider whether revisions to the lease run afoul of contractual arrangements with other parties. For example, the landlord's financing may prevent the landlord from agreeing to reduce rent, or reduce or extend the term of the lease, without the lender's consent. Most non-disturbance agreements also require the lender's consent to material changes to a lease.
A landlord should also consider predecessor tenant(s) or indemnifiers or guarantors. If an indemnity or guarantee was given in the context of an assignment of the lease, such predecessor tenant(s) or indemnifiers or guarantors may not be liable for such amendments.
Finally, and perhaps most importantly, a landlord should consider whether a renegotiation of lease terms is actually warranted. In other words, a landlord should require the tenant to demonstrate that reduced rent will enable the tenant to continue to operate its business and pay rent. To this end, a landlord may request the tenant to provide the following:
- audited financial statements of the tenant for the last two or three fiscal years
- the monthly financial statements of the tenant for the last few months
- statements of cash flow for the last few months;
- cash flow budgets and forecasts for the upcoming year
- a revised business plan
The landlord may also consider requesting that the tenant's lenders/creditors be involved in any discussions that might occur.
Where a perfectly valid lease is in place, most landlords will instinctively resist changing its terms, especially if such changes mean accepting less if only for a short period of time. However, some short term pain on the landlord’s part may go a long way to enabling the survival of a tenant which in most cases will benefit the landlord in the long run.