The COVID-19 pandemic has negatively affected the commercial real estate. It continues to wreak havoc in businesses throughout the economy, and the commercial real estate industry is no exception.
The government has ordered business shutdowns, along with social and travel restrictions, and most commercial and social events have been canceled as well. Due to these strict measures, businesses are suffering from losses, some temporary, while some are much more permanent.
One of the many issues that are a result of these lockdowns includes the lease agreements between landlords and tenants. Several questions are being raised:
- How should the commercial landlord react to a tenant’s business closure or loss?
- Are commercial landlords willing to grant rent relief to their tenants?
- What about other payments that are due, such as real estate taxes, maintenance costs, and debt services on the property?
The commercial landlord and their tenant must amicably resolve these issues; otherwise, there will be a surge in lawsuits between landlords and tenants.
Tenants Out of Business
For those commercial tenants whose businesses have shut down permanently, ultimately, discussions to end the lease will be held. Most of these tenants will stress out and liquidate their business to avoid bankruptcy. A lot of them would seek the option of filing for bankruptcy, even though this option would be difficult.
Under the Bankruptcy-code, the debtor-tenant is usually required to pay all rent in arrears and deliver a satisfactory guarantee of upcoming performance by the purchaser of tenant responsibilities. Failing to comply would result in the debtor-tenant being unable to allot a lease to a buyer.
Due to the COVID-19 pandemic, these requirements would be difficult to satisfy. Most companies would be interested in buying a debtor’s entire business or a separate lease. Landlords might have to consider modifying the lease agreements to encourage buyers or find new tenants. Tenants that can’t pay rent probably won’t be able to sublet if they are behind in rent as the leases usually don’t allow for subleasing if there is a default.
Tenants Still in Business
Many other tenants are still in business. They are, however, temporarily closed or partially operating but are still incurring losses. The pandemic caused a decline in business due to which they might be unable to pay their rent for these few months. Landlords can help and be cooperative with these tenants by working out a short-term amendment in the lease.
1. Rent Relief:
The landlord could offer tenants rent relief until the tenant can pay again if there is convincing evidence that the tenant is unable to pay the rent as a result of the pandemic. There are broadly two kinds of rent relief: a deferral or an abatement.
2. Repayment of Rent:
Once the tenant resumes their business and starts earning again, they are to repay the rent of those months. Landlords and tenants should also consider discussing, in detail, the dates when the repayment would be due. A balance needs to be struck between the landlord and the tenants’ rights. Ideally, a landlord would want to have the rent paid at the earliest; however, asking the tenant to pay immediately would detrimentally impact the tenant’s post-pandemic recovery.
3. Tenant reporting and assurances:
Tenant’s obligation of reporting his financial situation, operating status, and receipt of financial assistance under the government’s relief laws is essential to ensure transparency. The tenant should be requested to provide accompanying financial information and estimated timelines as to when the business could recover. This will help in formulating the best rent agreement.
4. Modification of Clauses:
Amendment or suspension of operational contracts, co-tenancy, kick-out article, and other lease terms should be negotiated between the landlord and tenants to avoid disputes.
5. Third-party consents:
Tenants are obtaining binding agreements to contract amendments and rent relief from investors and other third parties. Therefore, loan documents need to be reviewed by the landlord. And before any relief is granted, landlords should ensure that they comply with any loan obligations.
Issues That Affect Short-Term Workout
For both parties to enter into the short-term agreement, evaluation of several financial, critical legal and practical problems should be conducted.
1. Critical lease terms:
Lease provisions such as recapture or submission of space rights, kick-out articles, co-tenancy, initial termination, tenant working hours, and obedience with law requirements, renewal choices and targets, secure payments, and other provisions need to be reviewed. These could affect the negotiations and agreements of the short-term workout.
2. Status of tenant’s business:
Parties must check the impact of COVID-19 pandemic on the tenant’s market and see if the tenant is in a loss, or is unable to pay rent with his current financial situation.
3. Tenant’s short-term business plan:
The tenant will need to discuss and share with the landlord whether they will close their business or still partially operate. And, whether the tenant has any other source of income during this time.
4. Seeking government’s help:
Landlord and tenant should figure out if they are eligible for seeking help from the government in terms of loans, grants, or benefits.
Generally, the landlord and tenant should only work out short-term workouts in case of complete business shutdown or loss. If the tenant is still financially stable to pay the rent even during the pandemic, then there is no need for a short-term workout plan.
Before acting on any of the ideas presented here, please consult with your tax and legal advisors as there is no one size fits all solution and all of the details need to be considered before making any decisions.
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