Phase in Cotenancy Requirements in Vacant Center

September 14, 2012
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Q: I’m negotiating a lease for space in a shopping center that has many vacancies. I want an operating cotenancy clause in the lease that allows me to pay only percentage rent, instead of a minimum rent and percentage rent, if less than a certain percentage of non-major stores or number of anchors are open and operating. But because of the vacancies, the shopping center’s owner is reluctant to give me an operating cotenancy clause. Is there away to structure such a clause so that the owner will agree to it?

A: An operating cotenancy clause is valuable to have. That’s because foot traffic generates sales, and fewer stores open and operating mean less foot traffic and thus fewer sales. An operating cotenancy clause protects you if the center’s occupancy rate drops below a certain level by giving you options for dealing with the decreased foot traffic, such as paying reduced rent or terminating the lease.

It’s important to get an operating cotenancy clause even if the center doesn’t have many vacancies when you sign the lease, because you never know what may happen down the road. But it’s critical to get an operating cotenancy clause if you’re considering leasing space in a center that has many vacancies. You’re taking a risk by leasing at the center in the first place in the hope that the owner will turn things around. While you may understand that the owner needs time to fill—or refill—its center, without an operating cotenancy clause, you won’t have any protections if it fails to do so.

If the center has vacancy problems—either because it’s new, undergoing major renovations, or has been hit hard by tenant bankruptcies—the owner will be reluctant to give you an operating cotenancy clause. The owner will argue that it’s not fair to impose the tough requirements of such a clause on it when you know going into the lease that the center has vacancy problems, but choose to sign a lease for space at the center anyway. And with vacancies already a problem, the owner may fear being in violation of the operating cotenancy clause’s requirements at the start of the lease, effectively turning the operating cotenancy clause into an opening cotenancy clause—something neither party bargained for.

You can compromise by agreeing to increase the requirements over time. Consider using the following approach to get the owner to agree to give you an operating cotenancy clause: Suggest an operating cotenancy clause that sets out less onerous requirements for the owner to satisfy in the first year of the lease and more onerous ones as the lease term progresses.

Here’s how you can structure the compromise: Suppose you want an operating cotenancy clause that requires 65 percent of the non-major stores to be open and operating at the center. If the center is being renovated and is only 50 percent leased, you can compromise with the owner by agreeing that only 45 percent of non-major stores must be open and operating during the first year; 55 percent during the second year; and 65 percent during the third year and thereafter. This compromise gives you protection that an owner can live with and reflects the actual situation in the center at the time you’re negotiating the lease. It allows you to “hedge your bet” that the center’s occupancy will go up. And by year three of the lease, you’ll have the full protection you initially wanted. Meanwhile, the compromise gives the owner “breathing room” and time to fill up the vacant spaces in its center without having to worry about you immediately exercising your cotenancy rights. If the owner agrees to this compromise, ask your attorney about adapting the following language for your lease’s operating cotenancy clause. (Note that, here, the operating cotenancy clause is tied to the percentage of the center’s non-major stores that are open and operating, but you can adapt this language if you instead want to tie the clause to the number of anchors open and operating.)

Model Language

a. For purposes of this Paragraph [insert #], the “Non-Major Stores Operating Requirement” shall be deemed to be met if the Required Percentage (as defined in paragraph b below) of the gross leasable area of the Center (excluding the gross leasable area occupied by Major Stores) is open and operating.

b. For purposes of this Clause, the phrase “Required Percentage” shall mean:

                        (i) [insert #, e.g., 45]% for the first lease year;

                        (ii) [insert #, e.g., 55]% for the second lease year; and

                        (iii) [insert #, e.g. 65]% for each lease year thereafter throughout the Lease Term.