TenantLandlord Relations Written by Ron Wilson

Foreword by Gary A. Wright

Published by

G.A.Wright MARKETING INC

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Foreword by Gary A. Wright A major obstacle confronted by many retailers in formulating an exit strategy is the problem of a lease obligation and terms that may prevent termination. Rather than considering an executed lease unchangeable, a retail tenant should look for ways to negotiate with the landlord for a solution that is mutually beneficial. If a retailer has a business that is failing or if a better lease opportunity appears elsewhere, a retailer generally wants the right to terminate, sell, or sublease the occupied space. In some cases, there may be a desire to reduce lease obligations if that will move the business into a profitable operation position. The landlord generally has a lease that will allow rapid recovery if a tenant defaults. In the event that the landlord sees an opportunity to improve the shopping center by canceling a lease, relocating a tenant, or remodeling, the flexibility to do so is desirable. Since landlords generate a large percentage of revenue from taking a percent of sales above a given threshold the landlord does not want under-performing tenants. In many cases, the objectives of the landlord and the tenant are not impossibly in conflict and reasonable negotiation can resolve conflicts. In the case of small tenants, the landlord normally has negotiating power and requires the tenant to sign a lease that favors the landlord. However, the tenant should always be willing to open negotiations intended to produce a result that is “fair and equitable” to both landlord and tenants regardless of the provisions of a lease. It has been my experience of many years and hundreds of tenant landlord negotiations that a tenant asking a landlord for any lease concession is normally met with a prompt refusal. The landlord has an overriding concern with protecting the integrity of the lease and not varying from the written word. However, the effort to negotiate should still be made. If the argument is reasonable and well supported, it is likely that the landlord’s position will soften. At this point of negotiation a professional, experienced in tenant landlord relations in the retail industry, is very helpful at bringing a landlord to the table. An unresolved dispute between a landlord and tenant over the obligations of a lease can always end up in court. Therefore, it makes sense to negotiate with the thought in mind that a court may review the negotiation and make a ruling based upon the good faith that the parties exercised or failed to exercise.

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If a tenant’s business is failing financially, one option to consider is an analysis of the lease obligations to see if a modification of those obligations might allow the business to succeed. This analysis can form the basis for a negotiation with the landlord to reduce rent or to allow a sublease or termination. This type of analysis and negotiation is increasingly common. Certainly there are many actions taken by landlords that may have an adverse effect on the business of a tenant. Although the provisions of the lease may allow these actions, they can nonetheless be raised in a discussion of whether or not the landlord has been fair and equitable in its dealings with the tenant. If a tenant wants to sublease space or sell a lease, this should be a subject of negotiation even if the lease contains provisions to the contrary. In some cases, this is the only way a tenant in trouble can solve the problem and still make sure the rent is paid. Regardless of the negotiation taking place or the relative interests of the tenant and landlord, it is usually in the interests of both parties to be reasonable and to negotiate in good faith to solve their problems while minimizing the damage caused to the other party. Although the initial negotiating position may be one of intransigence on the part of the landlord, it is likely that the landlord can be convinced to be reasonable. Frequently, the negotiation opens with a landlord willing to make no concessions. The tenant may then make the decision to close the store. The store goes dark, rent and common area maintenance payments cease, customer traffic is reduced because one of the shopping center draws is gone, and the look of the center is impaired because of the empty space. The landlord may then become much more willing to look for a solution. If the tenant has offered a reasonable solution to begin with, which the landlord has rejected, the tenant will very likely have an advantage when put to the “fair and equitable” test. Reasonable people can often negotiate a solution to a problem. However, negotiations over lease may need to be addressed by a qualified professional. A local generalist is often not up to the task of producing the best outcome for the retailer who may be dealing with a large, sophisticated landlord. Since these negotiations often involve retailers and landlords that operate in many states, the best negotiators are familiar with the issues in many jurisdictions.

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Tenant-Landlord Relations By Ron Wilson

Unfortunately not every retail location is going to be a winner. So what does a retailer do to protect himself should a location not work?

First, understand that the lease you will sign was written by the landlord to protect the landlord; all the clauses favor the landlord and they are a compilation of all the situations where he has been exposed or lost income. The lease’s ultimate purpose is to protect the rent stream and occupancy with quite strict language. Your job (or the job of your negotiator) is to try and obtain a more balanced lease.

These negotiations are crucial in protecting your downside exposure.

I will outline some of the areas where you will need to be tough in order to have viable options in the event of an unsuccessful location.

Pre-Lease Execution Strategies Corporation, Sub-S Corporation or L.L.C

Your primary consideration in protecting yourself is the choice of the entity that will sign the lease. I recommend that each location be leased by a separate corporation, Sub-S or L.L.C. This protects you in the event the location is unprofitable since no assets from any of your other stores will be affected --clearly giving you the option of declaring bankruptcy and closing the store.

You are also in a better position to renegotiate lease terms with the landlord should both parties want to keep the location open. Remember, all landlords do separate L.L.C.’s for each of their properties thereby protecting their overall portfolio against any bad centers.

Personal Guarantee Many landlords will require that you provide a “personal guarantee” to the lease since they recognize that the separate corporation you are using for any given location has limited assets. Please note, if you sign your lease as an individual, you are already the de facto guarantor; so you can see a personal guarantee is not in your best interest and they are to be avoided. However, when a guaranty cannot be avoided, here are a few suggestions to limit your exposure:

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Limit the term of the guaranty (for example, “only the first three years of the term.”)

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Limit the term of the guaranty to the amount of allowance a landlord may be giving you (i.e., if the landlord gives you a $30,000 allowance for the build-out of the store, then, as a rule of thumb, by the time you have paid the first $60,000 of minimum rent the landlord has recovered the allowance and the guaranty should end.)

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If you have to close the store due to poor sales, then do a guarantee whereby you would agree to pay a termination fee equal to 3 to 6 months’ rent.

Subletting and Assignment The key language for any assignment or subletting are the words “not to be unreasonably withheld, conditioned and delayed.” By adding this language you are generally able to sublet or assign the lease to another party. Most landlords will try to keep this language out of the lease and will counter with some requirements that will have to be met before they will give their consent. The following are the typical and usual points insisted upon by landlords. 1.

Net worth of any new tenant must be greater or equal to your net worth.

2.

Experience level of the new tenant must be a certain reasonable level.

3.

Your Use clause would remain the same (i.e. shoe store would stay a shoe store).

4.

Current tenant would have to stay on the lease.

Many landlords will further try to control any assignment or subletting by adding a clause giving the landlord the right to terminate the lease in the event you even request an assignment or subletting. This termination provision is easily corrected by the addition of a clause allowing you to withdraw your request and negate the termination.

Kick outs Volume This language allows either landlord or tenant to terminate the lease because of poor sales performance. Kick outs are generally figured using the lease’s gross sales definition as applied to a specific measure period (usually 3rd or 5th year of the term). These kick outs can be mutual or tenant only and they

can be written to apply different gross sales volumes to the landlord or the tenant.

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Co-tenancy In certain negotiations the landlord or tenant may negotiate a lower rent in order to keep the tenant in the location. It is common to explore this situation because the landlord does not want an empty space and if the tenant has paid their rent on time and has not been a problem then it is in the landlord’s best interest to keep the tenant. A new kick out is usually negotiated at this point.

Post Lease Execution Strategy The above remedies are proactive; that is, they are negotiated at the time the deal is negotiated. The following items are available when proactive measures aren’t available.

Buyout This situation is available when all other negotiations have failed. The tenant simply moves out and closes the store and then tries to buy-out of the lease. When the tenant is losing money, it may well be cheaper to close and pay the rent than to remain in operation. And when the landlord will not agree to terminate the lease there is little else to do.

Once you have “gone dark,” your negotiation position is stronger because the landlord has an empty space and wants it filled by another tenant. Since most real estate is valued by “supply and demand,” the better your real estate and the occupancy of your center the easier it will be for the landlord to re-lease the center and the easier it will be for the tenant to negotiate the buy-out.

Typically, most buy-out payments are in the range of 3 to 12 months of rent and charges.

If a court case does develop, the landlord in most states must mitigate damages, therefore it is highly unlikely that a judge would give the landlord more than 1 year of rent and charges with the prevailing thinking being that if the landlord has secured a replacement tenant within a year then he is not actively trying to lease the location.

Additionally, keep in mind that if the landlord is required to mitigate, he must offer the dark location to any replacement tenant before another location. State law and the landlord’s lender both apply pressures.

Bankruptcy This course of action is clearly that of last resort. Because of state and federal laws, please make sure you get sound advice from your attorney and accountant before selecting this option.

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Conclusion In conclusion given the trend of the shopping center business and rapidly changing demographics, the pre-lease exit strategies are perhaps, after rent, location and size, the most important issue requiring your attention. Make sure you treat it appropriately.

About Ron Wilson Ronald R. Wilson is president of Ronald R. Wilson and Associates, Inc., a Colorado based lease consulting firm since 1990. With over 25 years’ experience in the retail profession, including 10 years as Senior Vice-President of K-G Men’s Stores along with numerous retail positions with department store chains, he is noted to be one of the most knowledgeable lease consultants in the country.

If you wish to contact Mr. Wilson, author of this publication, his address is 6085 S. Iola Way, Englewood, CO 80111, or he can be reached at 303-691-0706, fax 303-681-0414, or email [email protected]. He will be happy to answer any questions you have at no costs to you.

About G.A. Wright, Inc. G.A. Wright, Inc. provides consulting and marketing support services to retail companies that are closing stores.

G.A. Wright works with between 500 and 700 retailers annually in six countries, including all 50 states, Puerto Rico, the Virgin Islands, Canada, the United Kingdom, the Republic of Ireland, Australia, and Mexico. The client list includes general merchandise and specialty stores in every segment of retailing.

Consulting services provided by G.A. Wright, Inc., in conjunction with store closings, address the following issues: timing, planning, merchandising, markdowns, advertising, signage, employee training, security, and public relations. Advertising and marketing support programs are also provided, with the following menu of services: target market research, full-service direct mail advertising, print advertising design and copy, point-of-sale materials including production and fulfillment, and frequent shopper programs.

G.A. Wright, Inc. headquarters in Denver, Colorado, where it has been managed by its founder and President, Gary A. Wright, since its inception in 1981. Gary Wright can be reached at 303-333-4453.

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