The coronavirus crisis and resulting executive orders from the Governor requiring businesses to close or reduce operations have significantly affected many businesses across California. The orders adopting moratoria on evictions and foreclosures have further affected the normal rights and remedies for parties to leases and rental arrangements. This has left both landlords and tenants with many questions.
Below are some approaches to these uncertainties, as well as some common solutions being adopted locally and across the country.
Landlords Landlords should be in communication with their tenants and talking to them about their situation. They should be encouraging tenants to pursue insurance claims, where applicable, and to apply for Small Business Administration Emergency Disaster Assistance Fund loans or the Paycheck Protection Program, which has loans for current payroll as well as some loan forgiveness programs. Landlords may also direct tenants to local assistance programs, including those run by cities and local chambers of commerce or regional foundations.
When a rent concession is requested, landlords should analyze each tenant independently and consider the following factors:
1. Long-term viability of the tenant
2. Tenant credit, current financials and prior years’ financials demonstrating an impact due to COVID-19
3. Tenant payment history
4. Remaining term on the lease
5. Existing lease terms that could be modified in exchange for a rent concession, such as the addition of a relocation clause or elimination of a right-of-first-refusal, right-of-first-offer, expense caps or other similar negotiable provisions
6. Whether a personal guaranty might bolster the tenant’s credit worthiness
7. Landlord cash flow needs and overall property cash flow
Landlords should also review their own insurance policies as well as existing contractual obligations to lenders and to other tenants. Many insurance policies will contain exclusions for viruses or pandemics, but it is worth reviewing the policy to determine if any coverage is available. Many loan covenants require minimum levels of rent or occupancy or require the landlord to provide 12 month trailing rent numbers. Loans often require minimal levels of cash reserve and cash flow. Many lenders would prefer to work with landlords to avoid loan defaults, so landlords should also be in communication with their lenders.
Landlords should also consult their attorneys and accountants to evaluate abatement and deferral requests so that they are structured to maximize the benefit to both landlord and tenant. Some leases have co-tenancy requirements or require specific anchor tenants. Landlords should consider whether obligations to existing tenants will be impacted if certain tenants are lost and the overall impact to the property. Finally, landlords should consider the long-term market implications for the property. Some factors to consider are:
- Property cash flow
- Occupancy rates
- Loans or leverage on the property
- Lender cooperation — covenant deferral or waiver, payment restructure, interest-only payments
- Rental interruption or other insurance without pandemic/epidemic as an exclusion
Just as in the original underwriting of a tenant, landlords should consider the backing of their tenant, their credit history, if there is a guarantor, how much cash the business has on hand and how robust sales were prior to the shutdowns. For a business that was already teetering on the edge, in a relative start-up position or breaking even, landlords might want to offer their greatest support to help these businesses make it through rather than being the straw that broke the camel’s back. This is a crisis that is not of the tenant’s making.
These are individual questions to each landlord and its own property. If a landlord refuses to abate rent (or grants only minor relief) and the tenant goes under, the vacancy loss and costs to fund a replacement tenant could be the same as the abatement requested. The number of viable tenants will be reduced drastically in the economic downturn caused by this crisis, and landlords will need to examine the cost to re-tenant when considering what abatement it can (or can’t afford) to grant/offer.
Some of the solutions that are being used by landlords include:
1. Apply the security deposit (if available) to rent.
2. Collect common area maintenance charges but defer base rent.
3. Reduce, defer or abate rent for a set period of time, with no repayment, in exchange for more favorable lease terms, such as an extension of the term, termination of options or rights of refusal/first offer or elimination of exclusive or restrictive use provisions.
4. Reduce or defer rent for a set period of time with repayment amortized over remaining term. If the term is short (under a year), and rent amounts are high, extend into a promissory note secured by a personal guaranty after term ends.
5. Reduce or defer rent for a set period of time, but tack term onto the end of the lease.
6. Reduce rent to percentage rent where applicable.
7. Suspend late fees and interest.
8. Suspend defaults for continuous operation, co-tenancy and operating hours.
9. Tie rent deferral or abatement to length of shut down so rent starts again when shut down ends, but to avoid unintended results add end date/cap to rent deferral or abatement in case shut down lasts longer than expected (i.e. rent is abated so long as the shutdown order is in place, but the deferral or abatement capped at 2 months).
10. Consider a prohibition against “double-dipping.” That is to say, if the tenant receives relief from another source, the landlord will not also provide relief, thus making relief available to other tenants.
11. Consider confidentiality requirements in any lease modification. Each lease is unique and one solution will not work for all leases. Therefore, it is not advantageous for tenants to “compare notes.”
Tenant Considerations Before requesting a rent concession, tenants should be prepared to demonstrate their loss and actual need for a concession with bank statements, balance sheets, prior financials, evidence of lost orders or other supporting documentation. Tenants should be prepared to demonstrate that they have applied for the various disaster relief programs and explored their insurance coverage. Tenants should understand that there are many fixed costs a landlord must continue to pay even when there is no income (such as debt service, property taxes, insurance). In fact, some costs (e.g. security) will be increased during this time. The information for landlords, above, will assist a tenant in evaluating their request of the landlord and working with the landlord to create a modification that will help both the landlord and the tenant weather this storm.
If the landlord and tenant are unable to reach mutually agreeable terms for a rent concession, what happens? In California, there is currently a moratoria on eviction actions. This simply means that, for the moment, landlords may not pursue eviction actions. While a tenant may not be evicted, the rent is still due and payable and will accrue. When the moratoria is lifted, the landlord may pursue all of their collection remedies, including eviction.
This crisis is unlike any we have undergone before and, though there are many unknowns, we are a resilient country. With cooperation and a universal desire for a vibrant economy, landlords and tenants, lenders and business owners can forge a successful and enduring relationship.
If you have any questions about managing the landlord tenant relationship or the impact of COVID-19 on your business, please contact the authors of this Legal Alert listed at the right in the firm’s Business practice group or your BB&K attorney.