Recent Court Ruling Highlights Importance of Co-Tenancy Clauses in Retail Leases
As more retail tenants file for bankruptcy and close shop, surviving tenants in strip centers and malls are increasingly invoking co-tenancy provisions in their leases to pay reduced rent.
Under a co-tenancy clause, which is a common provision found in many retail leases, a tenant is entitled to either pay reduced rent (typically based on gross receipts), or even terminate their lease, if an anchor tenant or a specified number of smaller tenants close for business and are not replaced by a comparable tenant or tenants within a specified cure period.
Co-tenancy clauses can create a domino effect in a retail center and are causing increased pain for landlords at a time when rents are continuing to fall. Savvy tenants are paying close attention to their co-tenancy clauses in an effort to cut fixed costs as sales continue to slide. A website, www.co-tenancytrack.com, is assisting tenants in these efforts. As a result, landlords must identify and work with tenants whose leases include a co-tenancy provision.
A recent Georgia Court of Appeals decision, Rainbow USA, Inc. v. Cumberland Mall, LLC (PDF), highlights the complexity involved in drafting a co-tenancy clause for Georgia landlords. In Rainbow, two department stores in Cumberland Mall closed, and the tenant invoked its right under the lease to pay 6% of gross sales in lieu of minimum rent. The landlord subsequently demolished the JC Penny premises and later constructed a Costco warehouse in a free-standing one-level building adjacent to the mall. The landlord then sought to return the tenant's rent to the pre-violation level. On appeal, the court reversed the trial court and held in favor of the tenant . The court reasoned that because the Costco was a free-standing building, it constituted an outparcel rather than a replacement tenant "in the shopping center." Therefore, the construction of the Costco store did not remedy the co-tenancy violation created by the closing of the mall anchors.
As indicated by the court's analysis in Rainbow, co-tenancy clauses are often lengthy and complex, and the outcome in any given situation will depend on the specific wording found in the lease. Because tenants have the leverage in the current economic climate, landlords in lease negotiations must attempt to limit their exposure in the event of a co-tenancy violation. Specifically, there are several ways in which a landlord may accomplish this:
- The landlord should have an adequate period of time (e.g., 90 days) to cure the violation before the tenant may invoke its remedies.
- There should be certain conditions that must remain satisfied while the tenant is paying reduced rent, such as the tenant remaining open for business (in order to mitigate further losses due to co-tenancy violations) and the tenant complying with the other terms of the lease.
- The lease should limit the length of time that the tenant may pay reduced rent. A typical provision may require the tenant to either terminate the lease or resume paying full rent within 12 months of the violation. (Although in the current environment, tenants may demand-and receive- longer periods of reduced rent.)
- The right to pay reduced rent should be waived if the tenant exercises a right to extend the lease term while the violation exists.
In today's environment, co-tenancy clauses will continue to be put to the test. Because numerous variables are involved in these provisions, each tenant will have varying rights and remedies depending on the specific wording of their leases. Many landlords may find that the outcome of these co-tenancy negotiations will be the tipping point in determining whether the landlord survives the current downturn.
