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Co-tenancy 101

By: Dan Halprin

For landlords and tenants alike, co-tenancy provisions are among the most important pieces of the retail-leasing puzzle. The right mix of tenants can create powerful synergies. For a retail tenant, the stakes are high: the right neighbors can mean the difference between success and failure. Consequently, understanding the different types of co-tenancy clauses, becoming familiar with the nuances and negotiations that accompany their inclusion in a standard lease, and appreciating the concerns and considerations that make them so important should be a priority for any retailer.

Categories and consequences

Co-tenancy provisions apply to leases in a multi-tenant shopping center setting — from enclosed malls and strip centers to larger mixed-use developments. A co-tenancy clause makes it possible for existing and prospective tenants to protect themselves by ensuring that they will not have to open their doors until and unless they have reasonable assurances that key anchors and other high-profile tenants are open and operating. Every retailer wants to be part of a vibrant commercial environment, with a high occupancy rate, positive synergy with other tenants, and the ability to maximize their operational flexibility going forward. A thoughtful and well-written co-tenancy provision maximizes a retailer’s chances of establishing and maintaining those priorities. Keep in mind, however, that a landlord’s willingness to include co-tenancy provisions in a particular lease is dependent upon a number of factors, such as the tenant mix and economic conditions.

Co-tenancy provisions apply to both new construction and existing centers. The latter scenario typically features more certainty (and therefore a little less risk for the landlord) as there are fewer variables involved. The tenants, leasing terms and makeup of an existing center are generally known at the time a lease is signed and much more predictable than when dealing with a new development which includes multiple unavoidable complications (such as permitting, construction, complex tenant timelines and store opening logistics, among other factors).

There are two primary categories of co-tenancy provisions: those that cover the conditions in which a retailer opens its doors, and those that establish certain standards and expectations for ongoing operations.

Opening co-tenancy clauses 

Co-tenancy clauses that cover the opening of a retailer or a shopping center are designed to ensure that retailers don’t have to open for business unless and until certain other specified tenants open their doors (typically referred to as “co-tenants”). Typically, the co-tenant or co-tenants are clearly identified, although co-tenancy clauses may also/instead include a provision stipulating that the retailer is under no obligation to open for business until a certain occupancy percentage has been achieved. Co-tenancy clauses are usually negotiated during the letter of intent stage of the leasing process, with representatives from the tenant’s side (typically the broker) pushing for favorable terms.

From a retail tenant’s perspective, the advantages here are evident: no retailer wants to open if there is little or no foot traffic, and reserving the right to wait until an anchor tenant or headline brand has opened its doors reduces the chance of a sluggish start. Perhaps unsurprisingly, this “you first” dynamic can sometimes create a real chicken-or-the-egg scenario for landlords, who may attempt to work out an alternate arrangement with tenants that allows for some wiggle room. Tenants and landlords, for example, may agree to include a clause that allows the tenant to pay reduced rent (typically referred to as “alternate rent”) if they do open prior to the satisfaction of the co-tenancy requirement. This is typically either a flat percentage reduction or perhaps a figure based on a percentage of gross sales (typically between 2% and 3%). A co-tenancy clause should also state the remedy or remedies that are available to the tenant if the co-tenancy requirement fails to be satisfied by the specified deadline.  Tenants typically have the right to terminate the lease in the event of such failure.

Ongoing co-tenancy clauses

The second category of co-tenancy clauses covers ongoing co-tenancy considerations. Such language typically states that if one or more specified co-tenants are no longer open and operating for business (or, in the alternative, if the center falls below a certain occupancy rate), the landlord has a certain number of days to secure one or more comparable replacement tenants. If the co-tenancy requirement goes unsatisfied for a period of time (typically anything from 90 to 180 days), then the typical ongoing co-tenancy provision will provide that tenant will pay alternate rent (see above discussion on alternate rent) until the requirement becomes satisfied, although some co-tenancy provisions provide that rent is immediately reduced once the co-tenant is no longer operating. If the co-tenancy requirement remains unsatisfied for a longer period (commonly between 12 and 18 months), tenants typically will have the right to terminate the lease.

It is important for tenants to properly define the standard for comparable replacements so that the landlord is only able to satisfy the co-tenancy requirement by replacing the existing co-tenant with equally established and known tenants. For example, the landlord should not be able to replace a national chain with a mom and pop/start up business that likely will not bring the same cache and traffic to the center. For this reason, astute tenants will seek a replacement tenant concept that only allows national tenants to be replaced with other national tenants or, as a fallback, regional tenants with a minimum number of stores in the region.

Tenants may also seek to establish other criteria for the replacement tenant, such as requiring that such tenant has been in business for a minimum number of years (to root out start-up concepts), setting forth the minimum length of the term of such replacement tenant (to protect against potential vacancies later in the term), and requiring that the replacement tenant operate in the same category as the original tenant.

There is some room for negotiation here, as landlords might negotiate for the right to substitute a co-tenant with more than one replacement tenant (particularly when a larger space is at issue) or to satisfy the co-tenancy requirement by having one or more replacement co-tenants operate in, by way of example, less than 100 percent of the vacant. In addition, landlords will push for more time to satisfy the co-tenancy requirement in the event a co-tenant’s business is closed due to repairs, remodeling, or events outside of the co-tenants control, such as a fire.

Priorities and best practices

While retailers would be wise to engage the services of an experienced attorney with demonstrated expertise in retail leasing, decision-makers should make a point to familiarize themselves with the basic guidelines and best practices that should be addressed in the co-tenancy provision of their lease:

Cover your bases. Tenants should be sure that the co-tenancy language in their lease covers both opening and ongoing co-tenancy provisions.

Get specific. From tenants to timeframes, the more precise and specific the language and details are in your co-tenancy provision, the better.

Give yourself a cushion. Astute tenants will give themselves some leeway by including language that provides some time after the co-tenant or co-tenants open to get their own business up and running before being obligated to pay rent and other expenses to the landlord.

Be flexible. Tenants would be wise to recognize that while they are well within their rights to demand standards and specificity with respect to acceptable replacement co-tenants, some flexibility might be necessary in order to reach an agreement with the landlord. There are a limited number of comparable replacements for a 120,000-sq.-ft. department store that closes, an all-too-common occurrence these days.

Finally, make sure that your co-tenancy provisions include specific remedies and courses of action in the event that the conditions outlined in the lease are not satisfied. If a worst-case-scenario arises and co-tenancy requirements are not met, it is essential to have a viable and legally protected course of action available to you.

To read the original article in Chain Store Age, click here.