One of the most important clauses of a lease contract for both the commercial landlord and the retail business owner is the co-tenancy clause. Without properly negotiating the co-tenancy provision, you put your business at risk for serious financial hardship. It's a critical point of the commercial lease that both the retail tenant and the landlord should pay attention to because it can lead to closing the store, foreclosure, or bankruptcy for either party. Read on to gain a better understanding of what a co-tenancy clause is and why it matters.
What is a co-tenancy clause?
A co-tenancy clause is a provision in the retail lease that specifies a minimum co-tenancy requirement, which the landlord must maintain or they are in breach of contract. If the lease term is not met, the tenant will have the right to reduce rent until an appropriate replacement tenant is found by the landlord.
This alternative rent amount is to compensate for the probable reduction in exposure and thus sales for the tenant that remains. An anchor tenant is much more likely to successfully negotiate beneficial terms, but a smaller tenant may be able to secure at least some co-tenancy protection, especially an opening co-tenancy clause, which is certainly better than none.
What does it do?
A co-tenancy agreement, also known as a rent abatement provision, sets the specific lease obligations the landlord must maintain for them to receive the full agreed-upon rent. If there is co-tenancy failure, a percentage of rent will be paid until the lease tenancy is met again.
Depending on the negotiations, a provision to allow for a sublease or even getting their full security deposit back after early termination of the lease agreement if a replacement tenant is not found quickly enough can be incorporated. This is a legal obligation that the landlord agrees to, barring a force majeure provision, which the court has consistently upheld. So don't assume that this co-tenancy right is an unenforceable penalty.
Co-tenancy clauses exist because the amount of rent paid is based on the probable exposure and foot traffic a particular commercial space has. If the prospective tenant is interested in a retail space in a fully occupied strip mall with an anchor tenant store that is well-known and a consistent draw for consumers, they will be willing to pay a reasonable amount of rent for that space. But if they sign a five-year lease and several stores vacate two years in, they won't get the same traffic and therefore should not have to pay the same rent.
Why does it matter for retailers?
The co-tenancy provision is to protect the tenant from reduced foot traffic when an anchor tenant vacates the property. If multiple tenants or a key tenant terminates their lease early or does not renew their lease, it can significantly impact all the other tenants. Without the draw of multiple stores, there will be fewer shoppers, which will ultimately hinder sales for the remaining tenants.
This is especially important for a smaller tenant or new business, which is relying on customers coming across their storefront without prior knowledge. The rent relief can help offset the financial hardship for the tenant until vacancies are filled.
Why does it matter for a landlord?
We've focused on tenant benefits, but it's critical information to understand for the landlord as well, since it can lead to further rent reduction at a point when there is already less income due to occupants vacating.
To compensate for the potential risks of a co-tenancy condition, it can be beneficial for a landlord to include a force majeure clause. This can supersede the co-tenancy requirement if there is any unforeseen major disruption to normal tenancy, like a natural disaster or pandemic. Within the co-tenancy clause, you can stipulate a longer period of time to find a replacement tenant to give yourself as much leeway as possible to meet straight-line rents. You can also negotiate a minimum rent that allows you to maintain a sufficient income to cover expenses so you're not faced with bankruptcy.
Remember that co-tenancy default has a history of being upheld in trial court, so it is a very serious component of the lease. As such, this is typically a tough point of negotiation between the landlord and tenant. The ideal scenario will be one where both the landlord has a reasonable amount of time to find a replacement tenant while still offering the tenant some financial relief for the difficulties associated with low tenancy.
Real estate contracts can be drafted by professional lawyers who have experience navigating this co-tenancy clause and more to ensure that everyone is protected.