The Co-Tenancy Dance: What A Shopping Center Landlord Should Know To Avoid Stubbing Its Toe

8.23.24

News & Publications

Today, many large or creditworthy retail tenants require co-tenancy provisions in their leases, which entitle them to certain remedies if the landlord is unable to provide a certain level of tenant occupancy or certain named tenants in the shopping center.  However, it is critical for landlords to properly negotiate these co-tenancy provisions to not negatively impact the value of their shopping centers.  This article explains co-tenancy provisions and focuses on the most important items that a landlord should attempt to negotiate when encountering them.

1. Opening Co-tenancy.  Co-tenancy provisions generally fall into two categories.  The first is an opening co-tenancy, which provides that a tenant need not open its store at full rent until and unless certain other stores, or a certain number of stores, in the shopping center are open.  An opening co-tenancy is usually found in the context of a shopping center in development, which may still be in the entitlement, lease-up or construction phase, but may also be found in an existing shopping center that is being redeveloped.  Likewise, in the case of a shopping center in an outlying growing area, where demographic projections are still somewhat uncertain, a tenant may want assurances that the shopping center will be built and occupied before it commits itself to opening or paying full rent.
2. Operating Co-Tenancy.  The second general category of co-tenancy is an operating co-tenancy, which provides that once a tenant has opened and is operating, it will be obligated to remain open at full rent subject to certain other stores, or a certain number of stores, also operating.  An operating co-tenancy is not limited to any particular type of shopping center, as no matter where the shopping center is located or how old or new it is, a tenant may not want to be required to stay open in a shopping center where numerous other stores are closed or “key” tenants are closed
3. Key Tenants.  Co-tenancies are often tied to certain so-called “key” tenants because they are viewed by the tenant seeking co-tenancy protection as critical to the success of the shopping center and/or the particular tenant.  Sometimes, a tenant may require that a certain percentage of the shopping center be open or operating before that tenant must open or keep operating at full rent.  Depending on the size of the project a tenant with significant negotiating power may require that a combination of two or even all of the above be satisfied before it must open or keep its store open at full rent – g., a tenant may require that one of two anchor stores, four of seven mini-major stores, and 75% of the shop spaces, or at least 100,000 square feet of space in the shopping center, be open before that tenant is required to open its store and begin operating, or, if already operating, to keep operating at full rent.  Landlords should go to great lengths to avoid providing too many tenants in the shopping center with these types of co-tenancy provisions.  When the economy goes through a “down” period, which it almost always does during the life of an anchor tenant’s lease, a landlord that has provided too many co-tenancy rights often faces a “house of cards” situation where one-by-one tenants with co-tenancy rights start to exercise rent abatement or other remedies leading to further co-tenancy problems, with the ultimate result being lender issues and, in the worst case scenario, financial ruin.
4. Replacement Tenants.  Tenants seeking co-tenancy protection typically specify the name of the anchor and/or mini-major store(s) that must be open and operating, as landlords usually try to obtain commitments from anchors and mini-majors before committing to develop a shopping center, and the tenant is relying on the existence of that (or those) particular tenant(s).  While a landlord may agree to a co-tenancy provision, it should avoid being locked into the specifically listed stores, because landlords are only too aware of the fickleness of the retail sector – today’s “hot” retailer might file in bankruptcy in a few years.  Therefore, landlords should require that a co-tenancy provision be satisfied if a “replacement” tenant or tenants is/are open and operating in lieu of a key tenant that is no longer operating.  This is usually acceptable to tenants if the replacement tenant is reasonably comparable to the named or departing tenant.  For example, a landlord may require that a replacement tenant which occupies most of the vacated space, has a similar business or a business that has a similar customer draw to the shopping center, and is comparable in creditworthiness to the departing tenant be deemed to satisfy a co-tenancy provision.  A landlord should also make sure that it can replace a “key” tenant with multiple tenants (i.e., usually 2) that will in combination be a similar customer draw as the “key” tenant being replaced.
5. Tenant Conditions That Must be Satisfied Before Utilizing Remedies for Co-Tenancy Violations.  Before a tenant can invoke a remedy under a co-tenancy provision, the landlord will want the tenant to satisfy certain conditions.  Foremost is that the tenant is not then in default under the lease.  But such conditions should also include that the tenant is itself operating at the time of a violation of the co-tenancy provision, and that the right to invoke the remedy is personal to the original tenant that signed the lease.  The landlord may also require that the tenant show a drop in sales during the co-tenancy violation period as compared to the period prior to the violation.  Finally, the landlord should make certain that, if the tenant invokes a co-tenancy provision, the remedy elected by the tenant for such co-tenancy violation is the tenant’s sole remedy for such violation.  The landlord does not want to be in a situation where the tenant obtains the benefit of a co-tenancy violation remedy, such as rent abatement or termination, only to have the tenant sue for other damages later.
6. Landlord Cure Rights.  The landlord should have the right to cure a co-tenancy violation before the tenant can invoke any remedies, as the violation might occur with little or no warning, such as a bankruptcy filing.  The cure right almost always involves the right to try to obtain replacement tenants for the key tenants, or, in the case of an occupancy threshold, to try to fill the vacant space.  Therefore, a landlord should only agree to co-tenancy remedies if the violation continues for a significant period, with the amount of time depending on the type of remedy that the tenant may elect.
7. Tenant Remedies for Violation of Co-Tenancy Provision.  The remedies that a tenant will want for a co-tenancy violation will commonly fall into three categories.  The first such remedy is rent abatement, where if a co-tenancy violation is not cured within the stated time period, the tenant has the right to pay a lesser rent for so long as the co-tenancy violation exists.  The lesser rent is typically based on either a percentage of the fixed annual rent or percentage rent only during the violation period.  The second remedy for a co-tenancy violation is termination of the lease.  But, as this is an extreme remedy, the landlord should not grant it unless the co-tenancy violation continues for an extended period – at least six months, often a year, and even longer if the space is particularly large (such as a space commonly occupied by retailers like Target, Home Depot or Wal-Mart), and only if the tenant’s sales are materially impacted.  The third remedy for a co-tenancy violation usually only arises if there is an opening co-tenancy violation, and allows the tenant to delay the opening and/or rent commencement date (although most tenants will also want to have the right to open but with rent abatement as set forth above).  However, the landlord should preserve the right to terminate the tenant’s lease if the tenant fails to open for an extended period.  The landlord cannot be in a position where it has premises leased to a tenant for an extended period with no rental being received and/or space remaining closed.
8. Return to Full Rent; Recapture.  If a tenant elects rent abatement, the landlord will not want the tenant to be able to take advantage of the substitute rent provision for the remainder of the lease term.  In such an instance, a landlord will typically require that if the co-tenancy violation is not cured within a certain period (typically one year) and the tenant has not terminated the lease within that time, then the tenant will have to return to paying full rent.  The obligation to return to paying full rent is based on the theory that if the tenant is remaining in the shopping center despite the co-tenancy violation it must believe that its store is doing well enough to warrant continuing at full rent.  If the tenant does not want to return to full rent, then the landlord should insist on the right to recapture the premises or the tenant exercising a termination right.

As is evident from the discussion above, co-tenancy provisions, if not drafted properly, can provide a tenant with tremendous control over a landlord’s shopping center, including its rental stream.  Nevertheless, sometimes a landlord must weigh the benefits of attracting an anchor or very desirable tenant to its shopping center against the potential pitfalls inherent in granting such a tenant co-tenancy protection.  If such co-tenancy provisions are drafted properly, the landlord can significantly mitigate its risks in the unlikely event that the co-tenancy provision is violated.