The “co-tenancy” clause is a lease provision where Tenant A has the ability to take certain actions (such as reduce rent or even terminate the Lease A) if Tenant B does something, such as ceases operations or even terminates Lease B (Tenants such as Tenant A and Tenant B are called “anchor tenants” or “lead tenants”).
Right now, it has the ability to both maim AND kill a retail center.
What is a Co-Tenancy Clause?
The clause is a lease concession granted by the landlord\borrower in order to attract the all-important anchor tenant to the center (Tenant B) after a “lead” anchor tenant (Tenant A) has already leased space in the center. Since the clause assists in creating the all-important tenant mix, it is viewed as a “good” clause. Rent is good! It’s great when consumers are spending money in the center; which of course, builds value in the center, allowing the landlord\borrower to finance the center. Everybody is happy.
The co-tenancy clause is important in bringing about all of this happiness.
So, the clause is overlooked or even applauded at loan origination when the rent roll and the tenant mix is the focus.
Co-Tenancy Clauses Can Sever a Limb
Of course, that perspective changes when consumers stop spending money. When tenants are no longer happy. When rent is slow-paid (or simply not paid). When tenants are looking at the lease as a major drain on their income statement.
In this economy, Tenant B now might do that “something” (such as ceases operations, or terminates Lease B), with the result that Tenant A will have the ability to invoke its right (under the co-tenancy clause) to reduce rent, to terminate Lease A, etc.
The result will be like losing the arms or legs to the retail center.
So, here are some suggestions:
- Add this clause to your short list of “most dangerous” lease clauses and be sure to flag it during your lease reviews
- As you modify leases, DELETE it from the lease
But wait, there is a new, innovative use of the co-tenancy clause, where it spreads like the flu and then threatens to kill the entire retail center.
Co-Tenancy Clauses Can Kill
Be aware of this new, even innovative, use of the co-tenancy clause:
- Tenant B is in distress and is considering ceasing operations or terminating the lease
- Tenant A learns of this, and starts to consider whether it will invoke its rights under the co-tenancy clause
- Tenants C through G (the other, “small” retailers in the center) learn of this. They meet and for the first time, realize that not only is their economic success tied to Tenant B and Tenant A, but that they should take this collective step with each other . . .
- All tenants, as a collective whole, (Tenants B, A and C through G) approach the landlord\borrower for new rental and lease concessions FOR ALL OF THEM.
This type of collective bargaining is taking place. It could spread to a retail loan in your portfolio.
It is flu season for landlords. And for lenders and loan servicers. It could kill.
