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5 Steps to Take When Commercial Tenants Cannot Pay Rent

Marianne Schaefer in Legal/Financial on May 7, 2020

New York City

Commercial tenants, rent arrears, workout, co-op and condo boards.
May 7, 2020

The current pandemic has thrown co-op and condo boards with commercial tenants into uncharted territory. The complete or partial shutdown of nonessential businesses has left many commercial tenants unable to pay their monthly rent. As a result, boards are being forced to rethink old ways of dealing with their commercial tenants – and with unexpected revenue shortfalls. Here are five steps for coping with the new realities:

Step 1: Look at the Lease. Everything will flow from the language in the lease. Occasionally, though rarely, commercial leases contain a clause for a rent abatement if the tenant cannot get access to the store. “We have a number of these situations pending,” says Stephen O’Connell, a partner at the law firm Smith, Gambrell & Russell. “Every lease is different, and the relationship among the parties is different. So are the tolerance levels and the leverage. This all has to be looked upon separately.”

Step 2: Talk to Your Lender. After understanding the language of the lease, the board’s next step is to talk to its lender. “Before you agree to any kind of formal rent deferment, you have to look at your loan documents and see what rights you have,” says Danielle Comanducci, an associate at Smith, Gambrell & Russell. “Most times the loan documents provide that you’re not allowed to forgive any rent or to not enforce the terms of the lease without the lender’s consent.”

In addition, lenders might be amenable to negotiate a reduction or a deferment on rental payments. “No mortgage document will have such a provision,” O’Connell says, “but if the commercial tenant has the ability to eventually pay up, lenders might agree to a deal. They will look for documentation to support such a request.” 

Step 3: Get Ready for a Workout. If the lender consents to allowing the board to negotiate with a commercial tenant, the board needs to realize that this is not the time to play hardball. “If a board kicks the tenant out, they will have a vacancy, and we know that retail tenants are not knocking on the door very hard right now,” O’Connell says. “The smartest thing is to do everything you can to make it palatable for the tenant to stay. Otherwise, you also might be left with a lawsuit that might be very difficult to collect. A vacancy is even worse than having it occupied with a tenant who pays reduced rent, because it is blight. Darkened stores on the first floor of your building just bring everything down.”

Step 4: Pick the Right Option. A board’s options are limited, but it’s important to pick the one that works best for both the tenant and the building. The board might agree to reduce the rent, defer a portion until a set later date, or use all or part of the tenant’s security deposit to cover a rent shortfall. Before making a final decision, boards should also look at the tenant’s balance sheets to determine if they really are unable to pay rent. “There is a risk at this time that a business does have the means to continue paying rent, but they might think, ‘Hey, why shouldn’t we use this situation to our advantage?’” O’Connell warns.

Step 5: Prepare for a Rainy Day. While some boards might be able to weather a decline in rental income for a few months, this pandemic’s ending is unknown. “Thankfully, all of our clients have been in a good financial position going into this crisis,” says Peter von Simson, chief executive officer at New Bedford Management. “If things get tight, though, boards could borrow from their capital reserve account, or they could borrow from their line of credit. I don’t think a lender would let you take out a loan right now. If this becomes an ongoing issue, then boards obviously will have to address this in their operating budget.”

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