A co-tenancy provision allows a tenant to exercise specified remedies if certain conditions regarding the presence and operation of other tenants in the shopping center are not met. Co-tenancy issues arise exclusively in the retail setting and come in many different forms. Retail tenants do not sit in retail developments alone. Sophisticated tenants want some form of recourse in the event that the shopping center is unsuccessful and other stores either do not initially open (in a new center) or, once open, close and leave the center (in an existing center). Landlords do not like such provisions because they can severely impact a center’s income steam and viability for reasons that are arguably outside of the landlord’s control.
The first type of co-tenancy provision, typically known as an “opening co-tenancy”, allows a tenant to delay its initial opening and payment of rent, pay alternate rent, and/or terminate its lease if certain tenants, a certain threshold number of stores, and/or a certain amount of the leased area of the shopping center do not open by a specified date. These provisions are most often found in leases of space in a new shopping center development. By requesting such a co-tenancy, a tenant seeks to ensure that certain promised anchor or other tenants will actually open in the center and generate the traffic and tenant mix necessary to increase the requesting tenant’s sales and visibility.
The second type of co-tenancy provision, the “ongoing co-tenancy”, usually provides that a tenant, once open, must only stay open at full rent if a certain number of anchor tenants and a certain percentage of the remaining gross leasable area of the shopping center are also open. If the agreed-upon threshold is not met, tenants typically have the right to reduced rent and, eventually, termination. From a landlord’s perspective, the problem with these provisions is that, if every tenant has an ongoing co-tenancy provision in its lease, no one is actually required to be open. Moreover, if the provision is drafted very specifically and tied to certain named tenants or a certain area in the shopping center, the closure of one named major tenant can trigger a domino effect that ultimately could result in financial ruin for the landlord.
Provisions that landlords can utilize to protect themselves from the severe consequences of an ongoing co-tenancy provision include (i) providing that the co-tenancy clause only applies to the originally-named tenant and only if that tenant is not in default beyond any applicable grace or cure period; (ii) providing that closing for certain reasons is considered “excused” such that the co-tenancy provision is not triggered (such as casualty, condemnation, force majeure and remodeling; (iii) allowing for the replacement of major stores in less than all of the original space, with one or more tenants; (iv) requiring that the tenant give notice of co-tenancy failure before exercising any remedies; (v) imposing a short window within which the tenant can exercise its remedies in the event of a co-tenancy failure; (vi) permitting a reasonable cure period for the landlord to remedy a co-tenancy failure; (vii) requiring a decrease of a certain percentage of gross sales for a certain period after the co-tenancy failure (compared to the same period prior to the co-tenancy failure) in order to trigger all or some of the tenant’s remedies; and/or (viii) designating and/or describing suitable replacement tenants if certain named major tenants go dark.
The factors each party must take into consideration when negotiating either an opening or ongoing co-tenancy clause differ. For example, landlords should consider any existing lender limitations on co-tenancy concessions or the effect that such concessions might have on the landlord’s ability to obtain financing, the current and future anticipated occupancy level of the shopping center in relation to the occupancy that will trigger the co-tenancy remedy, and the possible negative effect on the income stream of the property based upon the tenant’s requested relief. Tenants, on the other hand, should consider the importance of a particular anchor as a “draw” to the shopping center, the tenant’s location in the shopping center in relation to specific anchors, and a tenant’s minimum gross sales requirement for profitable operation in the shopping center.
In any case, it is especially important in today’s uncertain retail market to pay close attention to co-tenancy provisions in retail leases. Tenants should avail themselves of the protections that co-tenancy clauses provide should one or more of the national or regional tenants they are expecting to be a draw for the center fail. Likewise, that same uncertainty should cause landlords to push for limitations on co-tenancy that prevent any one tenant’s closure or failure from causing a financial catastrophe for the landlord.
