Is Your Commercial Lease Recession-Proof?
With the Federal Reserve raising interest rates for the fifth time in 2022 alone, many speculate a potential recession in the American economy in 2023 and perhaps beyond. With the difficulties of the COVID-19 pandemic and the government shut-down precipitated by it fresh in mind, commercial landlords and tenants may find the future full of a new set of difficulties requiring attention and planning in light of rising interest rates and an unclear economic outlook.
First, similar to the lessons of the COVID-19 pandemic, a force majeure clause is more than a “boiler-plate” provision stuck in the back of a lease. A force majeure clause excuses performance under the lease in the event of certain circumstances, for example, a governmental order prohibiting the operations of the tenant or tariffs and sanctions which effect or limit supply chains. Needless to say, landlords have reason to be concerned about the breath of such a provision, as many landlord obligations, such as mortgages, will not be excused in those same circumstances. However, thoughtful, well-crafted provisions can provide protection in the event of such difficult circumstances.
Second, with staffing shortages and concerns about funding in a less credit-available market, tenants may seek early termination clauses, allowing early termination from their leases in the event that certain staffing or income parameters are not met. Verbal promises to this effect are common, with landlords agreeing over a handshake to not force the tenant to pay in the event of certain hardships. However, those promises will not be binding when a lease is in effect and landlords will often be less willing to compromise when the landlord’s own situation is more challenging. We can help navigate the conversation about termination rights and provide valuable input on the termination rights and the substance of any related provisions.
Third, rents can be capped to a percentage of tenant’s net income, as verified through its financial statements. A lease can include a net income cap and a rent floor, indicating that any amounts greater than a certain percentage of the tenant’s net income shall be abated or converted to debt payable in the future, with a rent floor on the smallest amount of rent that will be required monthly regardless of the net income cap. This option can be beneficial to aid the tenant in long-term profitability while also ensuring that rent is paid when tenants have the ability to pay.
Fourth, tenants should consider granting greater security in return for better terms. In a recession, many landlords will be unable to replace tenants if tenants are lost or go out of business. As such, recessions often mean that security is more valuable to a landlord than higher rent amounts. Distressed tenants should consider if guarantees or security agreements are a strong enough bargaining chip to secure reduced rent or other desired terms.
Our attorneys specialize in commercial leases and can be available to aid in preparing and negotiating lease amendments and new lease agreements. For more information, please call 616-632-8021 and we would be happy to discuss our services.