Can I Have Your Space Back If You’re Not Using It? Please?

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Retail landlords have a legitimate concern when it comes to whether a tenant space is actively in use; industrial and office landlords, less so. If it isn’t obvious why to readers, here is a short list of some key concerns:

• Vacant space makes a project less desirable to potential tenants.

• Vacant space scares potential lenders.

• Vacant space invites crime.

• Vacant space incurs higher insurance rates.

• Vacant space depresses sales for other tenants at a retail project.

• When a Tenant vacates space, it can be an early indication of pending financial problems.

Landlords try to address this concern in three ways, two of them “indirectly” and one of them “directly – in your face.” Before we start down that road, Ruminations feels obligated to set forth another “obvious” “fact.” We’re assuming that the tenant who “ain’t no longer” in business at the leased premises is still paying its rent and doing everything else the lease says it must do. If not, its landlord holds a sledgehammer – eviction.

What are the “indirect” ways? Those are where a lease makes it a breach or default for either the tenant to have abandoned the leased premises or to have left them vacant. If the lease called these defaults, and the landlord wanted to get its leased premises back, the landlord would seek to evict its tenant and then pursue a claim for damages. [For our blog posting about “damages” arising from a breach of lease, click HERE.] Essentially, the landlord would be able to both “recapture” the space and get a judgment for any damages it could prove based on its tenant having breached the lease.

Assuming that a tenant, for one reason or another, accedes to either or both abandonment and vacancy as being an event of default, what do those terms mean? That’s not a stupid question, because it isn’t intuitive. Understanding why is easily demonstrated when it comes to “allowing the leased premises to become vacant.” Suppose the tenant strips everything out of the space but for one used, left shoe in the storeroom’s broom closet. Are the leased premises vacant? What if it was a broom? What if it left behind all of its store fixtures (or all of its desks and filing cabinets in an office space)? Readers can play the game themselves. Basically, without a definition for “vacant,” assuming the tenant is still paying rent, it is a long and expensive fight, often unsuccessful, to get the space back. After all, the tenant left the fixtures there so that it could sell them to a hypothetical assignee or tenant or so that it could resume business in the leased space when the economy turned around. Vacant? Not Vacant? Who knows?

The meaning of “to abandon” isn’t really any more obvious. That’s because there are two aspects of an abandonment, both of which must be satisfied – “intent” and “non-use.” Courts aren’t that foolish; they’ll recognize non-use. On the other hand, courts aren’t mind readers, and that’s the rub. Intent, unless expressly stated by the tenant, has to be inferred by “facts and circumstances.” Basically, unless a lease has a definition for “abandonment,” a landlord must show identifiable and unambiguous evidence that the tenant isn’t coming back. That would support an inference of “intent” to abandon. Another way to say that is that the landlord must show that its tenant’s behavior shows that the tenant has relinquished its interest in the leased premises. That will prove nigh impossible if, as we have hypothesized, the tenant is still paying rent, heating the place, cleaning the windows, and whatever.

Of course, a lease could define “vacant” and “to abandon,” but have you ever seen a lease that did so? Landlords, here is a suggestion. Either take those default events out of the form lease or add a definition for each.

Now is probably a good time to throw in a “caveat” about today’s posting. Over the last few weeks, Ruminations has been somewhat (quite?) opinionated. Today, for that reason and one or two others, we’re going to lay off and go “plain vanilla” (“just the facts ma’am” – Joe Friday). That will give us the opportunity to revisit the entire topic about what rights “should” a landlord have to recapture space and what rights “should” a tenant have to “go dark.” Anything to earn us friends!

This gets us to where we were headed. What about “recapture” on a tenant’s “going dark”? Whether a lease includes a “recapture on going dark” provision is a matter of the parties’ bargaining. There isn’t any “right or wrong.” There is an inherent balance in this recapture concept – the landlord gets the space back and the tenant is off the hook, rent-wise and lease-wise, going forward. If the concept is generally acceptable to both parties, there are still several items that specifically need to be handled. Here are three of them: (a) what is the definition of “going dark”; (b) can the landlord sit back forever before exercising its right or not; and (c) does the landlord pay anything to the tenant at the time of recapture?

Separate and apart from those three big questions is a fourth – should a tenant be permitted to use the recapture provision as part of its exit strategy to move “down the street” to a competing shopping center. A landlord with that concern may want to negotiate for a provision prohibiting its tenant from opening another store within a given distance from the shopping center, making that a default. Yes, another topic for healthy and hearty bargaining.

Before we move on to what a “recapture on going dark” lease provision might say, let’s take a detour to look at what a tenant might want the lease to say if it hasn’t agreed to be exposed to losing its space upon “going dark.” Try this or something similar to this:

Notwithstanding anything contained or set forth in this Lease to the contrary, nothing in this Lease shall be construed, in any manner whatsoever, as an express or implied covenant of continuous operation on the part of Tenant, and Landlord acknowledges that there is no covenant of continuous operation with respect to the Demised Premises, arising hereunder or otherwise, express or implied, on the part of Tenant. If Tenant elects, in Tenant’s sole discretion, to cease business operations at the Demised Premises, such cessation of business will not be deemed a breach or default of this Lease, and Tenant will remain liable for the performance of its obligations hereunder.

While we are at it (i.e., tossing around some lease provisions), here is one that a landlord might favor:

However, in the event Tenant ceases operations at the Demised Premises for more than one hundred twenty (120) consecutive days for any reason other than repairs or by reason of Force Majeure, Landlord may elect to terminate this Lease and recover possession of the Demised Premises by giving Tenant thirty (30) days prior written notice of such election to terminate, and upon such termination, Tenant and Landlord will have no continuing obligation to the other under this Lease.

Sometimes, it’s wise to define “cease operations,” and here is a common way that is done:

Tenant is deemed to have “ceased operations” when it is not operating a fully stocked, fully staffed retail store open to the consuming public for at least eight (8) hours each day (other than on Sundays or legal holidays in the State of Bliss, whereon Tenant may operate or not).

There are many ways for the parties to negotiate this type of provision. Here is an example of one such result:

If, after Tenant first opens for business for the one (1) day period as required above, Tenant (or any person or entity holding under Tenant) ceases to operate a retail store within at least fifty percent (50%) of the floor area of the Demised Premises, and that condition exists for a continuous period of more than three hundred sixty (360) days (not counting, for any purpose, those days when such operation is halted by reason of remodeling, fire or similar casualty, condemnation, government intervention, or reasons beyond Tenant’s reasonable control, and treating such days as they didn’t exist), then Landlord, as its sole remedy, may terminate this Lease on ninety (90) days’ notice to Tenant and this Lease will so terminate on the ninetieth (90th) day if retail operations are not resumed within at least fifty percent (50%) of the floor area of the Demised Premises on or before the ninetieth (90th) day. If this Lease is so terminated, Minimum Rent and Additional Rent for the last month of Tenant’s occupancy will be prorated and Landlord agrees to refund to Tenant any Minimum Rent and Additional Rent paid in advance, within thirty (30) days after such termination. Upon such termination, Landlord must pay Tenant an amount equal to the Tenant’s unamortized book balance on account of Tenant’s real property improvements to the Demised Premises, if any. The unamortized portion of Tenant’s expenditures shall be determined by multiplying such expenditures by a fraction, the numerator of which is be the number of years of the Term of this Lease which have not expired at the time of such recapture by Landlord (making the assumption that Tenant would have exercised at least one 5-year renewal option, if at least one remains) and the denominator of which is the number of years of the Term of this Lease which have not expired at the time Tenant’s expenditures were made (making the assumption that Tenant would have exercised at least one 5-year renewal option, if at least one remains).

Short (for Ruminations) and sweet today. If you want to know how we really feel about this topic, keep watching Ruminations week after week.

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Comments

  1. Ira, interesting clause, that last one. I didn’t play with the numbers but I’m not certain whether for your fraction which assumes (for both the numerator and denominator) that one 5-year option as being exercised is being unfair to one of the parties, but I suspect is the poor landlord. I believe tenants set up their depreciation schedule on the basis of the original term. If the original term is 10 years, then it’s 10 years. If it is a 5 year term plus a series of 5-year options, then it is still 10 years (writing off the last 5 if not exercised). If the original term is more than 10 years, then it’s the longer period subject to GAAP . The longer the depreciation schedule (or one agreed to by the parties for purposes of this payout calculation), the bigger the payoff for the tenant.

  2. I agree a dark space in a retail center creates a negative even if tenant is still paying rent. Ira gives solid examples of the damages. But those damages are difficult or impossible to calculate.

    If an operating covenant is part of the deal, then liquidated damages are appropriate. (As with any liquidated damages provision, one must be careful that they are not deemed unreasonable and thus an unenforceable penalty. I was tangentially involved with a case in Ohio in the 1980s where a 50% increase in rent was held to be reasonable liquidated damages.)

    If there is no operating covenant, then I don’t see how tenant can justify not allowing landlord the right to recapture. And when it comes to recapture provisions, I frankly never understood the rationale behind landlord having to wait for some arbitrary length of time, often 180 days, before the recapture right kicks in. Nor have I ever understood the rationale behind giving landlord a limited window of time within which to exercise the recapture right. And I can see how costs of improvements have anything to do with it.

    I think the heart of the issue is whether tenant can close its business, and what happens if it does. The right to go dark should not allow tenant to maintain inconsistent operating hours, to go down the street and block competition by keeping the space tied up and dark, to force landlord to also have to cut its rental stream or to compensate tenant for improvements it has decided can’t be put to profitable use.

    If the deal is tenant can go dark, then I think tenant should have to notify landlord of its election to do so. Until tenant makes the election, it should have to maintain consistent operating hours (and be subject to liquidated damages if it fails to do so). And at the point of tenant’s election, landlord should have the right to recapture so it can start reletting efforts. Another legitimate issue to address is whether, and when, tenant can vitiate landlord’s right to recapture by electing to reopen.

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