When a commercial tenant leases space in a shopping center or mall, a primary consideration for the tenant is the expected benefit to their business of the foot traffic from the customers that will be attracted to the other businesses being operated by their neighboring tenants. This is particularly true when the neighboring tenant is the “anchor,” or one of the “anchors” in the center, who is expected to attract many customers to their business, who then would then very likely also patronize the other nearby businesses. In order to protect themselves from the negative impact on their business by the closure of their co-tenant, many smaller retail tenants have historically been able to negotiate for the inclusion of a “co-tenancy clause” in their lease.
A “co-tenancy clause” is a provision in a commercial lease agreement that allows the tenant the opportunity to terminate its lease, or in some instances changes the terms of its rental obligation, in the event that one or more specified other tenants in the same retail center cease their business operations, usually for a specified period of time. Although the other tenants are usually the anchors, or largest stores that attract the most tenants to the center, that is not always the case. A well written co-tenancy provision will specify when the tenant can exercise the right, including whether the tenant must either exercise it within a specified period of time after the “co-tenant,” whose closure triggers the right, ceases its operations, or whether it is a continuing right that can be exercised at any time, even years later. It will also specify whether the right is impacted if the tenant whose operations have ceased is replaced within a certain period of time by a similar retail tenant. For example, if the named co-tenant is Walgreens, which ceases operations, can the co-tenancy provision be utilized even if Walgreens is immediately replaced by a CVS? And if the answer is “no,” what are the criterial for determining whether a replacement tenant is “similar” enough, and what is the time period within which the replacement tenant must commence its operations?
Shopping Malls in the Era of COVID-19
The co-tenancy issue is becoming increasingly important as many large retail stores are closing all over the country. Such closures, which were commonplace even before the current COVID-19 pandemic, are now expected to escalate greatly during the rest of 2020, and potentially well beyond that. The growing popularity of online retail sales was already causing a steep decline in in-store sales, and now, with many stores being forced to temporarily close or greatly reduce their hours, it is inevitable that the number of permanent closures will grow exponentially. UBS is predicting that there will be 100,000 retail stores throughout the country permanently shut between now and the end of 2025.
When these closures of the major tenants occur, many of the secondary tenants in the same center will be exercising their rights provided to them by their co-tenancy clause to either substantially reduce their rent, or to terminate their leases. While tenants who do not have the benefit of a co-tenancy clause may look for other means to terminate their leases under the current conditions, such as through a force majeure clause, or by arguing that the purpose of their lease has been frustrated, or their performance has been rendered impossible, their landlords may have viable defenses to the any such claims. The same, however, does not hold true with co-tenancy clauses, which, if unambiguously written, provide an ironclad “escape route” for a tenant upon the occurrence of the specific conditions in the lease that trigger its application.
The result of this could spell disaster for many mall owners and other commercial landlords, which certainly was not anticipated when they entered into the leases containing a co-tenancy provision. In a world where what had once seemed impossible is now part of everyone’s reality, commercial tenants will undoubtedly be more aware of the need to negotiate for a co-tenancy provision in their leases, while commercial landlords will undoubtedly be more cautious about including them.