May 14, 2017
This week, I was working on an office acquisition and came across a clause I had never seen applied in office before – a most favored nations clause. The clause essentially read:
Notwithstanding anything in the lease to the contrary, no other tenant in the Property shall have a more favorable rental rate (which was further defined to include base rent, tenant’s share of operating expenses and tenant’s share of taxes).
It reads fairly simply – no other tenant shall have a more favorable rental rate – but the consequences of administering that language can have a material impact on cash flow and value. Most typical in retail leases, I would estimate that we see this language once out of every three malls (so figure 1 in 400-450 leases) and perhaps once out of every 10 open air centers (maybe 1 in 200 leases).
When I first got into the industry 30 years ago and saw this language, I remember thinking that the tenants that had the language in the lease were the laziest leasing agents around. Essentially, 「Yes. I will agree to this, but if someone was better than me and negotiated a better deal. I get that.」 It did not take me long to realize that the tenants that negotiated this language had the absolute best leasing agents in the country because of the same exact statement, 「Yes. I will agree to this, but if someone was better than me and negotiated a better deal, I get that.」
They not only have their own skills and experience to draw from, but they have the collective skills and experience of every other leasing agents with space at that property.
It is so dreaded for many reasons, but the most obvious are the amount of administration it takes to properly bill a tenant and the financial implications. Imagine, you have finished the final review of the year end settlements of CAM or taxes and are ready to post the billings. But, you find that the tenant with the most favored nations clause is required to pay $4.00/sf, another tenant has a $3.00/sf rate. You now have to go back and change that first tenant’s rate to $3.00/sf. Now, imagine that tenant was an excluded area for other tenants in the center. That change from $4.00/sf to $3.00/sf could affect every other tenant. Now, take it a step further. You have a struggling tenant. You agree to put that tenant on a percentage in lieu of minimum rent and all other charges. All of the sudden, that $4.00/sf goes to $0/sf.
A truly awful clause for the landlord and a truly wonderful clause for the tenant.
Often I am asked about how can you be sure if the landlord is administering the clause properly. Honestly, you can’t – unless it comes out in discovery during a lawsuit. However, what I can share is that the tenants with most favored nations clause are often anchors or other highly desirable tenants that landlords have (or want) a solid relationship with. In 30 years, I have seen hundreds of these. And, in all but one instance, when the landlord was made aware of the clause, they properly administered the clause (prospectively).
One way landlords can all but eliminate the impact of this clause (through attrition as leases turn over) is to include 「allocation language」 in their standard lease form which essentially gives the landlord the right to allocate base rent, percentage rent, or any other charge to another lease required charge. In that case, when you see the $3.00/sf charge, or the $0/sf charge, if those leases have allocation rights, the landlord can allocate $1.00/sf or $4.00/sf from one charge to another and have no tenant with a rate lower than $4.00/sf.
While you may want to put your head in the sand and hope you don’t have them in your portfolio, they are probably buried in your leases. So, be proactive and address them head on.