Cotenancy and the importance of ‘Acceptable Replacement’ language
March 12, 2017
Lately, we have spent a fair amount of time focused on cotenancy provisions – specifically monetizing the impact of these clauses (think 「How much minimum rent will we lose in the first 12 months if Sears closes?」 What percentage of our tenants have the right to close if Sears closes.」). With the number of department stores announcing closures, analysts are quick to ask these questions.
Cotenancy provisions typically read 「If at any time during the term there are less than some number of department stores (Majors, anchors, etc) or less than some percentage of the gross leasable area (other than department stores) for more than X number of months, the tenant has the right to pay x% in lieu of minimum rent (or all rent). If the condition continues for x months, the tenant has the right to terminate.」 There are countless variations of these clauses – adding other requirements like 「and the tenant’s sales have dropped by more than x% over the same period,」 or 「the tenant has the right to terminate. If the tenant does not terminate, full rents resume.」
But, one of the most costly mistakes a landlord can make is not including a term – 「Acceptable Replacement.」 A department store or major may be defined in the lease as greater than a certain square footage, or it can sometimes be tenant name specific. In that case, the cotenancy provision will often read something to the effect of 「If Sears or its Acceptable Replacement,is not operating for more than 12 months, then tenant has the right to …」 If the lease reads only 「If Sears is not operating for more than 12 months,」 then we could have a Cotenancy provision that can never be cured.
Think about that – you have a mall. Sears closes. And, you replace the vacancy with a Nordstrom or a Macy’s or a Bloomingdales. Because it was name specific and because you do not have acceptable replacement language, a cotenancy failure will always exist.
So, make sure you include acceptable replacement language!
Feel free to comment if you have any thoughts or questions about cotenancy.