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EXPERT ANALYSIS: Watching Your Back

Cotenancy, once only used by tenants to assure concessions or even the right to terminate a lease if an anchor leaves a mall, are increasingly found in lifestyle-center and mixed-use projects leases.

The clauses, in which in-line tenants demand certain other stores be present, provide a unique example of the clash between a landlord's development or investment goals and a tenant's business objectives. (See related story on page 22.)

The old common law view of a rental obligation enduring regardless of the condition of the premises or a tenant's ability to operate is probably undercut more by a cotenancy clause then any other modern retail lease provision.

In a cotenancy clause the assumption is made that the tenant is entitled to abatement, a reduced “substitute rent,” or percentage-rent-only based on the behavior of the other tenants in the landlord's project, as opposed to most other termination or rent-reduction rights, which are triggered by a landlord's acts or omissions.

The tenants' rationale is that they are only committing to enter a project and pay the agreed-upon rent if the project meets certain cotenancy requirements. The fact that a landlord may not be responsible for the other merchants' failure to open or continued operations is not relevant to the applicability of the cotenancy remedies.

Assuming a cotenancy has been negotiated and agreed upon, certain provisions can provide some protection for the owners. Landlords should:

Require the right to obtain a substitute tenant.

Require a gross sales test to determine if the failure to meet the cotenancy threshold has caused the tenant to suffer losses.

Provide a clear time period for which the cotenancy failure has to last before the remedies become applicable.

Require the retailer to be open and operating to benefit from the clause, at the time the cotenancy threshold failure occurs and thereafter for the duration of the period during which the tenant benefits from the clause.

Require the tenant to terminate or waive its rights under the clause if the cotenancy failure is not cured within a certain period of time.

Provide that named cotenants will also be deemed to include successors resulting from mergers, sales of all or a regional portion of a retailers business or other corporate transfers.

Avoid references to named tenants occupying required floor areas. You may have no control over the size of premises built by a build-to-suit tenant.

If percentage rent is not part of the rent to be paid ordinarily, but the cotenancy remedy provides for payment of a percentage of sales in lieu of contract rent, make sure that the lease contains detailed sales reporting provisions and alternate payment dates during the cotenancy rent period.

Provide for staggered remedies to decrease the severity of the tenant's remedies as different elements of the threshold tests are met.

Exclude any areas within the project that will be built or leased as part of a later phase. If possible, exclude any areas within the project that you do not control.

Require tenants to comply with the terms of the lease in order to exercise any rights triggered by the failure to meet the cotenancy thresholds.

Require the tenant to refund the unamortized portion of the tenant allowance and brokerage commission in the event they terminate due to the failure of a cotenancy requirement.

If possible, limit the applicability of the cotenancy clause to the initial term of the lease or some other start-up period.

Keep a comprehensive list of all cotenancy clauses that you have granted so you can tell which tenants will rely on which others to open and then to operate.

Tara A. Scanlon is a partner with Holland & Knight LLP in Washington, D.C., specializing in commercial real estate transactions. She is co-chair of the law firm's retail development and leasing team, and an adjunct professor at the Allan L. Berman Real Estate Institute at Johns Hopkins University.

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