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COVID-19: Lease Modification Considerations for Landlords

March 31, 2020

As discussed in our prior alert on General Leasing/Rent Concerns, due to the economic impact of the COVID-19 crisis we anticipate that commercial real estate tenants will increasingly request or demand that their landlords grant relief in the form of rent abatements or deferrals or other lease modifications. Depending on the particular tenant’s needs and the proposed terms, a modification may make sense for both landlord and tenant. In considering any such request, however, a landlord should take certain precautions, including (a) reviewing its existing mortgage loan documents and any subordination, non-disturbance and attornment agreement ("SNDA") entered into between the applicable tenant and mortgage lender, and (b) considering whether to condition any discussions with a tenant upon the execution of a confidentiality agreement, to ensure that such discussions are not disclosed to third parties (including other tenants of the building), and/or a pre-negotiation agreement, to set forth the parameters of those discussions and limit the likelihood of any miscommunication between the parties regarding the outcome of such discussions.

Mortgage loan documents often prohibit lease amendments, modifications and terminations absent lender consent. Additionally, entering into any such modifications absent lender consent may give rise to a recourse carveout obligation backed by a guaranty. Prior to agreeing to any amendment, modification or termination, it is important to review and understand your loan document obligations in this regard.

Fortunately, many loan documents permit amendments and modifications to leases that are not “major” leases. These provisions may allow a landlord flexibility in entering into certain lease modifications absent lender consent. Loan documents often define a major lease with respect to the amount of square footage a tenant may lease and other considerations (including whether the tenant has any purchase rights with respect to the property). However, loan documents typically suspend a landlord’s ability to modify a lease that is not a major lease if the loan is then in default. If tenants are not paying rent, reduced cash flow may give rise to a mortgage loan monetary default or debt service coverage default. In this environment, such a default could arise after landlord and tenant commence discussions but prior to reaching an agreement, and thus further complicate things for landlord and tenant.

Tenants and landlords may also be restricted contractually in their ability to modify a lease via an SNDA. SNDAs often prohibit any modification of a lease absent lender consent. It is important to review the terms of any applicable SNDA prior to determining whether to obtain lender consent.

Additionally, the impact of the COVID-19 crisis on the business operations of any tenant and the relief a landlord may be willing to give a particular tenant will likely differ from tenant to tenant. Accordingly, it is important to make sure that discussions with one tenant remain with that tenant and are not communicated to other tenants of the property. A properly prepared confidentiality agreement will help ensure that any discussions or agreement entered into with any one tenant are not broadcast to other tenants. Moreover, it is possible and even likely that a landlord may request financial and other information from the applicable tenant and the tenant may want that information to be kept confidential as well.

Many times parties may discuss a modification and leave that discussion with two wholly different interpretations. In the current environment, a tenant may leave such discussions believing it is entitled to reduce its rental obligations and a landlord may leave such discussions with a much different understanding. As such, it is important to use a pre-negotiation agreement to set forth the rules that would govern any discussions a landlord may have with a tenant. Pre-negotiation agreements can be complex and a challenge to enter into; however, even a short agreement specifying that (a) by entering into discussions concerning the lease, neither party is obligated to amend or otherwise modify the lease, (b) no amendment or other modification of the lease shall be effective unless set forth in a writing signed by both parties and (c) the landlord is or may be required to obtain mortgage lender consent before any agreement becomes effective, may prove helpful.

The preceding discussion assumes the tenant will attempt to negotiate a lease modification with the landlord; however, a tenant may instead inform the landlord that it does not intend to pay rent due to an existing or perceived offset right or for any other reason, or may just fail to pay rent without notice. In addition to limiting a landlord’s right to modify leases, mortgage loan documents typically require a landlord to use commercially reasonable efforts to enforce their leases. In the current environment it may be difficult to determine what would be considered a commercially reasonable response to such a tenant notice or default. The courts may be closed or access to the courts may be severely restricted, shelter-in-place or other governmental orders may make it impossible for certain tenants to operate their business, or for a landlord to communicate effectively with its tenant. Nevertheless there are a number of enforcement or workout avenues a landlord may be able to pursue in response to any such tenant notice or default. In order to determine the appropriate action, a landlord should first review the terms of the lease (including any offset or abatement rights claimed by tenant) and attempt to obtain and review the tenant’s financials. An understanding of both the terms of the lease and the tenant’s financial position and needs will help guide a landlord’s decision making process and assist landlord in dealing with any questions or concerns its mortgage lender may have with respect to the same.

If you have questions regarding this alert, please feel free to contact Rob Grady or Kate Mylod. We will endeavor to analyze and explain the relevant law in these areas and related considerations, and update our Coronavirus Resource Center (specifically, the Real Estate Leasing page) periodically to include relevant Connecticut, New York, federal and local laws, rules and regulations that are enacted during this crisis, as well as court filings and relevant precedent or other topical information, which are being circulated on these matters.

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