Add Lease Amendment to Renegotiate Painlessly with Struggling Tenant

The sluggish commercial real estate industry is affecting both owners trying to keep up with mortgage payments and tenants who are in serious financial trouble—or even in risk of default. In this recession, it is more important than ever to spot struggling tenants in your shopping center or office building early on. Effectively dealing with a troubled tenant so that its financial problem won't hurt you doesn't have to be difficult. Follow our steps to painlessly renegotiate your lease so that you both may be successful in a tough economy.

Look for Red Flags to Identify Struggling Tenants

Sometimes it is very obvious that a tenant is under a lot of stress, says William B. Sing, a real estate transactional attorney with Fulbright and Jaworski LLP. “Late rent payments are one of the biggest warning signs,” he cautions, “but other things to look out for may be more subtle and will vary depending on the nature of the tenant.”

For example, a retail tenant that frequently holds sales could merit a closer look. But office tenants in need of help are more difficult to identify because their operations take place behind closed doors.

Financial reports may reveal problems with retail and office tenants, but are not always easy to get. For example, unless an office tenant's lease requires it to provide financial statements periodically, it will be more difficult to get reports because office tenants are less likely than retail tenants to generate them. Getting access to financial statements from retail tenants may be easier because you probably already require at least annual reports if you are entitled to percentage rent. This makes the production of retail financial statements a matter of course.

“If you see that there is a significant decline in either a retail or an office tenant's financial condition, it may be a sign that something is wrong,” notes Sing.

Use Good Judgment in Offering Unsolicited Help

Your instinct may be to approach a struggling tenant as soon as you see that it is having a problem. But be aware that offering unsolicited help isn't always a good idea. Whether you should approach a tenant on your own will depend on the relationship you and your property manager have with it. Being on friendly terms with the property manager will make the tenant less likely to try to take advantage of your concern for it. This is more common with small tenants.

“There is no general rule as to when to approach a tenant. There is no substitute for knowing your tenant and exercising good judgment,” says Sing.

Take the Stress Out of Renegotiating

If you have decided to renegotiate the lease for a financially troubled tenant that you want to keep, the following steps will make the process less painful.

Tell tenant that discussions are nonbinding. Your first move after deciding that you will renegotiate the tenant's lease is to talk with it about the situation. However, many owners are concerned about having discussions with a tenant that might later claim that the owner said certain things, and then try to hold the owner to the alleged promises.

“It's not universal, but it is common for owners, whether they or the tenant initiates the conversation—but especially if the tenant initiates the conversation—to draft a preliminary letter stating that the owner and tenant both agree that any discussions are not binding unless and until there is a binding document,” says Sing.

If you are concerned, present your tenant with a letter about nonbinding discussions that basically says: “We don't have an agreement until we have it in writing.” Additionally, make sure that your tenant knows that nothing in the discussions can be held against you and that the original lease is in full force and effect until it is amended and executed.

Ask for financial statements, business plan. Ask for financial statements even if you otherwise are not entitled to them under the current lease. Condition talking to the tenant on being furnished with these statements. Remember that it is asking for something from you. Require it to tell you where it is financially, and to back that up with documented information and a business plan.

In one case that Sing worked on, a struggling tenant who operated in two locations felt that consolidating into one location was the most effective way to turn the business around. Because the tenant went to the owner with a good plan, it made some concessions.

Require a struggling tenant to present you with a business plan. You have to find out what the tenant's particular problem is and whether you can recapture the loss on whatever concession you will have to make in order to alleviate it. Looking at the business plan may help you to estimate whether you will be able to recapture the loss by the end of the lease.

Practical Pointer: When you are determining whether reducing the tenant's rent is a viable option, take into account—especially in retail situations—that having a dark space can stigmatize your property. Prospective tenants may worry about moving in to a property that has little foot traffic or that doesn't seem viable.

Take opportunity to change terms in your favor. The good news is that, in light of changed circumstances, you have an opportunity to cut options that you gave to the tenant in the initial lease that now are a risk, such as an expansion option. And you can add terms that you regret not including in the first lease—for example, requiring the tenant to provide financial statements at certain intervals.

Arrive at and document agreement. You can put together a fairly simple approach to this situation if you understand your current lease, your goals (such as incorporating new terms that benefit you into the lease), and the tenant's needs.

After your tenant has agreed to your preliminary nonbinding discussions letter and renegotiations are over, it is time to add an additional provision to the lease that incorporates the changes. This is done by executing an amendment to the lease, like our Model Amendment: Use Amendment to Change Lease Terms.

A written document avoids ambiguity later, says Sing, who points out that you can also use an amendment when renegotiating with solvent tenants. “When renegotiating a lease with a troubled tenant, exercising good judgment and working with your property manager and your attorney or negotiator are a winning combination,” he advises.

Insider Sources

William B. Sing, Esq.: Fulbright and Jaworski LLP, 1301 McKinney St., Ste. 5100, Houston, TX 77010-3095; (713) 651-3709; wsing@fulbright.com.

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