Commercial Real Estate Negotiations

At Shenwick & Associates, as a result of the current hard times that we are facing, and the increased number of bankruptcy filings, we are receiving a number of calls from clients regarding the consequences of a bankruptcy filing by their Landlord or Sublandlord, and what protections they need when negotiating a lease or sublease with a Landlord or Sublandlord who may be in financial trouble.

First, let’s talk about the situation where a Landlord or Sublandlord files for bankruptcy. Section 365(h) of the Bankruptcy Code says that if a debtor files for bankruptcy (the debtor would be a Landlord or Sublandlord) and seeks to reject an unexpired lease of real property under which the debtor is the lessor, if the lease term has commenced, the tenant or subtenant may retain its rights under the lease. These rights include rights related to the timing and amount of the payment of rent and other amounts payable by the tenant or subtenant, and any right of use, possession, quiet enjoyment, subletting, assignment or hypothecation for the balance of the lease term, and any renewal or extension of such rights, to the extent that those rights are enforceable under applicable non-bankruptcy law. Section 365(h) also provides that if the tenant or subtenant retains its rights under its lease, then the tenant or subtenant may offset against the rent reserved under the lease for the balance of the term after the date of the rejection of the lease and for any renewal or extension of the lease:

1. The value of any damage caused by the nonperformance after the date of rejection;

and

2. Any obligation of the debtor/Landlord or Sublandlord;

but the tenant or subtenant shall not have any right against the estate of the debtor on account of the damage occurring after such date due to nonperformance. In plain English, 365(h) provides that if a Landlord or Sublandlord files for bankruptcy, then the tenant or subtenant may vacate the space or remain in the space pursuant to the terms of the lease or sublease and may offset against rent any damages resulting from the Landlord/Sublandlord’s bankruptcy filing.

As a result of the protections provided to tenants and subtenants by Section 365(h), they may use the opportunity of a Landlord/Sublandlord’s bankruptcy filing as an opportunity or leverage to renegotiate their lease/sublease, particularly if the real estate market has dropped. With respect to a tenant or subtenant that is concerned about the Landlord/Sublandlord’s financial condition, provided below are some tips regarding lease clauses that they may want incorporated into their lease/sublease:

1. The ability to review financial statements from Landlord/Sublandlord.

2. Tenant/subtenant improvement funds from Landlord/Sublandlord should be in
escrow or in a letter of credit.

3. Large tenants/subtenants (full floor) should obtain a non-disturbance agreement from Landlord/Sublandlord’s mortgage lender.

4. In the case of a sublease, negotiate the right to remain in the space with the Landlord if the Sublandlord defaults or files for bankruptcy through a recognition or attornment agreement with the Landlord in the Landlord’s consent to sublease.

5. The right to take over Landlord/Sublandlord work if the building owner falls behind on maintenance or upgrades (“self help rights”), and to reduce the amount paid for building maintenance from the payment of rent (right of offset).

6. The right to deal directly with a Landlord/Sublandlord’s lender if the Landlord/Sublandlord goes bankrupt (a non-disrupt clause).

7. The right to terminate a lease if the tenant/subtenant’s business condition deteriorates.

8. The right to sublet space to whomever the tenant/subtenant chooses at any price.

9. The right to open negotiations for a lease renewal eight months before the lease expiration instead of the standard 24 months.

If any parties are interested in additional information regarding a potential bankruptcy filing by their Landlord or Sublandlord, or assistance in negotiating a lease, please contact Jim Shenwick.