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Round Two: Commercial Tenant Lease Options During COVID – Pros And Cons Of Not Paying Rent

Are you currently a tenant leasing space in a commercial (retail, office, industrial usually) property? Is  your business suffering significant losses?  If so, do you want to know what your options are and what you should be doing about it now and in the future?  

This is the second part of a series of articles I am covering on this subject, so make sure to tune in for all of them shortly.  The first article covered the pros and cons of subleasing and assignment.  Future articles will cover when/how to terminate your lease early, and other relevant options.  This particular article of the series will deal with when you should and shouldn’t pay rent, along with the pros and cons of each.

Not paying your rent is usually not a good idea if your landlord has offered you a reasonable alternative like not having to pay  your rent now and adding on the deferred rent to your lease. This can be done at the end of your term via a term extension (adding 3 months or whatever length of the deferred rent amounts to in months) or in some other fashion like raising your rent some time in the future to recoup the abated rent. There are also many other options such as paying a percentage of your rent based on the percentage of your gross/net income that you are currently making, compared to what it would have been before COVID began.  However, if these types of rent arrangements don’t work for you for some good reason, one being that your business simply isn’t going to make it and you are losing money, then you have to find a different solution.

What happens if you ask the landlord for some kind of help and he isn’t responding to you?  Then in my opinion, not paying your rent could be your best option.   Both landlords and lenders don’t want empty buildings as landlords might give a building back to a lender if too many tenants aren’t paying rent or vacating their building.  My experience is that by not paying rent, you will get your landlord’s attention and get a response with what the landlord is willing to do for you quickly.

Some of my clients I have spoken with fear litigation if they don’t pay their rent.  They ask whether the landlord can sue or evict them or if this will hurt their credit?  Assuming the courts are even open, it will probably take over two to three years because of the current legal case backlog for your case just to make it to court. Also, it has not traditionally gone well for the landlord or the lender if they have to spend a lot of money on legal fees chasing tenants and creating vacant spaces at their property.  And you can always change your mind and pay the rent once you get a notice of default as long as you pay within the allotted time, but, even then, most times I would probably recommend that you still don’t pay.  At the same time, it’s unclear how the courts are going to decide the legal matter of a tenant not paying rent if the government shut their business down or the tenant simply couldn’t reasonably open due to COVID related issues.  There is a legal term called “frustration of purpose” and it’s my opinion that this legal doctrine applies to the nonpayment of rent issues and that the courts should not require a tenant to pay rent during such times if they can’t reasonably operate their business.

If you can’t afford to pay all or part of the rent and don’t have any assets that are legally attachable via a legal judgment, then, in my opinion, it’s pretty easy to not pay rent as there isn’t much a landlord can do about it.  Many landlords would rather have the tenant in the space even if they aren’t paying, rather than a vacant space that might take years to release, as at least there is a chance the existing tenant might make it and even be able to pay some of the back rent due in the future.  But if you can afford to pay the rent, even though your business isn’t making much income and have legally attachable assets via a legal judgment, the decision is a little tougher, but not impossible, and not paying rent still might be your best option.

Note to Landlords:  It’s probably in your best option to work with your existing tenant rather than have their space go vacant and try to release it.  Legally pursuing your existing tenant for rent might backfire on you and cost you more in money and time than is worth the effort.  If your lender won’t help you, give them a strong warning about how you might have to default on your loan.  In my opinion, one of the best ways for the tenant, landlord, and lender to get through this is for all three to work together and share in the pain.  Example:  If each party agreed to pay 1/3 of the rent due for 3-12 months, then everyone might get through this as best as possible with no tenant going out of business or a lender having to foreclose on a property at great expense.

Each situation is unique and needs to be figured out carefully but you have to know and consider all of your options so you can pick the best one.   I have settled these types of matters both as a landlord and tenant hundreds of times so I can assist you if you need help so please contact me here:  

David Massie

DJM Commercial Real Estate

david@djmcre.com

805-217-0791

David Massie

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Round One: Commercial Tenant Lease Options During COVID – Subleasing Your Unused Space

Are you currently a tenant leasing space in a commercial (retail, office, industrial usually) property with your business suffering significant losses? If so, do you want to know what your options are and what you should be doing about it now and in the future? This is the first part of a series of articles I will be writing on this subject so make sure to tune in for all of them shortly. Upcoming articles will cover: when not to pay rent to your landlord, when/how to terminate your lease early, and other relevant options.

Let’s start with what a tenant would normally do if they didn’t pick a course of action with any risks of legal action by the landlord, such as terminating a lease or not paying rent. Subleasing part of your space or assigning all of it are two viable options.

Under a sublease, you would lease part of your space and you are still the tenant, but become your new subtenant’s landlord which is called a “sublandlord”. You could also sublease all of your space, but this isn’t as common. You still pay your rent to the landlord normally, and you collect rent from your “subtenant” based on the agreement you have made between you and your subtenant. You and the subtenant can agree to pretty much whatever you want to on lease terms as long as it doesn’t violate the main lease between you and your landlord.

Subleasing sounds simple enough but here are some issues to consider that make it more complicated: a) The subtenant’s business use should be compatible with yours because if it isn’t, it could be very disruptive to your business; b) You should have a very good written sublease agreement prepared by a real estate attorney or possibly your commercial real estate broker if he is qualified and should try not to create or change the form on your own. This is because if something were to go wrong with the relationship, and the subtenant creates a problem (not paying, disruptive, etc.) you want to make sure you are on solid legal ground to evict them and make them pay for any damages they cause you; c) You should check out your subtenant’s criminal and financial background thoroughly just like your prudent landlord did with you and make sure you get enough security deposit and/or personal guaranty but get professional help when making this determination from a CPA or your commercial broker if he is qualified to do so; d) You should market your sublease space to reach the widest audience you can. This will usually require costs (advertising, commission, time, and energy) so it’s best to hire a commercial broker to do so as you simply will not have the same audience reach or expertise that the broker does and this broker will bring you more quality options than you can find on your own and lease your space faster.

Switching to an assignment works somewhat like a sublease but an assignment is normally done when leasing the entire space to someone new rather than just part of it like through a sublease. Your new replacement tenant is called the “assignee” and you become the “assignor”. The assignee pays rent to the landlord directly as opposed to paying you like the sublease example above. However, this assignee pretty much takes your place and assumes your existing lease without making changes to it, although it is still possible to have changes made, your landlord has to agree, and there normally isn’t an incentive for your landlord to do so. You remain on the hook under the terms of your original lease like a guarantor would, so if your assignee defaults on the lease and doesn’t cure it then you will be responsible to do so. This will result in you having to pay any rent difference each month to your landlord that your new assignee doesn’t pay if this assignee is paying less than you were.

Both of the above options normally require landlord approval so check your lease carefully in the applicable sections and make sure you do what it says. Your landlord can usually decline a request to sublease or assign your lease based on reasonable grounds. Reasonable grounds can be items like bad financials or a criminal record, too many employees, business use not compatible with other tenants in the building, etc.

Each situation is unique and needs to be figured out carefully but you have to know and consider all of your options so you can pick the best one.   I have settled these types of matters both as a landlord and tenant hundreds of times so I can assist you if you need help so please contact me here:  

David Massie

DJM Commercial Real Estate

david@djmcre.com

805-217-0791

David Massie