Co-Tenancy Clauses in a COVD-19/Post-COVID-19 World: Preparing for the “New Normal”

Co-Tenancy clauses have historically been included mainly in leases for mall and shopping center tenants (i.e., retail centers with big-box tenants, such as Dick’s Sporting Goods).  While the landscape for retail shopping center leasing has changed significantly in the years following the economic downturn of 2008, the onset of COVID-19 brings new challenges and considerations with respect to the co-tenancy concept.  Here’s what you need to know:

The Basics

There are two major types of co-tenancy clauses: opening co-tenancy clauses and operating co-tenancy clauses.

Opening co-tenancy clauses state that the tenant does not have to open and pay full rent until certain other stores are open and/or a percentage of overall space is occupied.  These clauses are more commonly found in a new shopping center development, or one which was undergone major redevelopments; this makes the clause unlikely to be as relevant in the near future.

Operating co-tenancy clauses apply to existing shopping centers.  These clauses may allow tenants to pay reduced rent, cease operations and potentially terminate their lease, if specified tenants within that same shopping center close and are not replaced with an acceptable replacement tenant within the required timeframe.

COVID-19/Post-COVID-19 Landscape

Following the economic crash of 2008, hundreds of stores housing recognizable tenants like Sears, GAP, Payless ShoeSource, Toys-R-Us, etc. closed, leaving large vacancies in many shopping centers.

Leading up to the COVID-19 pandemic, landlords already faced the arduous task of backfilling these vacancies, drawing from a quickly dwindling pool of suitable replacement tenants. The stay-at-home orders enacted across the country brought on by the COVID-19 pandemic effectively brought the brick-and mortar-retail experience to a screeching halt for months, and have already caused a number of what were previously thought to be stable and substantial companies to file for bankruptcy.

As sectors of the country are beginning to reopen, major mall landlords should consider reviewing their shopping centers’ existing leases and reciprocal easement agreements, to evaluate their options.  Some considerations include:

• When does the clock start for a breach (or claimed breach) of a co-tenancy clause?
• As business and stores begin to reopen on a staggering basis (or inevitably not at all for some unlucky businesses), when can a tenant effectively claim a breach?
• Can a landlord utilize the force majeure provision to extend the period it is allotted to backfill a defunct tenant?
• What constitutes a suitable replacement tenant?
• Can an anchor tenant’s premises be split into two or three smaller premises?
• Can an anchor tenant be replaced by an experiential retailer, like a climbing gym, Esports arena or movie theater to attract foot traffic?

Landlords should anticipate that creative solutions to backfill shopping centers that deviate from the terms of existing co-tenancy clauses, can come at a price.  For example, tenants with a co-tenancy clause will likely ask for (or may already be entitled to under the terms of their lease) rent reductions and/or a tenant improvement allowance for renovations to their premises, in exchange for accommodating vacant neighboring premises and/or amending their co-tenancy clause to permit a less traditional use.

In the worst-case scenario for a landlord, a violation of a co-tenancy clause may eventually result in a termination of the lease by the tenant (depending on the rights in their lease), which may snowball into an onslaught of vacancies throughout the shopping center.  Creating a plan and engaging in conversations early with counsel and tenants may increase the viability of a shopping center facing uncertainty in the coming months.

While these shifts in the co-tenancy space may be frustrating, they are a harsh reality and one which can be navigated with the appropriate guidance and changes to future leases. Please let us know how we can help you audit your existing protocols and plan to avoid running into issues in the future.

For information on other changes in retail leasing in the COVID-19/Post-COVID-19 world, please click here. For more information, please contact Jennifer Zohorsky: jzohorsky@rosenbergmartin.com or Shannon Byrne: sbyrne@rosenbergmartin.com.