Want to Restructure Your Restaurant Lease? You’re Not Alone

    COVID-19 times has opened negotiations across the country.

    Diners grabbing pieces of a pizza pie.

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    These are not normal times.

    It can be intimidating for a quick-service restaurant owner to approach his landlord and ask to restructure lease obligations. Understandably, there are a whole host of negative emotions that can overwhelm a restaurant owner when he first reaches out to the property owner. You might feel nervous or embarrassed or ashamed when asking for relief from your obligations. In addition, lease negotiations are outside of the normal course of business for operators. On the other hand, lease negotiations are part and parcel of what retail landlords do. They’re good at it, and very comfortable doing it. This means that retailers, such as quick-service owners, must prepare more than their counterparties.

    To start, I want to substantiate what many of you already intuitively understand. You are not alone.  Hundreds of thousands of retail locations either struggle with their rent or believe they are entitled to relief. Moreover, as discussed below, in many instances landlords, lenders and investors are also struggling. Finally, your lease may provide relief from obligations normally due (also referred to herein as “lease rent”). Again, you wouldn’t be alone. For example, Victoria’s Secret believes it is entitled to relief at its Herald Square store where rent is almost $1 million per year.

    The Desire to Restructure Might Not Stem from the Inability to Pay Rent

    The desire to restructure does not necessarily stem from economic hardship. Starbucks indicated losing almost $1 billion in sales during its fiscal second quarter and is pursuing lease concessions from landlords. Starbucks attributed the lost sales to store closures, reduced operating hours, and lower customer traffic due to COVID. In spite of revenue lost, the company maintains strong liquidity. More specifically, in its most recent quarterly filing Starbucks disclosed cash and cash equivalents in excess of $2.5 billion.

    Notwithstanding its ability to pay rent, Starbucks believes that many of its landlords should provide concessions. Starbucks isn’t seeking to profit from the pandemic. To the contrary, it is merely seeking to adjust its obligations in light of prevailing circumstances.

    In a May 5 letter to landlords, Starbucks’ Chief Operating Officer Roz Brewer wrote:

    “Effective June 1 and for at least a period of 12 consecutive months, Starbucks will require concessions to support modified operations and adjustments to lease terms and base rent structures.”

    The day before Starbucks’ May 5 letter to landlords, president and CEO Kevin Johnson wrote a post on Starbucks’ website stating that Starbucks “will not just survive, but with adaptations and new routines, it will thrive.” So, once again, Starbucks’ initiation of restructuring negotiations does not have its genesis in necessity, but from the conviction that such restructuring is reasonable and appropriate in the wake of the pandemic. Such conviction from a credit tenant would normally be predicated on a number of factors, including the terms of its lease agreements, and the determination that its requests are justified in light of such terms.

    During a quarterly earnings call, Starbucks’ Chief Financial Officer added that, “We are having ongoing conversations with our landlords in various markets regarding what may be commercially reasonable lease concessions in the current environment.” In spite of having the funds to pay lease rent, Starbucks decided that pursuit of lease concessions is commercially reasonable under the circumstances.

    Many landlords are critical of the pursuit of relief by tenants able to pay. I am firmly convinced that landlords and tenants must work together in order to find the best way forward for all concerned.  Such a conviction is consistent with a tenant reasonably relying on lease provisions to support its contention that rights to relief have been triggered. Relying on favorable lease provisions means resorting to objective criteria, something landlords routinely do, and an integral part of merit-based negotiation. Similarly, there is nothing wrong with a tenant or landlord relying on legal recourse if negotiations fail to produce a satisfactory result. Such reliance means resorting to BATNA, the Best Alternative to a Negotiated Agreement. Litigation may not be optimal, but is sometimes necessary before the parties commit to meaningful negotiations.

    As we will see below, Simon Property Group (Simon), the largest retail REIT is pursuing its legal rights in respect of a $3.6 billion transaction, apparently believing that the pursuit of such rights through the courts will produce better results than negotiations.

    It’s No Secret, Starbucks Isn’t Alone in Pursuing Lease Restructuring

    Starbucks isn’t alone. Other large corporations are trying to restructure lease obligations, sometimes asserting that such obligations have been terminated. For example, Victoria’s Secret and Bath & Body are both suing their landlord, the highly regarded office and retail REIT, S L Green. Victoria’s Secret pays almost $1 million per month in rent for its Harold Square store, adjacent to Macy’s flagship department store. Victoria’s Secret is asking the Court to rescind its 2001 lease. Among the legal theories proffered by Victoria’s Secret is “frustration of purpose”.

    Litigation By Landlords Is Mounting

    Hundreds of thousands of retail locations are behind on lease rent.  For example, by the end of April Vornado Realty Trust had collected only 53 percent of the lease rent from its retail tenants.  Landlords are not sitting idly by. For example, Simon Property Group has sued the GAP. Simon claims that GAP owes three months’ rent totaling $65.9 million. GAP has more than 390 stores at Indianapolis-based Simon’s malls, including its namesake brand, Old Navy and Banana Republic.

    Some landlords have indicated frustration at the failure of large publicly traded companies to remit their lease rent. However, in many instances the size of the tenant, and their ability to pay, are immaterial to whether or not they are legally obligated to pay. Retail leases are heavily negotiated agreements. Companies like Starbucks evidently believe that they have valid legal arguments for restructuring leases. The rent called for in the lease, lease rent, may be subject to adjustment from a variety of other lease provisions embedded in the document.

    Quick-Service Restaurants Must Have a Firm Grasp of Their Rights & Responsibilities

    Retailers like Starbucks, Victoria’s Secret, and Bath & Body are engaging in the same process that Simon is, carefully reviewing their leases and ascertaining their rights and responsibilities. You and every quick-serve tenant should be going through the same process. The first task in merit-based negotiations is to “study.” Such studying is best undertaken with the assistance of a skilled retail lease attorney. In this way, you will know what you are legally obligated to do, and the potential downside if you fail to fulfill such obligations. In turn, this will help you identify your BATNA-Best Alternative to a Negotiated Agreement. A thorough understanding of your rights and responsibilities will help ensure that you don’t over or underestimate the strength of your bargaining position.

    Determine Your Rights & Responsibilities

    So, the determination of your legal rights and responsibilities is a task which must take place prior to any outreach regarding your rent. Such a prerequisite is consistent with my advocacy of merit-based negotiations, as detailed in the COVID-19 Rent course referenced at the end of this article. Such a determination is also consistent with the approach adopted by many landlords.

    Moreover, the entire tenor of your negotiation may be different after learning more about your rights and responsibilities. For example, your lawyer might advise you that you do have a defense against payment of rent during mandated closure. Even if no such right exists, you may want to learn about changes to language which may be prudent to include in an extension or renewal, particularly important given the chance of a resurgence later in the year. In fact, there are reports of COVID cases spiking while I’m writing this article in mid-June. 

    Simon Relies On Contractual Terms to Terminate its $3.6 Billion Acquisition of Taubman

    Simon is a highly respected retail real estate negotiator. Simon’s negotiation expertise encompasses the acquisition of assets, the negotiation of leases as well as the enforcement of the rights negotiated.  Simon’s reliance on contractual terms and language is exemplified in its lawsuit against Taubman Centers (Taubman), a large retail real estate REIT. On February 9, after extensive negotiations Simon agreed to acquire most of Taubman for approximately $3.6 billion.

    Taubman agreed that Simon could terminate the deal if Taubman suffered a Material Adverse Effect (MAE) or if Taubman breached its covenant to operate its business in the ordinary course until the acquisition closed.  The parties expressly agreed that a pandemic would be an MAE, if it disproportionately affected Taubman “as compared to other participants in the industries in which [it] operate[s].”

    Simon avers that on June 10, it properly exercised its right to terminate the agreement to acquire Taubman for two distinct reasons. First, Simon avers that the COVID-19 pandemic constitutes an MAE because Taubman suffered a uniquely devastating and disproportionate effect when compared with its impact on other parties in the retail real estate industry. Second, Simon avers that Taubman repeatedly violated the ordinary course protocol in the aftermath of the pandemic, causing serious and irreparable damage to its business.

    Reference is made to Simon’s legal action in order to underscore the need for you to carefully evaluate your legal rights. Simon agreed to purchase Taubman for $52.50 per share, or a CAP rate of about 6.2 percent. The retail real estate industry was particularly hard hit by the pandemic, with the stock of many retail REITs dropping sharply after Simon agreed to the aforementioned terms. In fact, Taubman’s stock dropped sharply after Simon announced its decision to terminate and filed its Michigan court action.

    Simon Isn’t Saying It Can’t Pay The Previously Agreed To Price

    Rather, Simon is saying that it has the legal right to terminate the agreement with Taubman because specific contractual criteria are satisfied. 

    Simon Relies on its Interpretation of Contractual Terms to Litigate Retail Leases

    As a large retail landlord, Simon is dependent upon leases with tenants. Such leases are often heavily negotiated, with Simon expecting tenants to abide by the terms and conditions agreed to.  Simon has exhibited its willingness to resort to litigation when a tenant does not adhere to lease provisions.

    For example, in 2017 Simon initiated litigation against Starbucks regarding leases for 77 Teavana stores located in Simon malls. These leases contained a “Continuous Operation Covenant.” In 72 of the leases, Starbucks expressly agreed to the remedy of specific performance for any breach of the Continuous Operation Covenant. The leases also generally stated that none of the remedies granted to Simon were exclusive.

    In spite of the Continuous Operation Covenants, Starbucks announced that it had decided to close all of the Teavana-branded stores. Simon sought and was awarded a preliminary injunction, enjoining Starbucks from failing to occupy and conduct business in the leased premises. 

    Notwithstanding its decision, the Court’s Order did not limit Simon’s or Starbucks’ rights to negotiate early closure of any Teavana stores at issue in the case. So, the commencement of litigation doesn’t preclude consensual settlement before litigation runs its course. Settlement of lease-related litigation occurs if and when the parties believe it is in their best perceived interest to settle; when settlement is perceived as better than continuing to bear the burdens and risks of prolonging litigation.

    Impact on Tenants

    Due to COVID-19 and its economic repercussions, tens of thousands of retailers across the country did not pay all of the rent called for in their leases within the time allotted1. This includes a broad cross section of retailers such as H&M, GAP, Neiman Marcus, Old Navy, 24 Fitness, Supercuts, LOFT, Barnes & Noble, AMC Theatres, Regal Cinemas, Dick’s Sporting Goods, Ross Stores, Nordstrom, Foot Locker, and Burlington Stores. Many restaurants have also grappled with the issue of rent including Panera Bread, Five Guys, Jamba Juice, Subway, and IHOP.

    Impact on Landlords

    In turn many landlords have fallen into arrears on their mortgage obligations. Such arrears pertain to properties as large as the American Dream Mall, a retail and entertainment complex in the Meadowlands Sports Complex boasting more than 3 million square feet. Wells Fargo indicates that Triple Five missed April and May payments on a $1.4 billion mortgage. Triple Five isn’t alone among retail landlords. Companies such as mall REIT CBL have missed payments, in CBL’s case an $11.8 million interest payment to bondholders. And just what is CBL seeking? To restructure. Again, you’re not alone.

    Impact on Lenders and Investors

    The pain doesn’t end there. Many landlords have been unable to remit mortgage payments, with many mortgage loans trading at steep discounts. Lenders are being adversely impacted by the pandemic.

    Investors have also been materially and adversely impacted. One example is the steep decline in the shares of retail REITs.  There are many other examples, including the discount at which the debt on retail properties is trading.

    Conclusion

    The entire retail industry has been turned upside down in the wake of the pandemic. Retailers that were already struggling against the headwinds of ecommerce have been pushed over the edge.  Many retailers that were doing fine are now struggling. This includes many quick-service brands. Having closed, many restaurants and bars will never reopen.

    The more the parties cooperate, the greater the chances for more to survive the mandated closures, social distancing, and any resurgence or slow recovery. All parties must do their part, including thoroughly preparing for lease restructuring negotiations. For operators, this means undertaking that due diligence needed for a thorough understanding of their rights and responsibilities. Without such an understanding you may be characterizing a right (you already possess) as a concession (that you’re asking your landlord for). As detailed above, lease restructuring can be triggered by necessity (e.g., lack of liquidity) or because of contractual rights providing for departure from the rent identified in the lease.

    The truth is that the time is long past due when retail tenants invest the resources needed to meet landlords on a more level playing field. While expensive, failure to do so can have dire consequences, particularly in an unforgiving environment where many landlords are confronting their own challenges, such as servicing mortgage obligations with rental payments often falling short of pre-COVID levels. Events can move swiftly, magnifying the importance of clearly articulating relevant rights stemming from lease language. 

    The importance of preparation is underscored by the size of a typical quick-service restaurant sale (e.g., $4–$7 per meal) in relation to a typical quick-service restaurant rent obligation (often ranging between $7,000 to $13,000 or more per month). This disparity makes it almost impossible to overcome a poorly drafted lease, whether original or restructured. The problem is often compounded by other unfavorable provisions, such as the lack of an appropriate exclusive, low breakpoint on Percentage Rent, uncapped CAM that increases more quickly than menu pricing etc. The stakes are even higher during the pandemic and lease restructuring negotiations.

    Randall Airst is CEO of Exceedant, a platform for real estate owners, occupiers, lenders and investors seeking to optimize their investment in commercial real estate. Randall is also creator of COVID 19 Rent, an online course for tenants, landlords and their representatives. For more information visit www.covid19rent.com. This article does not constitute either legal or financial advice. Every situation is different and solutions must be tailored to fit individual circumstances.