How are you getting along with your landlord? How you answer that question will be critical in the weeks and months ahead as the industry puzzles out the impact of COVID-19 on our businesses. One thing is certain:
“This is not the time to just stop paying rent and not communicate with your landlord,” says Jonathan Keyser, founder of the self-titled Arizona-based, global real estate advisory firm, and a long-time IAMC associate member. “More than anything else, what needs to happen in this environment is communication, and you need to be proactive about it.”
Volvo Group Real Estate’s Jon Anderson couldn’t agree more. “As soon as you make that notice, you’re in potential default, and the landlord could go in and seize what’s in the building,” says the property leasing subject matter expert. “In a way, you’ve walked out. But were you prepared for someone to take everything you left behind?”
Force majeure clauses--stipulating events beyond the control of the tenant or landlord--go only so far, and as Anderson points out, they’re typically weighted in favor of the landlord, at least in the US. “The UK and France both have stronger tenant-oriented force majeure clauses,” says the Greensboro, NC-based Anderson, who oversees over 15 million square feet of leases globally. “Sweden is one of the few countries in the world where they use a standard commercial contract for pretty much everything. But in the US, most of our commercial paper is written on landlord contracts.”
“A lot of the force majeure clauses in leases, written by sophisticated landlords and attorneys who’ve experienced similar events in the past, carve out rental payments,” says Keyser Industrial Practice Group leader Ryan Steele. “The clause may release either party from certain obligations and responsibilities, but it usually says that in no event shall it excuse the tenant from prompt rental payments.”
AkzoNobel, like Volvo, is considered an essential business. But depending on how any specific country manages its shutdown decrees, they can nevertheless still be subject to closures and staff cutbacks. In fact, in a way, the designation ties their hands.
“We’re an essential business, so I don’t see how I could even use force majeure as a primary remedy,” says Peggy Blais, who is manager of Corporate Real Estate & Facilities for AkzoNobel, with 6.3 million square feet of North American holdings in her portfolio.
“We were already in the process of reducing a few locations,” she continues, “and we’ve worked out deals with those landlords. I don’t see any other cost-savings by enforcing force majeure.”
Act of God or the Courts?
Blais notes that force majeure is governed by state law. It’s not surprising then that earthquakes can be folded into the wording in California, hurricanes in Florida. But the win will still probably go to the landlord.
“In Miami,” says Anderson, “I can be out almost a full year before I can terminate. That’s common there because of the hurricanes. Otherwise, everyone could terminate, and the entire real estate market would crater. You may have some rent relief, but in the US generally the landlords have a longer time to remedy any issues concerning damages. Force majeure is basically a last resort, one that will tie you up legally.”
“There's a lot of irresponsibility and rushes to judgment,” says Keyser. “Companies are assuming force majeure will apply, but they're acting without full understanding. This isn’t the landlords’ first rodeo. We saw force majeure litigation after 9/11, revolving mostly around whether the attack was one or two events. Ultimately it went to the courts.”
Plus, as of this writing, we’re still in the grip of the pandemic. Jon Anderson states frankly that there can be no resolution this early in the game as to how leases will read going forward (See sidebar). “Certainly we’ll be looking at how to word standard clauses in terms of force majeure,” he says. But it will be uncharted waters. “No one has ever dealt with this before.”
On one hand, “Forewarned is forearmed,” says Blais. “But it's still a little too early to be an actionable item. I can’t see any state touching it until the coast is clear. Is the pandemic an act of God? I would leave that question to brighter legal minds than mine.”
But from a practical standpoint, she says, it will all come down to what the climate of the times will be when the dust clears, buildings start to open and landlords and tenants face off. At that time, “If you have a non-essential business and you ultimately discover that you have the opportunity to use force majeure as a hammer to get out, begin building your business case and start landlord discussions,” says Blais.
Can’t We All Just Get Along?
But is a face-off always the only option? We ask again: How are you getting along with your landlord? “Yes, the Legal Department can provide your options, but my approach is that we're all partners in this, and we should figure out how to partner through this,” says long-standing corporate member Gig Codiga. “We should all try to be reasonable so no one is damaged one way or the other, neither the landlord nor the tenant.”
Any case you want to make with the landlord can only be helped if you show them a bit of due diligence and lay out a clear plan. “You need to demonstrate to your landlord that you aren't just looking specifically to them for relief, but that you’re looking at other relief options as well,” says Keyser. “Demonstrate to them what you were doing before, how this shutdown impacted you, the specific help you’re requesting and how it will remedy the situation on the other side of this. You need to cooperate to achieve a successful outcome.”
That can be a particular challenge in cases such as Volvo’s. Anderson reports that, given its far flung holdings, “we have 700 leases and more than 600 landords.” So getting cozy with landlords has to be left to the locals.
Knowledge Is Power
Whoever does the cooperating, it needs to be informed cooperation. The act of God question started to rear its head as soon as the forced closures began, says Ryan Steele, but every situation is different. It’s important to go beyond force majeure to know and understand every lease provision that could help provide some solution or relief, he urges. “Know what force majeure covers. And remember that every lease is written differently, and geographically it can be applied in a different way.”
“Sometimes in lease negotiations, the things most people dismiss as not that material--the ‘it can never happen here’ mindset--can become material, and that can mean the difference between survival and profitability,” says Keyser. We all hope for the best, but “understanding all of the different elements of your lease on the front end when you’re negotiating it and planning for the worst is critical for all IAMC executives.”
Even though the legal eagles will do the heavy lifting in disputes, and even though it’s all too early to pull the trigger on any post-COVID strategy, now’s a good time to start that due diligence. At least it’s a good time for CRE executives to brush up on how a shutdown can inform (and be informed by) the other clauses in your leases, such as holdover, TI completion, restoration and business interruptions.
“Also know your SNDA [subordination, non-disturbance and attornment] clause,” says Keyser. “There'll be significant issues for tenants without a well-negotiated SNDA clause, which means that, if the building goes back to the bank, their tenancy isn't affected.”
In short, “You have to know the market,” says Codiga, “which is why you have to get started early when you're negotiating for a site or build-to-suit, so in case the landlord isn’t cooperative you can get out and work harder on the next option. If they're a good partner, there won't be a lot of difficulty. If the landlord isn't a good partner, we wouldn’t be negotiating with them in the first place.”
There will come a day when COVID will be a thing of the past. But it's likely to leave in its wake a rethinking of how corporate real estate executives approach new leases and renewals. That has the potential of adding another layer of drama over strategic approaches to leasing that are already shifting.
“In Europe we have a lot of leases that are auto-renew,” says Jon Anderson. “But we’re starting to change that and become more proactive. We’re looking at starting renewal conversations 18 months out.”
That shift presents its own challenges in that the department is also looking to shorten many of its leases down to three years. “If you're writing a three-year lease and starting negotiations 18 months out, you're constantly in the process. We’re currently reviewing that as well to take a more proactive stance.” Part of the solution Volvo is mulling is contracting with a third-party facilities advisor to help with the volume.
In these post-FASB days, the Purchasing Department is also scrutinizing leases, adding yet another layer to the internal approvals process in the form of a learning curve. Anderson says that traditionally Purchasing saw leases more in terms of “parts and pieces, as opposed to real estate.”
Depending on the size and the location, Peggy Blais says she starts the groundwork for renegotiations 18 months out, longer for more complex site needs. “We’re no longer doing five-year renewals,” she says. “We're doing two threes or three twos to get more flexibility for the businesses. These are the things that drive our landlords crazy, but this is the only way to address changing business needs and get approvals from my business units.”
That’s as hard-and-fast a rule as the local market will allow. “Of course, it depends on how tight the market is,” she says. “We’ve had landlords tell us they won't renew unless we take a five-year deal.” In those cases, it’s back to the business unit.
More time upfront equates to more leverage, says Ryan Steele. “You need to give yourself enough time to evaluate every viable option,” he says, “whether it’s a renewal, a relocation or even a build-to-suit.”
Until we all get our post-COVID sea legs, Jonathan Keyser recommends adopting a “wait and see” strategy. “The real impact of this downturn hasn’t yet been felt,” he says. “If you can, it's probably wise to wait to let this play out a bit before you strike any significant new deals. But start early so you can navigate and plan through this.”
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