What is the best way to work through tenant defaults?
After Shelter-In-Place: A Primer For Landlords – Part Three in a Four-Part Series
Shelter-in-Place orders, while certainly prudent, have created financial difficulties for many. And while recent data has shown that tenants have continued to pay their rent at a higher-than-expected rate, forecasts tell us that the worst has yet to come, and that requests from tenants for rent relief will only continue to escalate through the remainder of 2020.
Landlords need to be prepared to address these requests. The right to legally demand full and timely payment will do little in the face of the practical realities faced by virtually every sector of the global economy, and landlords would do well to be armed with a solid understanding of the options available to them.
Here are a few ways for you to protect yourself while also trying to help your tenants get through this crisis:
- Deferral by Proration: Agreement can be reached to defer two or three months and to make that rent up by adding a prorated amount to the remaining months in the lease. The challenge here is: (a) if there are not many months remaining on the lease, the prorated rental rate could be economically unfeasible (example: if there are only two months left after two deferral months, that amounts to double the rent due for each of the two remaining months); and (b) if the tenants have lost their jobs, there is no guarantee that the tenant will be able to sustain the increased rent after the shelter-in-place order is lifted, particularly because government stimulus and benefits programs will begin to dry up.
- Deferral and Extension: Another deferral option is to defer two or three months of rent and to also agree to extend the lease for another set period of time, beyond the current lease expiration, and to prorate the deferred rent over the remainder of the lease term, as extended. This will help alleviate some of the challenges mentioned above. If the tenant has been a quality tenant in every other sense, this is a strong option to consider.
- Accepting Partial Payments: Landlords can agree to accept set amounts of partial rent, and on different schedules than called for in the lease. For instance, a landlord could agree to accept 50% of the full rental amount, paid in three equal installments on the 1st, 10th and 20th of each month for a set number of months. The balance of the rent due for these months could be deferred, or even waived where a landlord can afford, and feels inclined, to do so and no other tenant defaults exist.
- Security Deposits: For those landlords holding security deposits (the vast majority of our Chicago-based clients no longer take them), with tenant’s written agreement, these can be applied to a period when the tenant has been unable to pay rent. Landlords must remember to account for the statutorily-required interest accrued on the security deposit. A statement showing the amount and application of the security deposit plus interest should be promptly remitted to the tenant.
- Exhausting Financial Aid Opportunities: Although the initial wave of governmental support has subsided, there are still many local and national organizations sponsoring housing support initiatives. Savvy landlords should keep a list of these programs available and distribute them to tenants in need. Many of these opportunities can be identified by contacting local Chambers of Commerce or government officials.
- Security Deposits: Just as with residential tenants, commercial landlords can work out written agreements with tenants by which some or all of the security deposit is applied to current rent obligations. Be sure to include tenant’s covenant to replenish the security deposit account within a set period of months after operations have returned to some normalcy.
- Letters of Credit: Landlords should check their records to see if tenants have deposited letters of credit as collateral to guarantee their rent obligations. These can be exercised to offset unpaid rent and agreement can be reached to have the tenant replenish the LOC within a reasonable period of time. If you have an LOC and wish to exercise collection, be careful to comply with all notice and certification obligations in the LOC.
- Guarantors: Landlords should remember to require evidence that guarantors are also personally unable to satisfy rent obligations before entering into any rent relief agreements.
- Percentage Rent Amendments: Many tenants are in need of support during this crisis as a result of severely reduced or completely eliminated incomes during the government-mandated shutdowns. And even after they are permitted to reopen, it is anticipated that it will be many months before business returns to pre-coronavirus levels.
While landlords should do whatever they reasonably can to support good tenants by granting rent concessions during these down periods, they should also use this as an opportunity to review the tenant’s financials to consider whether amending the lease permanently to add a percentage rent clause might make sense.
A percentage rent clause is a provision which establishes a certain gross sales threshold, above which the tenant must pay a percentage of those sales to the landlord as additional rent. This is a particularly effective tool for those large scale, big-box tenants that have negotiated very tenant-favorable leases and have historically performed very well but are now seeking to pressure landlords for significant rent concessions as a result of the temporary loss or reduction of sales.
- Insurance Updates: The current crisis has proven how few Business Interruption insurance policies actually cover the shutdowns caused by health pandemics like COVID-19. It is often repeated that, “the devil is in the details,” and many commercial tenants have been shocked to find that their business interruption policies lack the specific language needed to provide coverage in this situation. Landlords may bear the brunt as well, as their “non-essential” business tenants are unable to sustain rent payments. Landlords should take this opportunity to require that their tenants obtain updated insurance that covers pandemics and government mandated shutdowns related to health crises.
Reviewing Tenant Records
Whether dealing with residential or commercial tenants, landlords should know they are entitled to ask for certain documentation from any tenant requesting concessions. These records can include proof of having applied for stimulus funds or housing support, and proof of loss of income. Landlords should also request commercial tenants’ financial records from both prior years and current year-to-date, for comparison’s sake.
Carefully Documenting All Agreements
Whatever agreements might be reached between landlords and tenants, it is critical they be carefully-crafted, well-written and well-documented, taking care to not unnecessarily waive any rights contained in the original lease agreements.
At Erwin Law, we’ve been creating, documenting, updating and revising landlord-tenant agreements in both the residential and commercial arenas for over 25 years. And we’d be happy to discuss how best to protect your assets during this challenging time and beyond. For more information, call 773-525-0153.