Leases With High Risk Tenants

On behalf of Kaplin Stewart Meloff Reiter & Stein, P.C. posted in on Nov 2, 2016.

In order to fill vacant spaces in commercial buildings, a high risk, financially weak tenant may be a landlord’s only option. In negotiating a lease with such a tenant, however, a landlord must be careful to minimize the risk associated with the increased potential for a tenant default early in the term.

Landlords should be cautious not to incur an expensive build-out cost for such a lease or pay a high risk tenant a substantial tenant improvement allowance. In the alternative, the landlord could provide the tenant with free rent for one or more of the months at the beginning of the term and, in consideration therefor, the tenant will pay for the build-out of its premises.

Landlords should also negotiate for guarantees from the owners of the tenant. In Pennsylvania, it is important for any guaranty to also be executed by the guarantors’ spouses; otherwise, the landlord will not be able to collect against any jointly held assets. If there is resistance from the tenant to provide such guarantees, the parties can negotiate for a guaranty limited to the amount that the landlord incurred in constructing the premises or paid as an allowance, as well as a portion of the rent. If agreeing to a limited guaranty, the landlord should provide that such limitation will only be effective if the tenant voluntarily gives back the premises to the landlord and does not legally defend any eviction action. Depending on the amount of money that is being invested in the premises by the landlord, this proposal might be beneficial to the landlord since it will be able to re-lease the premises in a timely manner without having to spend legal fees in attempting to gain possession of the premises.

Additionally, landlords should negotiate for a security deposit to offset the amount of the construction costs and allowance in the event of a tenant default. The amount of this security deposit could be reduced during the term of the lease in the same proportion as the construction costs and allowance is amortized during the length of the term. If the tenant does not have sufficient cash to pay such a security deposit, the landlord could accept a letter of credit as a security deposit, so long as the letter of credit is unconditional and the landlord has the right to present the letter of credit for payment and use the proceeds thereof to cure any tenant default.

Although the credit of a tenant should be considered in every lease, landlords can be creative and lease to high risk tenants and still be protected.