How to deal with problem commercial real estate tenants

Henry F. Luepke III, Partner, litigation department, The Stolar Partnership LLP

Henry F. Luepke III, Partner, litigation department, The Stolar Partnership LLP

Most retail tenants are subject to the whims of the economy. When the economy goes bad, business slows down, and there’s less money to pay the rent. And when the rent doesn’t get paid, landlords suffer, says Henry F. Luepke III, a partner in the litigation department at The Stolar Partnership LLP.

“A commercial landlord depends on the rent that is to be paid for all of the space that it leases out,” says Luepke. “If a retail or commercial tenant won’t or can’t pay the rent, the landlord may have to evict that tenant and replace it with one that will pay the rent. But finding a reliable replacement tenant can be a challenge. If a new tenant is not available to fill the space, the landlord may hesitate before pursuing an eviction that won’t do much more than create another empty space in a property, such as a shopping center, where each tenant relies on the traffic generated by the other tenants.”

As long as the tenant is trying to pay the rent and there is a good chance it will be able to catch up on past-due amounts, it may be in the landlord’s best interest to hold off on an eviction and instead try to work with the tenant, until it becomes clear that the rent won’t be paid.

Smart Business spoke with Luepke about problem tenants and what landlords can do to deal with them and continue to get paid.

What makes a good landlord/tenant relationship go bad?

In the beginning, the landlord/tenant relationship is an amicable one — the tenant wants to succeed so that it can pay the bills and make a profit, and the landlord wants the tenant to succeed, because if it does, the rent can be paid, the space is filled and the increased level of commercial traffic will benefit all the neighboring tenants. It’s a win-win.

But if the business starts to struggle and misses a rent payment, the relationship can quickly become adversarial. At first, some landlords may be sympathetic to the tenant’s issues. The tenant may be allowed to pay late, or the landlord may forgive a portion of the rent.

Landlords, however, have to protect their rights under the lease. When the tenant gets behind on its lease obligations, and the rent and late fees begin to add up, further efforts to accommodate the tenant are likely futile, and the landlord must take prompt action to take back the space and collect as much of the past-due amounts as possible.

What other tenant issues should landlords be on the lookout for?

One issue is building maintenance and repair. A struggling tenant who has failed to pay the rent may try to turn the tables by claiming its failure to pay rent is due to the landlord’s failure to repair some part of the occupied premises.

While such a claim generally will not relieve the tenant of its obligation to pay rent, it will complicate an action to evict and collect the amounts owed. The landlord can avoid this complication by promptly responding to tenant complaints and maintaining its premises.

Sometimes it is the tenant who has caused damage to the premises or that is conducting activities in the premises that may be hazardous or cause damage. In these instances, the landlord often must seek immediate court intervention to close the tenant’s business, prevent further damage and collect the costs of repairing the damage.

Another issue, particularly in the context of a shopping center, relates to tenant mix. One tenant may disapprove of another tenant in the same commercial center. For example, say a shopping center landlord rents commercial space to a chiropractor. The landlord then leases space in the same center to a physical therapy business. The landlord doesn’t see the two businesses as being competitive, but the chiropractor does and feels its business is being hurt as a result.

From a legal standpoint, the landlord is within its rights to lease to the physical therapy business, but from a landlord/tenant relationship standpoint, it’s an unfortunate situation for all involved. If the landlord had known that the chiropractor would object, it might not have leased to the physical therapy business. But once a lease is signed, it’s an iron-clad contract, putting the landlord between a rock and a hard place.

This is why tenant mix — and knowing your tenants — is so important.

Short of eviction, how can problem tenants be dealt with?

The threat of court-ordered eviction is a powerful tool to make tenants pay and live up to their lease obligations. Landlords can use the court system to obtain settlements and consent judgments that, if not complied with, will result in the immediate eviction of the problem tenant.

Such settlements and consent judgments are effective because they create mutually acceptable terms under which delinquent tenants can become current on their lease obligations and, at the same time, grant landlords the ability to recover immediate possession without the costs and delays of filing another lawsuit.

What preemptive actions can landlords take to avoid these problems in the first place?

A thorough, well-drafted lease will anticipate and address most problems. The lease should spell out in detail what circumstances will constitute an event of default under the lease and should state the remedies that are available after an event of default, including immediate eviction and the recovery of damages, attorneys’ fees and other costs of enforcing the lease.

Beyond that, the best thing a landlord can do is find and sign solvent, reliable tenants. Landlords should conduct proper due diligence and get detailed financial statements from prospective tenants. To help ensure payment from corporate tenants, landlords also should require written personal guarantees from the individuals and their spouses who own the corporation or other entity that is the named tenant.

Henry F. Luepke III is a partner in the litigation department at The Stolar Partnership LLP. Reach him at (314) 641-5128 or [email protected]