The rise of online shopping and the accompanying decline of brick-and-mortar retail stores is a trend that’s threatening a lot of people. Among them are co-op and condo boards who have commercial space in their buildings.
Boards have responded to rising vacancies in commercial spaces in a variety of ways – by signing 99-year leases with investor groups, by lowering rents, by welcoming once-shunned tenants such as restaurants, gyms or bars. Regardless of how they deal with the changing retail climate, though, boards need to realize that big money is at stake when a commercial lease runs out.
Many co-ops have commercial tenants under leases that were negotiated years ago by the sponsor of the conversion plans. Those leases often contain options to extend the terms, sometimes for decades. As a commercial lease nears its termination date, every board should take the following steps: review the lease; understand the renewal terms; and police the exercise of any renewals where base monthly rent, periodic rent escalations or other financial provisions are below market.
Another thing for boards to be aware of is that option-renewal clauses typically contain time-sensitive or notice-specific provisions. An option to renew the lease must be exercised by a prescribed deadline, the so-called “law date.”
But even when a commercial tenant inadvertently fails to exercise a renewal option in a timely manner, the lease is not necessarily terminated. New York courts have the jurisdiction to protect a tenant from a loss of a lease due to a missed law date. However, that power is not open-ended or unlimited.
In the landmark case of J.N.A. Realty Corp. v. Cross Bay Chelsea, Inc., our state’s highest court addressed the following scenario: the tenant operated a restaurant in the leased premises, where it had invested substantial funds for improvements, but missed the deadline for exercising a 24-year lease renewal. The landlord refused to recognize the late renewal notice and instead started a proceeding to evict the restaurant tenant.
The court considered two questions. First, will the tenant suffer a forfeiture (loss of a loyal customer base) if the landlord is permitted to enforce the letter of the agreement? Second, can a court grant the tenant reprieve from a default when the forfeiture is the result of the tenant’s own negligence or inadvertence?
The court determined that the tenant had made considerable improvements to the premises, and if there was a forfeiture, the gravity of the loss would be out of proportion to the gravity of the fault. The court also determined that the tenant would be entitled to relief if there is no harm to the landlord. (Legal harm, in such a case, would exist if, for example, the landlord had already signed a new lease with a third party.)
The courts consider several factors in such cases. Will a retail tenant lose its customer base if it cannot remain in the same location? And will the tenant lose the benefit of a substantial investment in improving the space if it cannot stay put?
To sum up: a commercial tenant who fails to properly exercise a renewal option will be relieved from a default only if the tenant would suffer a loss of the value of its location or a loss of improvements made in contemplation of the renewal – and the landlord is not harmed by a court-imposed extension of the lease.
The lesson here is clear. Co-op and condo boards – and their commercial tenants – need to understand the gritty details of commercial lease renewal options. Big money is at stake for all parties.