Co-tenancy Clauses in a Lease for a New Mall Construction

In the fashion world, we are constantly being approached by landlords and brokers anxious to bring our brands into the mix of their stores in a Mall. A Mall is a unique situation whereby the marketing of your brand is sublimated to the greater whole of the Mall; if the Mall is a success your store supposedly will also be a success. But this sublimation leads to a fundamental conundrum; when does the marketing for the Mall in toto, inclusive of brands that may be not on the same level as your own, detrimentally affect the good will of your brand? If the answer is that the marketing and demographics of the Mall are oriented towards a customer not willing or able to patronize your brand, except on an aspirational level, entry into the Mall will be a negative; both in terms of return on CapEx as well as dilution of the Brand.

This seems obvious enough as far it goes. You or your agent walk the Mall, review the occupancy, request representations as to sales per square foot and voila, we know if it’s a fit. However, what do you do if you are approached for a space in a new Mall construction? Obviously the developer and its agents will try to prove that your brand is not only a good fit but on the flip side they will use your brand to entice others into the Mall. One could say a virtuous cycle…unless the cycle is broken by misrepresentations of potential tenancies.

To ensure that your brand will be a good fit and not the anchor in the marketing process a Co-tenancy clause is an insurance policy to keep the cycle virtuous. While each Co-tenancy should be calibrated to the particular project there are the proverbial seven (7) deadly sins—when someone is not shall we say fully forthcoming– to consider.

First, the list. You will want to make sure that the Landlord lists as potential co-tenants the main brands that seduced you to enter into the Lease negotiations in the first instance. Since this is a moving target, there may be a list of ten (10) from which the Landlord has to secure say five (5) to (7) signed leases before you are obligated to commence operations.

Second, from the list there may be your anchors; the Brand(s) that must sign leases otherwise you would not proceed. Usually it is one (1) or two (2) and may include a major anchor. But the reasoning is obvious: you do not want your Brand to be the linchpin leveraged for success. Since your Brand positioning is sublimated to the Mall it must be insulated by having core co-tenancies in sync with your own.

Third, timing. When do you have to start spending money on construction, immediately in anticipation of the projected Grand Opening Date or only after the landlord has signed a minimum number of the co-tenancies? Clearly you want breakpoint so your CapEx is not wasted. But this can be ameliorated by…

Fourth, a tenant improvement allowance, the TI. TIs are common enough but are more aggressively promoted in new mall projects. Depending on the size of the store and importance of the Brand full build out costs inclusive of hard and soft costs are negotiable. If the landlord is bearing the cost then timing is ameliorated except you will have to float the costs pending proof of completion.

Fifth, quality of the purported leases. This is the tricky part, how does one ensure that the signed co-tenancy leases are “real” leases. Are they short term pop ups, licenses or leases with favorable kick out provisions? In effect you want to make sure that even if for the Grand Opening Date the co-tenancy requirements are technically met, they reflect true commitment commensurate with your own lease term; if not the value of the co-tenancy clause is totally vitiated. So to hedge, you would require that the co-tenancy leases meet certain standards; as a simple example they must be for terms of no less than five (5) years without a kick out provision. An early kick out provision on favorable terms to the co-tenant is merely an option not the commitment commensurate to insulate your risk.

Sixth, location. The mere fact that the co-tenancy requirements are met does not mean you have immediate value if the brands are located on a different levels, or areas of the Mall. If your brand is in the North 2nd floor of a Mall and your co-tenants are in the South 1st floor the traffic for your co-tenants are unlikely to accrue to your benefit.

Seventh, what happens if the co-tenancy is not met even colorably by opening day. Termination? Probably not. The remedy should be to go to percentage rent only until the co-tenancy is met with a drop dead date of between 12 to 18 months. If the co-tenancy is not met by the drop dead date then tenant usually has the right to terminate.

New projects can be exciting and economically incentivized since the developer is highly motivated to secure tenancies. But the devil is in creating the traction and making sure you are not alone in the vanguard of the developer’s project. A carefully crafted and modulated co-tenancy clause while not a panacea to an inductive analysis of the merits of the particular project, can be a safety net to ensure the economic viability of your shop.

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