Friday, October 26, 2018 9:00 – 10:15 AM

Workshop 22

Thinking Outside of the Traditional Box, What to do When Your Anchor Tenant Goes Dark

Presented to

2018 U.S. Center Law Conference JW Marriott Orlando Grande Lakes Orlando, FL October 24-27, 2018

by:

Susan Winchurch, Esq. Robert C. Ondak, Esq. Director, Senior Counsel, Real Estate Partner Burlington Stores Benesch Friedlander Coplan & Aronoff LLP 1830 Route 130 N 200 Public Square, Suite 2300 Burlington, NJ, 08016 Cleveland, OH 44114 [email protected] [email protected]

Thinking Outside of the Traditional Box, What to do When Your Anchor Tenant Goes Dark

I. SUMMARY OF THE CURRENT STATE OF

A. Bankruptcies, Store Closures, and Liquidations

One of the most visible trends in retail is the proliferation of bankruptcies, store closures, and liquidations of retailers. Some industry observers have taken to calling the large number of American retail stores over the last few years as the “”. In 2017 alone, retailers announced the closing of approximately 6,985 retail stores in the U.S. According to Business Insider, a total of 50 retailers filed for bankruptcy protection in 2017, including major national retailers Charming Charlie, Toys R Us, HHGregg, True Religion, Perfumania, Rue 21, Payless, and Radio Shack.

One of the most

pronounced casualties in the retail industry is the apparel category, which has suffered the greatest losses compared to other major retail categories. In 1977, apparel represented approximately 6.2% of consumer spending. Consumer spending on apparel in 2017 is nearly half of the consumer spending in 1977. Total spending on apparel since the turn of this century has declined by approximately 20% as consumers continue to shift spending from apparel to traveling, dining out, and other entertainment options. Exacerbating the issues facing traditional apparel retailers is that apparel is now the largest online retail category.

B. Consolidation in Retail Industry

As the market for traditional retail continues to evolve, more retailers are acknowledging the reality that organic growth for certain categories is becoming harder to achieve in the face of changing consumer preferences and retail over capacity. Examples of retail consolidation include the Michael Kors acquisition of Jimmy Choo, Walmart acquisition of online retailer Bonobos, Amazon’s acquisition of Whole Foods, and the acquisition of Golfsmith and Sports Authority by Dick’s Sporting Goods. The Walmart acquisition of Bonobos is an example of a traditional retailer looking to an online retailer for new ideas and a new approach omni-channel retail development. The Amazon acquisition of Whole Foods and Dick’s Sporting Goods acquisition of the assets of Golfsmith and thirty-one leases from Sports Authority are examples of a retailer acquiring the assets of a liquidating retailer at a substantial discount.

Retail consolidation will likely include consolidation of malls and developments. Between 1970 and 2015, the number of malls grew by more than twice as fast as the population according to Cowen and Company. The U.S. has 40% more gross leasable area per capita than Canada. Accordingly, mall visits declined by 50% between 2010 and 2013 during the Great Recession, the rates have not since recovered.

Among the most visible mall departures are the closure of department stores and other anchors. Macy’s began 2017 by announcing 11 additional store closures (adding to the 100 planned store closures announced in 2016). J.C. Penney announced it was closing 8 additional stores in 2017, adding to its 140 previously announced store closures. Bon-Ton announced it planned to close 40 stores in 2018. Sears Holdings announced it would close 103 Sears and K-Mart stores, adding to its previously announced planned closures.

C. Proliferation of Online Retail Sales

Online sales, which represented 14% of all retail sales in 2017, continues to lead the retail industry growth, accounting for 49% of retail industry growth. Industry watchers predict online sales will account for 17% of all US retail sales by 2022. Traditional store retailers are shifting resources to provide omni-channel retail experiences, which aim to provide seamless customer experiences online and in a store. Even department stores are making heavy investments into e-commerce and now earn 15% to 25% of their sales online.

D. Amazon and Other Online Retailers

Although online retail growth accounted for 49% of the growth in the retail industry, Amazon represented a substantial portion of that growth. It is reported that 50% of U.S. households are now Amazon Prime subscribers. Amazon is expected to be a major driver of online retail sales growth. Approximately 83% of U.S. adults that purchase products online bought products or services on Amazon in 2016. In addition, 55% of U.S. adults that purchase products online used Amazon as a research tool before making the purchase. Amazon and other online retailers continue to drive retail sales across all product categories.

II. CURRENT RETAIL TRENDS

A. Retail Shopping Center Development

In 2018, developers and landlords continue the trend of updating retail mixes, by reducing department stores and big box anchors, and providing more entertainment, food options, fitness studios, medical uses, and other mixed residential and office uses. Food halls and celebrity chef concepts will continue to replace traditional food courts and restaurants. According to industry analysts, developers and landlords will continue to pivot away from leasing to some apparel specialty stores while working to attract grocery and other experiences that appear to be less vulnerable to online sales. Since 2014, 90 regional malls have spent approximately $8 billion on property renovations and upgrades according to Jones Lang LaSalle. Developers are also rebranding regional shopping malls as “shoppes,” “villages,” and “town centers.” Vacant anchor spaces will continue to be replaced with hotels, apartments, office spaces, and other mixed uses.

B. Restaurant and Entertainment Anchors

As consumers continue to focus their spending on “food, fun, and fitness” experiences, shopping center developers will continue to attract experienced based retailers such as restaurants, children’s theaters, craft brewers, and other entertainment retailers like Dave & Buster’s. Entertainment’s share of consumer spending continues to climb. In some shopping center developments, restaurants (including local and celebrity restaurant concepts) are replacing traditional anchors as key traffic drivers. Ten years ago, restaurants accounted for approximately 10% of shopping center gross leasable area and now accounts for between 20% and 40% of shopping center leasable area. Traditional food courts are being replaced by “destination restaurants.” Entertainment tenants like Punch Bowl Social and Dave & Buster’s are filling the vacant department store spaces. Dave & Buster’s reported forecasts growth of approximately 14% in 2018.

C. Showroom Concept Stores

Some retailers are investing resources to create showrooms and other low inventory retail stores that support an overall omni-channel retail strategy. In some cases, underperforming stores can be replaced by showrooms that allow a retailer to test new concepts or enhance the consumer experience. A typical showroom would include knowledgeable sales associates who provide in-depth advice regarding products or services or merely facilitates the ordering process, but products are typically shipped from fulfillment centers or other stores. Showrooms have the advantage of requiring less retail space, fewer associates, and could provide for a more engaging experience over some traditional retail spaces.

Bonobos began its entry as an in-store retailer with its popular “Guideshops”, which are showrooms featuring knowledgeable sales associates (called “ninjas”) and beer. Guideshops have been hugely popular and enhances the Bonobos brand and the customer experience.

D. Non-traditional Retail Uses

Some of the non-traditional leading replacement tenants that are backfilling vacating anchors, including bowling alleys, theatres, fitness centers, medical offices, karaoke booths, and arcades are tenants that provide engaging experiences for children like Crayola Experience.

Among the growing trend of non-traditional retail uses are pop-up stores. Both traditional retailers and new entrants to the physical store retail market are using pop-up stores to test and refine new concepts. Warby Parker continues to test pop-up shops and “stores on wheels” to reach its customers. For three days in December

2017, J.C. Penney opened a pop-up store in Manhattan under the name “Jacques Penne.” The store featured gift ideas from television personality Nicole Richie. Shopping center developers are now getting into the business of fostering the development of new concepts by promoting the use of pop-up stores. Simon Property Group created a pop-up market place at The Edit@Roosevelt Field, which is a permanent space for pop-up shops.

E. Emphasis on Experiences

Most industry observers anticipate the rise of “experiential stores” that allow a consumer to learn more about a product or brand or try out [and try on] new products but will not maintain the same level of inventory as traditional retail stores. Experienced and knowledgeable sales associates will be critical to the emphasis on providing seamless customer experiences. For example, ’s newest 3,000 square feet concept store (Nordstrom Local) in Los Angeles provides only high end concierge services like alterations, tailoring, online pickup, and styling consulting, but provides no in-store merchandise. The intent of this concept store is to complement the Nordstrom brand, but not to replace the anchor stores.

F. Retail Store Fulfillment Centers

As online retail sales continue to increase, retailers will continue to re-evaluate its real estate assets. Seamless omni-channel experiences require optimal inventory management that allows consumers maximum flexibility to order and pickup retail orders. Some industry watchers believe some brick and mortar retailers have an inherent advantage due to the size of their store networks. These existing stores can be leveraged in furtherance of a distributed warehousing strategy to support online sales. Brick and mortar stores continue to be relevant as customers return to stores to retrieve orders and engage sales associates in stores. In addition, adapting existing in-store capabilities to provide enhanced online fulfillment, Walmart announced that it intended to convert 10-11 Sam’s Club retail stores entirely to fulfillment centers.

III. NAVIGATING THE LANDSCAPE WHEN AN ANCHOR TENANT CLOSES

A. Subleasing

1. General Summary of Subleasing

(a) Sublease: The tenant transfers something less that all of the tenant’s interest in the premises. The tenant, acting as a landlord, leases some or all of its interest in the premises to the subtenant, but the tenant retains an interest in the premises. That interest may be continued possession of a portion of the premises, or a reversionary interest in the premises, such as some term extending beyond the expiration of the sublease term or a right of reentry.

(i) The sublease is a contractual relationship between the tenant/sublandlord and the subtenant. Unless the landlord is specifically made a party to the sublease agreement (as discussed below), the landlord is not a party to the sublease contract. The subtenant does not “step into the shoes” of the tenant/sublandlord under the lease.

(ii) The rights of the subtenant are subject to all of the terms and conditions of the prime lease between the landlord and the tenant. The leasehold estate of the subtenant arises out of the leasehold estate of the tenant.

(iii) The estate and rights of the subtenant cannot be any greater than the estate and rights of the tenant under the prime lease.

(iv) The term of a sublease cannot be longer than the term of the prime lease.

(v) Termination of the prime lease will result in a termination of the sublease as well.

2. Why Sublease?

(a) With an assignment of a lease, the assignee takes over the entire premises of the assigning tenant for the remaining term of the lease at the same rental amount, and subject to all of the other terms and conditions, as provided in the lease.

(b) The sublease is a new leasing arrangement between the tenant and the subtenant, offering more flexibility than an assignment (although subject to limitations created by the prime lease) to meet the needs of the parties.

(i) Can sublease something less than all of the premises. An anchor tenant may no longer need all of its original space and may desire to cover some of its rental expense for the unused space. The tenant can continue to use the balance of its premises under the terms of its lease. Likewise, the subtenant may not need all of the premises.

(ii) Sublease term can be shorter than the balance of the prime lease term.

(iii) Sublease rent can be at a different rental rate. Under some circumstances, the rental market may be such that the anchor tenant can sublease the space for a rental amount greater than that which is being charged under the lease. In that situation, the anchor tenant can actually make a profit on the transaction. Conversely, if an anchor tenant is motivated to sublease unneeded space to cover its costs, the subtenant may be able to rent the space at a rental rate lower than current market rates or asking rents in the shopping center.

3. Landlord’s Perspective.

(a) The landlord’s concerns with a sublease are very much the same as the landlord’s concerns with other leases in the shopping center.

(i) Nature of the subtenant and its business.

(ii) Proposed use of the premises.

(iii) Potential effect of the subtenant on the tenant mix, the reputation of the shopping center and co-tenancy issues.

(iv) Violation of any exclusive use provisions in other leases.

(v) Greater demand on parking, utilities or common areas.

(vi) Is the subtenant of the same “quality” or reputation as the tenant?

(vii) Will the subtenant generate the same amount of customer traffic or gross sales as the original anchor tenant?

(b) By subleasing, the tenant is, effectively, competing with the landlord for leasing space in the shopping center. A subleasing tenant is likely to be more aggressive in offering a lower rental rate and thereby depress rental rates in the shopping center. The landlord’s concern is more pronounced when vacancy rates in the shopping center are high or the leasing market is soft. When vacancy rates are low or the leasing market is strong, the landlord may not object to the sublease if it keeps space occupied or perhaps assists a financially troubled tenant from otherwise defaulting on its lease.

(c) Since a landlord is not entering into a direct leasing arrangement with the subtenant, the landlord may not be as concerned as the tenant/sublandlord with the financial strength of the subtenant. A landlord may nonetheless be concerned that the subtenant be able to meet its obligations under the sublease to avoid disruption in the shopping center or a negative impact on the tenant. If the subtenant proposes to make alterations to the premises, the landlord will want to know that the subtenant can pay for them.

(d) Landlord’s rights to consent or impose restrictions.

(i) Anchor tenants usually have broad assignment and subleasing rights.

(ii) Unless prohibited by the anchor tenant lease, the anchor tenant will have a right to sublease its premises.

(iii) A landlord must also consider whether the subletting is permitted under any mortgage or loan documents encumbering the landlord’s property or whether a lender’s consent is required.

(e) The anchor tenant lease may provide other restrictions on subleasing.

(i) Landlord’s right to “recapture” the proposed sublease space. That recapture right may be triggered by the anchor tenant’s request of the landlord’s consent to the sublease. The landlord may want to recapture the space when market rents have increased and the landlord can relet the space at a higher rate than under the existing lease or to protect against a co-tenancy violation. The landlord may also want to recapture the space if it permits the landlord to combine the proposed sublease space with other space in the shopping center for lease to a new tenant or to accommodate another tenant’s expansion.

(ii) Certain rights of the anchor tenant, such as expansion rights, options to extend the lease term, rights of first refusal, rights of first offer and the like may be voided by the subletting or may not be granted to the subtenant.

(f) The landlord may also have the right to share in some or all of the rental income under the sublease that exceeds the amount of rent payable under the anchor tenant lease. Leases that permit the landlord to capture all of such excess rent provide no incentive to the anchor tenant to ask for a sublease rental rate greater than the rate under the prime lease. Similar provisions, which provide for the landlord and the anchor tenant to split the excess rent in some proportion provide the landlord and the anchor tenant with incentives to obtain the highest sublease rents as possible.

(g) With leases that have a percentage rent provision, the landlord will want to have all sales by the subtenant included in the calculation of the anchor tenant’s sales for purposes of calculating percentage rent.

(h) In some cases, a landlord may want to preserve (or have a right to preserve) a sublease and retain the subtenant (as a direct tenant) in the event the anchor tenant lease is terminated.

4. Tenant’s Perspective.

(a) When subleasing, an anchor tenant is acting as a landlord and, consequently, has many of the same concerns that a landlord will typically have with leasing.

(b) An anchor tenant may be motivated to sublease space in an effort to at least cover the cost of space that is no longer needed by the anchor tenant or to take advantage of a market in which rental rates have risen, permitting the anchor tenant to make a profit on the sublease space.

(c) The anchor tenant must consider the subtenant’s financial strength, proposed use of the premises, and potential liabilities that might arise from the subletting.

(d) An anchor tenant needs to recognize that it is becoming a landlord and be prepared for that. If an anchor tenant is subleasing a large amount of space, it may end up with multiple subtenants and need to act as a property manager.

(e) An anchor tenant must first review its lease to determine whether subleasing is permitted and, if so, under what circumstances; however, the majority of the time an anchor tenant will have broad transfer rights.

(i) Is the landlord’s consent required?

(ii) Does the landlord have a recapture right or right to share in rent?

(iii) Will the subleasing impact any other rights of the anchor tenant, such as voiding any expansion rights, options to extend, rights of first refusal, etc., as noted above?

(f) The anchor tenant will continue to be obligated under its lease, regardless of the obligations undertaken by the subtenant. The anchor tenant will continue to be obligated to pay rent to the landlord, maintain insurance, maintain the premises, indemnify the landlord, and be liable for all other tenant obligations to the extent required under the anchor tenant lease. In many cases, any guarantors of the anchor tenant lease will continue to be liable under the lease guaranty.

(g) When drafting a sublease, the anchor tenant must be careful to “match up” the terms of the sublease with the terms of the anchor tenant lease.

5. Subtenant’s Perspective.

(a) In many ways, the subtenant is in the most precarious position of the three parties involved in the sublease relationship.

(b) The subtenant’s rights are subject to all of the terms and conditions of the anchor tenant lease and can be extinguished upon the termination of the anchor tenant lease. If the anchor tenant lease is subordinate to financing on the shopping center, the sublease will also be subject to the terms and conditions of the mortgage and other loan documents as well as the anchor tenant lease. A foreclosure that terminates the anchor tenant ease will also terminate the sublease.

(c) This position is precarious for the subtenant, because the subtenant is not a party to the anchor tenant lease or the landlord-lender relationship and has no control over them. Before making a substantial investment in a sublease, the subtenant may want to consider the financial strength of both the landlord and the tenant. A strong and/or sophisticated subtenant will require a recognition/acknowledgment agreement from the landlord and/or landlord’s lender to protect the subtenant’s interests. Strong anchor tenants will negotiate the right to obtain a recognition/acknowledgment agreement in the anchor tenant lease.

6. Enforcement of Landlord’s Obligations.

(a) The subtenant will expect to receive the benefit of the performance of the landlord’s obligations under the anchor tenant lease. Those obligations may include certain services, maintenance of the building/premises, and restoration in the event of a casualty. However, since the subtenant does not have a contractual relationship with the landlord, the subtenant has no means of enforcing the landlord’s obligations.

(b) This issue is addressed in subleases by requiring the anchor tenant to enforce the landlord’s obligations on behalf of the subtenant.

(c) Usually, the anchor tenant’s obligation is limited to taking reasonable actions to enforce the provisions of the anchor tenant lease, without requiring the anchor tenant to enter into litigation.

(d) The subtenant may want the right to take action and to litigate in the anchor tenant’s name (but at the subtenant’s expense).

(e) The anchor tenant will usually have certain self-help rights under the anchor tenant lease and the subtenant may want to require the anchor tenant to take reasonable actions to exercise those rights on behalf of the subtenant or to permit the subtenant to take action in the anchor tenant’s name.

7. Pass Through Charges.

(a) It is common for common area maintenance (CAM) charges, insurance costs and real estate taxes under the anchor tenant lease to be passed through to the subtenant.

(b) Anchor tenants usually have audit rights. The subtenant will want to require the anchor tenant to take the necessary actions to preserve the anchor tenant’s rights to audit the charges and to pursue such audits at the subtenant’s request (and expense).

8. Time Periods.

(a) When drafting the sublease, the parties should be careful about the time periods for performance of their obligations and cure periods.

(b) Where the anchor tenant’s obligations under the anchor lease are passed through to the subtenant, the subtenant must perform those obligations within a time period that avoids a default under the anchor tenant lease.

(c) The sublease rent and other charges must be paid in time to permit timely payment of rent and other charges under the anchor tenant ease.

(d) If the subtenant has cure period for the payment of rent (or other obligation), that cure period should be shorter than the corresponding cure period under the anchor tenant lease to permit the anchor tenant time to enforce the provisions of the sublease and avoid a default under the anchor tenant lease.

(e) If the sublease requires the anchor tenant to take action to enforce performance of the landlord’s obligations under the anchor tenant lease after some notice from the subtenant, then the period of time permitted for the anchor tenant’s action needs to be longer than the cure period given to the landlord under the anchor tenant lease.

9. Surrender of the Premises.

(a) The surrender provisions of the anchor tenant lease and the sublease may contain pitfalls that are easily overlooked.

(b) If the subtenant assumes the anchor tenant’s obligation to return the premises to the landlord in the condition that they were in at the beginning of the anchor tenant lease term, then the subtenant may be taking on a substantial demolition/restoration expense that it did not intend.

(c) Similarly, if the subtenant performs a substantial build-out of the premises, and the sublease does not require the subtenant to return the premises to their prior condition, then the anchor tenant may unexpectedly have to bear the demolition/restoration expense.

B. Downsizing

1. The Downsizing Program.

(a) Identify the right number – how many downsize projects can realistically be accomplished in a given year?

(b) Identify the right stores – the retailer needs to achieve the right synergy between Real Estate, Finance, and Construction to identify the best prospects for rolling out a new downsized store format. There are myriad issues to consider beyond whether it works from a real estate development standpoint. When was the store last remodeled? Is it woefully out of date or does it satisfy the retailer’s current “brand standards”? If a remodel is initiated with a downsize, what are the finance implications of the write off associated with replacing store fixtures?

(c) Focus on the landlords – can we leverage existing relationships to partner across multiple deals?

(d) Focus on the co-tenant – Do downsizing deals work best with certain co-tenants? Example: your company has a history with national chain of fitness centers as a next door neighbor – you know the synergy works and each company understands the other’s construction timelines – and you know that operationally you can co-exist.

2. Downsizing Issues for the Landlord and Tenant.

The process of downsizing a large retailer has been compared to performing surgery on a living patient. This is not a ground-up store where team can focus exclusively on completion of construction and satisfaction of delivery requirements to the exclusion of operational issues. In most cases, the store will remain open during the process of separating and surrendering the “Giveback Space” and remodeling the “Remainder Space.” This can cause the downsize deal, while conceptually simple to articulate at the letter of intent stage, to take on a level of complexity that is often not appreciated by all of the stakeholders in the deal – until the process is underway and issues start to materialize.

Examples of issues that may crop up during a downsize:

Landlord and Tenant may agree immediately on responsibility for separation of major building system and utilities (gas, electric, water) but mid-way into the performance of Landlord’s work, questions may arise about “secondary” systems: telephones, burglar alarm system, fire alarm and other “general” building systems. Who will assume that cost?

Lesson Learned: Construction and Real Estate need to account for all aspects of the separation work that needs to be done to result in the Remainder Space being able to function as an independent unit with no remaining interdependency on systems shared with the Giveback Space.

Landlord and Tenant may agree on a date to surrender the Giveback Space based on Tenant’s current configuration in the leased premises, but Tenant may need to hold on to the Giveback Space to use as “swing space” for storage of its inventory and fixtures during the reconfiguration of the Remainder Space.

Lesson Learned: In many cases, depending on the scope of the remodel being performed by the downsizing tenant, that tenant will need domain over the entirety of the premises to perform its remodel and will not be in a position to surrender the Giveback Space until the remodel is complete and the inventory has been redeployed in the remodeled store. Don’t assume that the Giveback Date is a no-brainer merely by virtue of the fact that the space isn’t actually in use – that space may provide necessary staging space during the retailer’s remodel.

3. Documenting the Downsizing Deal.

THE LETTER OF INTENT IS NOT JUST A FILE STUFFER. Don’t “punt.” The legal team – whether in- house or outside counsel – should be encouraged to work with the Real Estate Development team to develop a meaningful letter of intent that will set realistic expectations on both sides with regard to phasing, responsibility, time lines and deal points. The downsize deal does not have to be overly complicated; nor should it be over-simplified. To that end, it is helpful to introduce in the LOI some fundamental deal points:

i. Identify Remainder Premises and Giveback Space. Tenant’s current Premises of ______square feet shall be reduced by ______square feet (the “Downsizing”) in the area depicted in the attached Exhibit A (the “Surrender Premises”) [ATTACH A FLOOR PLAN] resulting in a new reduced Premises of ______square feet (the “Remainder Premises”).

ii. EARLY IN THE PROCESS Work with your store development team to develop a floor plan to attach as Exhibit A to your downsize amendment showing the surrender space and the remainder space – work closely with your store planning teams to understand exactly the dimensions of the box and resolve any historical discrepancies. It is not unusual to find meaningful discrepancies that can affect the economics on either side.

iii. Address When Negotiated Rent Changes Take Effect. The downsize amendment may provide that the Lease continues at the existing rental rates and otherwise on all of the same terms of the Lease until the date Tenant has vacated the Surrender Premises. Upon surrender, the lease term would be amended, restated and extended by [“X”] years following the New Commencement Date. In lieu of any other options contained in the Lease, Tenant would have [“X”] options (“Extension Options”) of [“X”] years each (the “Option Terms”).

iv. Point to be negotiated. Keep in mind that if a downsizing tenant is getting a rent reduction, the tenant will want to pay downsize rent immediately upon surrender of the “Giveback Space.” On the other hand, Landlord will want commencement of the “new rent” to wait until the co-tenant opens and pays rent in its new location.

v. Address Any Restructuring of Percentage Rent Provisions. Does Percentage Rent Breakpoint Need to be Revisited? If Tenant is operating under an old lease that has been amended repeatedly over the years, the breakpoint may be a detail that has been overlooked, and may be overlooked by a deal person who is focusing on the more immediate development concerns presented by a reduction in the size of the Premises. The tenant’s attorney should assess the current percentage rent structure. Tenant may be operating under an artificial breakpoint set in a different economic climate that should be re-analyzed and possibly revised so that it will be in line with the revised economics that accompany the downsize.

vi. Address Tenant Improvement Allowance: How Much and When Paid? Landlord will pay Tenant: [“X”] Dollars per square foot of the Remainder Premises as the “Tenant Improvement Allowance” within [“X”] days following the New Commencement Date.

vii. Address Needed Adjustments to Triple Net Charges and Repair and Maintenance Obligations: On the New Commencement Date, Tenant’s pro rata share of taxes, common area expenses and insurance will be based on the square footage of the Remainder Premises. If Tenant is a stand-alone or single space user that directly maintains the entire shopping center, provide for shift of responsibility to Landlord for paying taxes and insurance and maintaining common areas. If Tenant has previously not paid its pro-rata share of these items, Tenant will want to negotiate a commercially reasonable cap. viii. Address Signage: Address changes in signage rights, if any. What signage rights does the co-tenant have? Does the addition of the co-tenant affect Landlord’s overall allotment of signage and/or Tenant’s signage? Tenant will want the right to update to its standard signage prototype as part of the remodeling of its store, and have the right to update to current prototypes from time to time.

ix. Address Any Revisions To Exclusives and Other Restrictions: Because the Surrender Space is immediately adjacent to the Remainder Premises, both Landlord and Tenant will need to consider the extent to which use of the Surrender Space will be restricted prospectively. If Tenant is operating under a very old lease, the existing use and co-tenancy provisions may be out of date or not on point. The downsize deal provides an opportunity to take a fresh look at these provisions; updating them is often to both Landlord’s and Tenant’s advantage.

x. Address Any Major Alterations to be Performed by Landlord in Conjunction With Tenant’s Downsize and Remodel. New roof? Façade rebuild? Tenant will want the façade of the Surrender Space to be occupied by its new neighbor to be architecturally harmonious with the Remainder Premises façade and not to exceed the height of the Remainder Premises. Since the Surrender Space is getting a new façade, Tenant’s downsizing deal may include provisions for a new façade added to the Remainder Space to ensure architectural and aesthetic harmony.

xi. Address Exterior, Parking and Common Areas: The Site Plan of the Shopping Center may need to be updated to reflect the multi-use of the Shopping Center with protected parking area and critical areas depicted on an updated Site Plan. xii. Construction/Work Letter Issues. Develop and attach to the LOI a downsizing work letter that addresses the critical construction and operational concerns:

 What is current roof condition? Is replacement necessary?

 What is current HVAC condition? Do units have to be added or relocated? What tonnage adjustments need to be made to account for the smaller downsized space?

 Separation of utilities/water/sewer/gas/sprinkler/other systems

 Necessary reconfiguration of loading docks/trash compactors?

 Who builds the demising partition? If Tenant builds, negotiate reimbursement.

 What is the timing of the construction of the demising wall? Does the downsizing Tenant need domain over the Surrender Space to use as staging area or “swing space” to store inventory during its remodel? if so, the downsizing Tenant will want to perform its remodel and have the demising wall constructed at the end of the remodel process.

In addition to Addressing the Specific Scope of Work and Construction Details, the Work Letter Should Incorporate the Following Concepts:

i. Landlord recognizes that Tenant will remain open for business during the performance of Landlord’s Work.

ii. Landlord will use commercially reasonable efforts to minimize any disruption to the business operations of Tenant.

iii. Any demolition or other work causing excessive noise shall be performed before or after the store’s operating hours.

iv. Landlord shall provide a new structurally sound and watertight roof including all parapet caps, canopies, skylights, curb caps, and overhangs.

v. Landlord shall supply to the Remainder Premises (or reconfigure as necessary) all HVAC components to make a fully operational system that provides Tenant’s minimum tonnage requirements. This may require new rooftop units being added – a point of negotiation. Keep in mind that if rooftop units are located in the area of a demising wall, they may need to be relocated as part of Landlord’s Work.

vi. Landlord shall provide code compliant separately metered utilities, in existing locations or locations shown in the Final Plans, to the Remainder Premises.

vii. Separate electrical service (exclusive to the tenant)

viii. Separately metered or sub-metered water service.

ix. Separate sewer lines.

x. Separate gas lines.

xi. Separate fire and sprinkler system for Remainder Premises – cannot have a situation where a fire next door trips Tenant’s sprinkler systems.

xii. Separate any and all other mechanical and/or building infrastructural systems as are necessary for the Remainder Premises to function as an independent unit, such as, by way of example: data, phones, burglar alarm system, fire alarm system.

xiii. Are there blackout periods that need to be considered? E.g., no disruptive construction during holiday selling season after October 31. No construction one month before Easter.

xiv. Milestones and Phasing. Prior to Commencement of Landlord’s Work and Tenant’s Work, the parties should agree on a detailed Phasing Plan that coordinates Landlord’s Work and Tenant’s Work

Phase Milestone Date

Landlord Commences Installation of New Roof

Landlord Commences Installation/Relocation of any HVAC Units

Landlord Completes Installation of New Roof/Relocation of any HVAC Units

Tenant’s Commences Tenant’s Work (Remodel)

Landlord Commences Phases of Landlord’s Work (MEP Separation Work, Façade etc.)

Tenant Completes Remodel, Installs Partition Wall and surrenders Surrender Space (New Commencement Date)

Completion of Landlord’s Work

THE LEASE DOCUMENT. The downsize deal needs to be properly documented and that means some thought needs to be given to the document itself. Most often, this is not a 2 or 3 page lease amendment. There is more than one deal structure to consider: a traditional lease amendment, an amended and restated lease, or sale-leaseback all are options. Obviously, if all of the above-mentioned items are addressed and at least “socialized” between the parties in the Letter of Intent, addressing these items in the lease document or lease amendment will go down a lot more easily.

If the lease is an older document (e.g., Tenant took the premises by assignment from Kmart and the lease dates back to 1978 and both parties are “living with” various obsolete terms), consider whether Landlord and Tenant are amendable to working through a wholesale cleanup in the form of an amended and restated lease. This approach presents the obvious advantage of giving both parties the opportunity to start over on a clean slate; there is no need to try to update severely outdated provisions by means of “surgical” insertion of updated lease provisions within a fundamentally obsolete document.

The obvious disadvantage is that the “amended and restated” lease may take three times as long to negotiate.

Regardless of the form the document takes, from a legal drafting standpoint, a downsize likely means that the Tenant is undertaking a significant capital investment in the form of a store remodel and making a commitment to stay for an extended term – possibly a 10 year term extension or longer.

Therefore, once the business and construction details are hammered out, it makes sense to consider a few updates to the It therefore makes sense to consider a few updates:

Casualty and Condemnation. Review the lease. Is the existing legacy deal structure for Tenant a stand-alone store or capital lease pursuant to which Tenant directly maintains and insures the entire building? Is this old lease language consistent with current reality or has it essentially been ignored over the years since the Tenant took assignment of the old deal? Consider whether these responsibilities need to be reallocated:

“Effective on the surrender of the Giveback Space, Landlord will assume responsibility for insuring maintaining, repairing and replacing the roof, structure, slab and exterior walls of the building containing the Surrender Premises and Remainder Premises.”

Also consider whether the casualty provisions make sense in terms of today’s dollars. Are you working with a 1978 lease that provides either side the option to terminate in the event the cost to restore a casualty exceeds

$250,000? If so, both Landlord and Tenant may want to revisit both coverage amounts and triggers for termination.

Site Plan and Protected Areas. Consider: The Site Plan of the Shopping Center shall be updated to reflect protected parking area and critical areas depicted on the Site Plan attached hereto as Exhibit B. Of course, this is particularly important if the Tenant is the sole occupant at a location and the downsizing will bring in a co-tenant, thus turning the property a multi-tenant center. In many cases the Landlord also contemplates addition of additional tenants on pads, so this may be an opportune time to have the conversation about how the Shopping Center may evolve over the extended term of the Lease.

Insurance. While it likely will not catch the attention of the deal negotiator, it is worth taking the time to review the insurance requirements in the lease. Who has responsibility for insuring leasehold improvements? Was that provision negotiated thirty years ago, such that the required coverage amounts won’t cover a fraction of today’s restoration costs?

Main Issues to Consider for Updating:

. Site plan and protected areas

. No build zones

. Co-tenancy if old lease references tenants no longer there

. Other historic lease provisions: insurance, casualty restoration responsibilities

. Insurance provisions if coverage requirements are outdated and not in keeping with current commercially reasonable standards

. Casualty and responsibility for restoration

C. Common Issues/Impediments Encountered When Anchor Tenant Closes/Downsizes

The retail real estate trends identified above require that both the landlord’s and tenant’s attorneys take a closer look at fundamental lease provisions, especially in the context of when an anchor tenant closes or downsizes. The following sample lease provisions will highlight some of the challenges that exist when an anchor tenant closes or downsizes. In our presentation we will review the lease provisions listed below and identify issues for both the landlord and tenant to consider.

1. Use Restrictions

The prohibited uses below are fairly typical use restrictions that are included in retailers’ leases and/or otherwise applicable to retail shopping centers. We will review the list below and discuss how these restrictions may impact a landlord and a shopping center when an anchor tenant closes/downsizes and the landlord or the anchor tenant is attempting to back-fill all or a portion of the anchor tenant premises.

1. outdoor circus, carnival or amusement park;

2. outdoor meetings and activities;

3. theater, pool or billiard establishment, bowling alley or other entertainment facility;

4. gambling or off-track betting;

5. massage parlor;

6. any residential use;

7. meeting hall;

8. day care facility;

9. school;

10. agency, department or bureau of any governmental authority or unemployment agency, service or commission;

11. gymnasium, health club, exercise or dance studio within the Prohibited Use Area;

12. bar;

13. video game or amusement arcade;

14. skating, roller or ice rink;

15. temporary or seasonal stores;

16. second hand store, close-out store, auction house, or flea market;

17. automobile sale, leasing, repair, display establishment or used car lot, including body repair facilities and quick-lube and tire and battery facilities, car wash, car repair or car rental agency; and

18. non-retail use.

2. Limitations on Service Retail Uses

Given the change in the shopping center landscape, is it still appropriate to have an aggregate cap on the percentage of GLA within a shopping center that can be used for “service retail” purposes?

“Non-retail uses shall be prohibited; provided, however, "service retail" uses, such as a medical-related operator, a travel agency, real estate office, insurance agency and accounting service, shall be permitted so long as such uses which are located within the Shopping Center do not exceed fifteen percent (15%) of the gross leasable area of the Shopping Center.”

3. Co-tenancy

The following is a fairly standard co-tenancy requirement that includes a major tenant co-tenancy requirement and an overall GLA co-tenancy requirement. We will review the components of the co-tenancy requirement and discuss how non-traditional uses will impact how the co-tenancy provision below may be negotiated.

The “Co-tenancy Requirement” means that (i) at least three (3) of the five (5) Major Tenants (as defined below) are open for business during the applicable Required Hours (as defined below) within such Major Tenants' respective premises existing as of the Effective Date; and (ii) Retailers (excluding the Premises) having an aggregate of sixty-five percent (65%) or more of the total GLA of the Shopping Center (excluding the GLA of the Premises) are open for business during the applicable Required Hours. If either or both of the foregoing are not achieved, then a "Co-Tenancy Failure" shall exist.

The "Major Tenants" are the Retailers identified below and occupying the approximate GLA identified below:

Trade name Approximate GLA

Ross Dress for Less 20,000 square feet

TJ Maxx 22,100 square feet

Michaels 21,583 square feet

Bed Bath & Beyond 20,427 square feet

Petco 15,006 square feet

(B) A “Retailer” means a business open to the public whose principal use of its premises is the retail sale of merchandise to customers within its premises, including, without limitation, retail stores and department stores.

(C) A store shall not be considered open for business if such store is open and operating (1) from 10 A.M. to 6 P.M. Monday through Saturday and Noon to 5 P.M. on Sunday (collectively, the “Required Hours”), (2) in less than seventy-five percent (75%) of all of its premises, and (3) under a lease containing an initial term of less than five (5) years.

(D) Substitution

If Landlord desires to replace a Major Tenant vacating its premises with another Retailer for purposes of satisfying the Co-tenancy Requirement, then (a) the use to be conducted by the substitute Retailer shall be substantially the same as that conducted by the vacating Major Tenant or another retail use that is consistent with the tenant-mix of the Shopping Center, (b) the quality, fashion level and retail price of the merchandise sold by the substitute Retailer shall be equal to, or better than, that of the vacating Major Tenant, and (c) the substitute Retailer shall be a national Retailer. For purposes of this Lease, “national” shall mean a Retailer operating at least one hundred (100) stores nationwide.

4. Protected Areas

Tenants, anchor tenants in particular, have a legitimate interest in ensuring that merchandise and customers have access to and from their premises. The site plan below illustrates “protected areas” that cannot be modified. How do you best balance the interests of the anchor tenant and the landlord when the landlord may need to redevelop the shopping center and the anchor tenant may no longer be operating at the shopping center?

5. Shopping Center Remodel Restrictions

Landlords need to be mindful of lease restrictions in anchor tenant leases that will restrict remodeling or redevelopment of shopping centers. How do non-traditional uses impact the manner in which the following lease restrictions are negotiated?

(A) Designated/Restricted Building Areas.

“Subject to Landlord’s right to construct or reconstruct within the “Building Envelopes” identified on the Site Plan, Landlord shall not build any additional buildings without obtaining the prior written consent of Tenant.”

(B) Height Restrictions

“No building in the Shopping Center shall contain more than 1 structural story in height. The heights of any existing building in the Shopping Center shall not be increased from that which exists as of the Effective Date. After the Effective Date, the height of any in-line buildings constructed in the Shopping Center shall not be greater than the height of the Premises, and buildings constructed on pad sites or an Outparcel shall not exceed 18 feet in height.”

(C) Consistent Architectural Themes

“All buildings and other improvements within the Shopping Center shall have a consistent architectural them.”

“All buildings and other improvements constructed within the Shopping Center from and after the Effective Date shall be constructed in a first-class manner and shall contain architectural features and characteristics that are customary within shopping centers similar to the Shopping Center in size, age, type and location. Additionally, the architectural features and characteristic typical of any national tenant’s premises shall be deemed to be in compliance with the terms of the preceding sentence.”

(D) Shopping Center Purpose Provisions

“The Shopping Center shall be used for the sole purpose of promoting and operating a retail shopping center comprised of retail stores selling, at retail, merchandise or services normally carried in other quality shopping centers.”

IV. THE FUTURE OF RETAIL

A. Continual transformation of the industry

B. Merging of online sales and brick and mortar operations

C. Speed and convenience will rule

D. Personal touch and appeal will be critical

E. Social aspects of shopping (the experience) will matter more and more