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Workouts for fun and profit.

A landlord's dilemma: What if a tenant is having problems paying rent and there simply are not enough good tenants to go around?

The major value in any commercial income-producing property is the ability to generate net income. Too often property managers view the above dilemma as offering only two possible solutions: evict the tenant and lose any possibility of collecting rent, or allow the tenant to stay and hope that they will not have to evict him or her later.

The alternative

Tenant workout offers managers a practical solution without resorting to contested litigation. A successful tenant workout often has a positive effect on the bottom line and should either result in a salvaged tenant who will pay rent into the future or a landlord quickly and easily recovering possession at minimal expense.

Workouts offer a great opportunity to save a tenant, maintain cash flow, cure lease defects, and adjust the landlord/tenant relationship to reflect current market conditions.

On occasion, parties enter into informal, ill-conceived workout agreements. If and when these fail, even tenants who have been quite agreeable to the terms beforehand sometimes decide that the manager is being unfair and that they have no choice but to "fight like hell."

In a worst case scenario, a property manager who had the right to evict a tenant previously may allow a tenant to remain under an informal workout agreement for many months. When the manager finally files suit, the tenant often fights hard, raises spurious defenses, and prolongs the litigation for many months. For these reasons, a manager's efforts to handle the matter informally may prove a very costly mistake.

Assess the problem

Tenants in trouble often send both subtle and direct messages to the manager who will listen. Some indicators that a tenant may be having financial difficulty include an evolving pattern of paying rent late, laying off employees, shortening office hours, or cutting down use of the facilities.

When a potential workout situation presents itself, savvy management and legal work can be vital. Tenants in the early stages of financial difficulty are more likely to believe that they will be able to work out their problems than tenants who have already been assailed by many creditors.

For this reason, the earlier workout negotiations begin, the more likely they are to result in an agreement. It is important for a manager to be aware of a tenant's evolving situation so that he or she can act quickly.

In determining a strategy, one major concern will be whether the manager can expect to be able to replace the non-paying tenant with a paying tenant.

Another factor to consider is the quality of the tenant. His or her credit worthiness, long-term business prospects, reliability, and honesty should all be reviewed.

Know your options

Managers need not chose between acquiescence and all out war. They have a range of options available to them, including:

* Do nothing. With the tenant already developing an arrearage, a manager might do nothing, accept what the tenant is able to pay, and hope that over time the situation will be resolved. This option may be appropriate in certain circumstances, but only for a limited period of time.

* Informal workout. The manager could enter into an informal, letter agreement with the tenant. Unfortunately, such an arrangement might be unenforceable or insufficiently comprehensive to be effective. In our view this is not a reliable option.

* Allow the tenant to vacate. The manager could allow the tenant to simply vacate, regardless of the likelihood of any eventual recovery.

* File suit. The manager could file suit for eviction and money damages. This option tends to be more appropriate when the manager believes that the tenant cannot or should not be salvaged, and no agreement can be reached.

* Formal workout. The manager could negotiate a formal workout. It would then be up to counsel to convert the business agreement into an enforceable legal agreement.

This generally involves reaching an agreement with the tenant that suits for possession and money damages will be filed, but that the agreement, whatever its terms may be, will be reduced to a formal stipulation filed in both actions.

Making the right choice

The manager should consider a number of factors before deciding among the options. Some of the questions managers need to ask themselves include:

* What is the nature of the tenant's problem?

* Are the difficulties temporary in nature, and are they solvable?

* What level of concessions would it take to enable the tenant to survive?

* Is the tenant having an overall positive effect on the property or a negative effect?

* Do I really want the tenant to remain at the property?

Beginning a workout

Once you have picked your course of action, it is time to start the actual work. Workouts generally start with informal discussions between the manager and the tenant, which move on to negotiations through manager's counsel. These allow the manager to maintain good relations with the tenant, and to "defer" to counsel--the hard negotiator. This point cannot be over-emphasized.

If a workout is successful, the parties are going to "live with each other" for quite some time. If a tenant feels that the manager has been too harsh, resentment can develop. It is better for the tenant to feel ill will toward the attorney than the manager. It is critical, however, that manager's counsel not make business decisions for the manager.

Eventually the tenant has to "put his money where his mouth is" and enter into an agreement that both (1) gives the tenant the time and terms that the tenant needs in order to work out problems and cure defaults over time, and (2) protects the owner and manager from costly delay and legal expense. A good workout will be done at no net cost to the manager because the very first requirement would be that the tenant pay all legal expenses.

Mechanics and terms

A workout should be viable for both manager and tenant. To ensure its success, managers may want to secure a financial plan from the tenant in order to make sure that the tenant will be able to succeed in the workout. He or she might also require relevant financial information as a way of confirming that the tenant is really in as much difficulty as has been represented.

Workouts also present an excellent opportunity to secure concessions from a tenant. Some of the concessions we have secured in the past have included getting new guarantees or "cleaning up" old, defective ones. We have also required security interests in personal property, changed the duration of a lease, and eliminated options or modified option terms.

In Florida we generally recommend an early formalized agreement with the tenant whereby we file two suits, e.g., one for possession and one for money damages.

For this reason, we will file a written stipulation (agreement) in each action, giving the tenant the agreed extension for payments, requiring tenant payment of legal fees, and modifying the lease terms as agreed. The stipulation should require that should the tenant default or be unable to meet the terms of the workout, the manager can proceed directly to final judgments for possession and money damages.

This structure provides the manager with the following advantages: the workout costs the manager nothing; the parties have a clear understanding of the terms of their agreement; the manager receives money, secures concessions, and maximizes the opportunity to salvage the tenant; and the manager is substantially protected against the possibility of protracted and expensive litigation.

Case study

The following example of a retail workout illustrates principles equally applicable to any commercial property. In this successful workout, our manager client had leased a pub/restaurant to a small corporation.

The lease was subsequently assumed by first one and then another tenant, the latter being a small, mom-and-pop corporate entity. The pub was well known in the area. It had a regular following and brought desirable patrons to the shopping center.

The tenant was good for the other tenants, as well as for the image of the shopping center. In a word, it was an asset to the shopping center.

Unfortunately, for the preceding year and a half, the tenant's business had dropped. The tenant claimed that business had been slow because of the recession. The tenant could sometimes only pay half the rent. When the matter was brought to us, the lawyers, the tenant owed the managers in excess of $35,000.

The first mistake made by our client was that he allowed the situation to continue for an inordinate amount of time before taking any action. The tenant came to expect extensions and acceptance of partial rent payments. Many early warning signs were present, yet the manager let matters take their course, hoping that things would get better.

With $35,000 in arrears, the manager was extremely uncomfortable with the situation, and the tenant was nervous about its future.

Through information and communication between our client and the tenant, the manager became convinced that the tenant had been telling him the truth--that he had a good business which was suffering cash flow problems due, in large part, to the poor economy.

Our client was convinced that if the tenant could hold on long enough, his business would improve as the economy improved. The manager was also convinced that he had a "good" tenant. Further, the manager felt that it was not likely that he could replace the tenant with a more solvent tenant, given the soft market. He concluded that he was willing to take a calculated risk and attempt a workout, evicting only if necessary.

Obviously, a workout payment plan and forbearance from taking legal action is the concession made by a manager to his tenant in the workout princess. What, then, is the incentive for the manager?

In our case, the tenant wanted the manager to take a chance with him. The issue then became just how far the tenant was willing to go to induce the manager to make these concessions. In other words, was the tenant and its principal willing to "put his money where his mouth was."

In this case, we filed suit against the tenant, but agreed to "hold off" further action pending the workout. In the workout, the tenant made the following concessions to the manager, all of which were embodied in a comprehensive stipulation for settlement:

* The tenant's principal gave the manager a personal guarantee of all sums due.

* The tenant granted the manager a recordable security interest in all of the personal property on the premises (furniture, fixtures, inventory, and transferrable licenses).

* Possession of the premises was awarded to the manager following a settlement stipulation in the eviction action. A writ of possession was issued, but execution was withheld pending performance of the parties' settlement stipulation.

* A judgment was entered in favor of the manager for all rent due under the lease (past due sums, and future rent, which had been accelerated), as well as attorney's fees, and all other costs and expenses. A judgment of foreclosure of the manager's liens was also entered, and a writ of replevin was authorized. All of the writs were issued, but levy was withheld pending the parties' settlement.

* All costs and expenses were borne by the tenant.

* The stipulations provided that the tenant would immediately reimburse the manager for all legal expenses, begin to repay the past due rent on an accelerated basis (weekly payments), and pay current rent as it became due. Further, if the tenant fell behind, the manager, at his own option, and upon simply filing an affidavit of noncompliance, could recover possession of the premises and seek execution of its money judgment.

The key elements of the stipulation were then that: (a) the tenant paid all legal expenses; (b) the tenant was to catch up on the arrearage; (c) the tenant was to stay current in the newly accruing rental payments; and (d) if the tenant defaulted, the manager would be able to secure possession of the premises on an expedited basis.

This is important because that created the potential for recovering a fully operational and equipped facility--a far more marketable and valuable commodity than a stripped and deserted space.

By effecting a formal settlement as described, the manager had substantial protection against the possibility of protracted litigation with all its attendant legal expense and loss of rental income during the course of the litigation.

In addition, the manager had the principal's guaranty, thus further enhancing the likelihood that he would recover sums due if there had been a default and, at the same time, making a default less likely.

We can happily report that in this case, the tenant honored his part of the bargain; all of his past due rent has already been paid, and he is on schedule. The parties then made a new deal, which both of them could live with, and which the tenant could realistically accomplish.

Tenant workouts like this one, done early and done well, can turn a potentially no-win situation into a "win-win" scenario. If the tenant is able to work out of his problems, everyone wins. If the tenant fails, at least the manager is able to regain possession quickly, with minimal loss of rental income, and at virtually no expense.

Jeffrey R. Mazor of Jeffrey R. Mazor & Associates, P.A., in North Miami Beach, Fla., has practiced law for 18 years. The firm primarily assists clients in real property sales and leasing-related transactions and litigation.
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Title Annotation:tenant workouts
Author:Mazor, Jeffrey R.
Publication:Journal of Property Management
Date:Nov 1, 1994
Previous Article:Good neighbor programs - retention in the 1990s.
Next Article:Incentives that pay.

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