The Importance of Co-Tenancy Clauses in Retail

The success of a brick-and-mortar retailer is based on high sales volume, which equates to high foot traffic entering the store, which equates to a favorable location around other successful retailers helping to generate that foot traffic.

When a retailer finds that perfect location with all those factors, they are excited and certainly do not want things to change; however, if that equation does change – look out!

Imagine you are a small retailer selling smoothies filled with wholesome nutrients for the health-conscious public. Your store is in the perfect shopping center location nestled between a large popular fitness center and a busy vitamin shop.

The pumping iron Arnolds, the yoga stretching Gumbys, and the Zumba dancing JLos all leave the gym and stop at your store to buy their favorite protein smoothies. The foot traffic generated from the retailers on each side of your store creates a majority of your customer base.

Business is booming!

The day after you celebrate your second anniversary in business with three magnificent years left in your lease term, the fitness center hangs up a banner that they are moving to a different shopping center. They will no longer be your neighbor.

The vitamin shop on the other side has decided not to renew its lease and will vacate at about the same time as the fitness center. Oh no!

Without them creating the foot traffic you had always relied upon, your sales will plummet, and your business will suffer. What can you do? 

A co-tenancy clause in your lease would be extremely beneficial (in fact, a lifesaver) in this situation.

What is a Co-Tenancy Clause?

A co-tenancy clause in a retail lease is a contractual provision that outlines certain conditions under which a tenant’s obligations and rent payments might be affected based on the presence or absence of specific anchor tenants or other neighboring businesses within the same shopping center or retail complex.

In a retail environment, anchor tenants are larger, well-known businesses that attract a significant amount of customer traffic to the shopping center. They could be major department stores, grocery chains, or other popular retail establishments. Smaller tenants in the same shopping center often benefit from the increased foot traffic generated by these anchor tenants.

What Does a Co-Tenancy Clause Mean?

A co-tenancy clause typically stipulates that if certain conditions are not met, such as the departure or closure of one or more anchor tenants or a predetermined percentage of total tenant space being vacant, the affected tenant(s) might have the right to take certain actions, such as:

• Rent Reduction: The tenant may be entitled to a reduction in their rent payment due to the reduced foot traffic and potential impact on their business.
• Lease Termination: The tenant might have the option to terminate the lease without penalty if the specified co-tenancy conditions are not met within a certain timeframe.
• Renegotiation: The tenant could negotiate with the landlord to adjust the lease terms or seek other concessions to compensate for the loss of anchor tenants.

Who Are Co-Tenancy Clauses Important For?

Co-tenancy clauses are particularly important for smaller retailers, as their business success often relies on the presence of larger anchor tenants to draw customers to the shopping center. If these anchor tenants were to leave, it could significantly impact the foot traffic and overall viability of the smaller businesses.

Landlords, on the other hand, might try to limit the impact of co-tenancy clauses, as they could create uncertainties and financial challenges for them if anchor tenants decide to leave or if co-tenancy conditions are triggered.

Why Are Co-Tenancy Clauses Important?

Negotiating and understanding the co-tenancy clause is crucial for both landlords and tenants to ensure a fair and balanced lease agreement that takes into account the potential impacts of changes in the tenant mix within a retail complex.

Depending on how it was written, a co-tenancy clause could allow you to terminate your lease early without being in default, or it could allow you to reduce your rent substantially until your landlord found replacement tenants for adjacent, vacated spaces.

Without a co-tenancy clause, unfortunately, you would not have much recourse, and it could be expensive to litigate in trying to exit your lease early – not to mention if your landlord also held a personal guarantee.

Note: A co-tenancy clause can be a challenge for a small retailer to get, but not impossible. A retailer should use its best efforts to get its landlord to agree.

Due to the strong retail market prior to the Covid pandemic, the co-tenancy clause was not fought for very often and was not as critical then. However, as our retail real estate industry experienced during the pandemic, many retailers had to close and vacate during that time, leaving the surviving retailers wishing they had co-tenancy clauses.

Therefore, the co-tenancy clause is slowly making a comeback post-pandemic. It is just one of many crucial lease clauses a retailer should consider when negotiating its lease.