February 23

How To Manage Commercial Tenant Delinquencies and Defaults

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Every commercial property manager has experience with delinquent tenants, whether the tenant’s delinquency is related to a change in industry conditions, overexpansion, an unanticipated event which causes the tenant’s business to suffer, or a recession.  Early identification of and response to a distressed, delinquent, and/or defaulting tenant is essential to limiting the amount of damages suffered by landlords from such tenants.

Identifying Distressed Tenants

The commercial landlord’s property managers should be familiar with the property, know the tenants, know the principals of each tenant, and speak with tenants frequently. More frequent contact with tenants will lead to additional communication, which may lead to a tenant discussing potential problems such tenant may be experiencing. In addition, a property manager that spends time walking the property and meeting tenants may be able to more quickly identify signs of tenant distress, such as a reduction in the number of a tenant’s customers or employees and changes in the level of activity at the property or at a tenant’s premises.

Of course, if a tenant is requesting that it be able to sublease space, assign the lease, or amend the lease in order to downsize, these are also potential signs of tenant distress. A property manager may also notice changes in rent payment patterns by a tenant or more frequent complaints from a tenant, which are additional indicia of a distressed tenant.

Responding to a Tenant’s Failure to Pay Rent on Time

Commercial landlords should react quickly to tenant defaults. Every rent payment missed by a tenant costs the landlord money; the more payments that are missed, the less likely landlord will be able to recover them. As such, a landlord should contact a delinquent tenant immediately after a rent payment is missed.

If a tenant misses a rent payment (or only makes a partial payment) and does not cure its default within the time allotted in the lease (if any), the property manager should call and/or meet with such tenant personally to discuss payment of the arrearage. The reason for the non-payment or partial payment must be ascertained. Typically, the tenant should be informed that, unless landlord receives payment immediately, it intends to turn the matter over to an attorney.

Every tenant which is late making a rent payment should be assessed late fees and interest as well, if the lease so provides, because failure to assess such penalties may encourage a defaulting tenant (and perhaps even other tenants) to miss rent payments or pay late routinely.

How to Proceed if the Tenant Fails to Cure Its Default Immediately

While each landlord will have different considerations that apply to specific tenants, as a rule, landlords should proceed quickly after the first failure of a tenant to cure a default.

First, the default provisions of the lease must be reviewed to determine whether there may be a grace period or a cure period and whether a written notice of default is required. If a written notice of default is required, landlord should strongly consider handing the matter over to an attorney, as default notices written and sent by landlords often do not strictly comply with the terms of the lease and/or the law. Furthermore, it demonstrates to the tenant that the landlord is serious (and follows up with its earlier stated intention to hand the matter over to its attorney).

Default notices should be sent out quickly after the event of default occurs, as such notices place the landlord in a stronger position to either obtain payment from the tenant or move forward with other solutions.  Workouts, if desirable, can then be completed promptly, limiting the loss suffered by landlord.  These can take the form of reductions in space or outright termination of the lease. Promptly sending proper default notices also empowers the landlord by allowing it to be able to commence a dispossessory action or other proceeding quickly, before the rent arrearage grows.

Summary

Landlords cannot afford to allow tenants who fail to pay rent stay in the space.  Early identification of and response to distressed and defaulting tenants is essential to limiting the amount of damages suffered by landlords from such tenants. Written notices of default should be sent quickly after it becomes apparent that the tenant is in default and will not pay the arrearage immediately. This will enhance landlord’s position and trigger the availability of remedies.

Failure to act quickly often leads to large rent arrearages, potential issues regarding forbearance, and greater losses to commercial landlords. Given that recoveries on unsecured claims are typically low even in the best of times, landlords should act quickly to prevent large claims from accruing and seek to prevent having the premises occupied for months by a non-paying tenant. Taking quick action in response to defaulting tenants should save landlords money in the long run.