When the struggle to stay in business comes down to the landlord.

From an unlawful detainer action to a 5 day pay or quit or simply an inability to meet your obligations, the strategy for finding a solution remains the same.

One of the issues we regularly come into contact with in our capacity as turnaround consultants for insolvent or underperforming units are our clients lease obligations. Typically executed during the “good times”, they have often proved to be an onerous burden on struggling units and when cash flow is tight and a business needs to be lean, the ability to renegotiate these leases is often the ‘make or break’ factor.

For a landlord to serve a 3 or 5 day notice to pay or quit, it may mean that talks to date have failed (or perhaps not occurred) and at this point the landlord is making it abundantly clear that they are willing to risk having a vacant property rather than keeping you as a tenant. Essentially, the landlord is looking to stop the bleeding as he or she does not have faith in your ability to remain as a tenant. At other times, the notice may merely be a strategic move to force you to repay some of the monies owing with no genuine intention of actually evicting you. Either way, receiving a ‘pay or quit’ is a nasty feeling for an operator and creates fear and insecurity for the business. As if cash flow was not tight enough already you now need to retain counsel.

Whilst we are not lawyers we do, however, work closely with our client’s legal team in defining a strategy that makes the most sense under the circumstances and provides the business with the maximum leverage. Our involvement is typically based on the competency of counsel as well as the operator’s ability to see the big picture. Our advice is ‘always get the best advice’. If you need legal advice, don’t use your local firm simply because you know them. Find out what they have done in your sector and ensure you are using someone with the right experience because good advice always pays its way, especially when dealing with something like an Unlawful Detainer – which has very little “appeal” process if you are on the wrong side of the judge’s decision.

Whilst OnSite can make a significant impact on the non fixed costs and provide drastic savings, increased operational profitability and streamlining the concept, if the rental amount (typically 7% to 10% of gross sales) is unsustainable, then the value in trying to save the business may be flawed from the day we arrive.

In a majority of recent cases we have been involved in and where we have engaged with landlords in cases of crippling rent, landlords have often been willing to make a number of concessions when presented with a fair option. It is critical not to ask the landlord to reduce the rent in order to offset operator error or concept failure – if you are running your business badly it is neither their problem nor their responsabillity to subsidise you. This is one area where our appointment provides immediate confidence and assistance to the business: We immediately step in to confirm that the operations are being streamlined and efficiencies are being introduced.

An operator who has made significant errors but successfully repositioned the concept and provided a viable and profitable model still has significant leverage because he or she has identified the problem and found a solution. Typically, landlords recognize the current economic challenges that their tenants face and to the extent that they have a good relationship with their tenant, a paying tenant is a better proposition than a vacant, non rent producing unit. You must engage with your landlord in a professional way as simply ignoring the situation will only make matters worse and enrage the already frustrated owner of your site.

When either handling a pay or quit, an unlawful detainer action or even thinking it may be time to attempt to renegotiate with your landlord, you must remember that as a paying tenant, despite your reservations, you certainly have leverage. You should offer a value proposition that makes sense, with financial payments you can meet in a timely fashion and that work both in the short and long term plans.

In all instances, we suggest the landlord be treated as a partner and where available, make modifications to the lease and rental amounts to provide for a base plus gross volume percentage. This would allow, in some instances, for an immediate reduction in the base but also provide the landlord with additional revenue potential based on the expectation that business will grow and ultimately, get back to its pre-recession top line revenues. This will only happen, however, when you can provide absolute data on your business and demonstrate its ability to provide the landlord with this upside.

We have clients where their landlords have offered rent reductions without it being offset into a loan for payback in the future, whilst others have required the operator to personally guarantee the value of the offset. Arguably this creates an unfair obligation and high level of personal exposure for the tenant, however in circumstances where the rent must be reduced to secure the future of the business, operators have to make tough decisions and compromise in areas they would typically consider off limits if they want a second chance on an existing rental contract.

When proposing a change to a landlord, it must be just that – a proposal. It cannot be neither theoretical or hypothetical nor can it be a napkin with some ideas scribbled on it. The operator is pitching his or her landlord to not only receive a reduced rent but also to have faith in the future of the business: This is a lot to ask. This pressure forces an operator to treat their business as a business and create the required cash flow statements and forecasts, to define a cash model that shows a number of different options to the landlord for them to be made whole and exactly how the tenant expects to realize that. You are pitching to your landlord and should make every possible effort to do so in the most professional way.

If your P&L shows a monthly loss, presenting a landlord with a burden you cannot meet and which you are likely to breach is much the same as saying you intend to breach it. You are not being honest and the landlord will spot this and have no faith in what you are proposing. On the assumption that the model will be redefined and the unit is either moving to, trending towards or is profitable, step one has been completed. A practical landlord has less reason to remove a profitable tenant if an equitable deal can be made and a clear path to get there can be defined.

With the P&L showing or trending towards profitability and the creation of cash flow allocations, forecasts and debt amortization tables, you should now be able to show your ability to manage the historic debt obligations you have and the shelf life on those. For most facilities, the P&L is not the problem – rather it is the cash flow that provides the greatest challenge. The ability (or lack thereof) to service the debt with the profits or available cash flow the unit generates is typically the biggest issue in turnaround business plans. This is immediately exasperated by the issuance of a landlord Pay or Quit notice, as lenders will now not be willing to lend money in such an unsettling environment.

This requirement to have a demonstrable business case also ties in to one of the important operational aspects of a business. You must understand your numbers and you cash flow because what it all comes down to is understanding your data and using the information the data provides to drive your business decisions. If you are running a business where you cannot see, down to minute detail, everything from your stock levels to your net margin on dishes served, then you are then running a business that is not worthy of a landlord workout. This financial information and the ability to scrutinize it is one of the keys to restoring profitability.

For our clients and now hopefully for you, with the creation and utilization of rolling cash flow forecasts showing your ability to manage your obligations, you are now able to create a number of options for your landlord or for that matter, any creditor. You can demonstrate with authority and confidence exactly how you intend to pay debts based on what you realistically earn and can pay. Every creditor would prefer to know what you can pay and will pay regularly rather than what you would like to pay but may not be able to with regularity. The intent to breach a deal or regular breaches of financial commitments made only compounds and exacerbates the problem and the relationship – and creates difficulty trying to structure a new deal.

In proposing to a landlord that an adjustment to the rent structure can be viable, it is important and crucial that the immediate recent cash flow shows that whatever is proposed can actually work now, not based on hypothetical projections of increased revenue.

It is also important to note that as a tenant, you should not be trying to salvage the situation if you are not confident that through renewed efforts and a workable landlord you can increase sales and improve the bottom line. This cannot be about working out a deal just to survive because that alone will certainly not incentivize the landlord to renegotiate.

While there are many different interpretations and variations, there are essentially two options for a reworked lease, “less now, more later” or “base plus gross percentage”.

The “less now, more later” option asks for the landlord to decrease the monthly rentin the short term but increasing the rent in the medium to long term. Less cash is therefore required ‘now’ when the business is in trouble but when it is thriving once again, the landlord can claw back rent lost in earlier years with higher income. This option provides for a set increase and is a less riskier option for the landlord but also negates any large reward for the landlords renewed faith and risk.

The “base plus gross percentage” model lets the landlord accept a lower base rental amount but participate in a percentage of gross revenue (important to note that this is always gross and not net revenue).  There are essentially two different types of percentage rent, the most common being based on receiving a percentage of sales benchmarked against a particular target (eg, $2k base and 6% of gross revenue over $500k). The other practical option is a percentage of total revenue but guaranteed with a base amount (eg, 3% of gross sales, base of $3k).  This is riskier for the landlord but has the attraction of a much more lucrative upside.

In some instances, however, the landlord is no longer willing to wait for rent or strike a deal and under those circumstances, a pay or quit is served. For many struggling venues, this is the final nail in the coffin and as if it could not get any worse, they now have to retain an attorney and use the few pennies left in the bank for legal service rather than operational or debt service.

In our experience, however, this onerous and unpleasant process provides a number of theoretical upside opportunities for both the landlord and tenant. If the process is managed appropriately, it can equally be a fresh start for the business as the decision makers are finally forced to make tough decisions that have likely been put off (perhaps in the hope they will disappear).

Upon being served, now knowing the landlord is willing to go ‘all the way’, the first step is to ask for an extension. This gives you all time to arrange to meet for a frank and open discussion (presuming the option is there) and with everyone’s chips on the table, it allows a thorough discussion as to whether there is a deal to be done. Whilst it is common to believe the landlord is in the driving seat, this is not always the case. If your financial modeling proves your ability as a tenant, the landlord is not looking for a vacant unit and financial exposure for the sake of it and would likely rather not restart the process of finding a new tenant. Equally, if no deal is to be found, you will have sufficient time to contemplate your legal position and take advice as opposed to making a rushed and insufficiently thought out decision.

This article is not about defenses to an unlawful detainer in an effort to find the landlord at fault with a defective service nor is this a step by step guide to the legal options available when responding (answer, demurrer or motion to quash) to such a motion. Furthermore, this is also not an article seeking to find potential covenant breach or retaliatory evictions. There are hundreds of options to drag out, extend and respond to a UD that your counsel can advise on. This is about the options or remedies that you may wish to explore if your concept is viable and you can “make it work” both on paper and in practical terms. This is about turning around your business and dealing with the issue of burdensome rent whilst also nursing your unit back to full health.

Understanding what has to happen and the legal strategy your business should take is unique to each situation. In some instances, the balance outstanding along with other debts may make a bankruptcy with intention of assuming the lease a viable option. In other instances, performing an Assignment for the benefit of Creditors (ABC) with your landlord allowing the debt to rollover to the new entity might be a potential solution.

At other times, it is just a matter of legal defense and starting the process of ensuring your lease is upheld. As an operator your entire business is tied to the lease and whilst there may be some assets (FFE, Liquor license and other items) the only real asset is the lease.

For clients who have run into difficulty with their lease obligations based on year on year and month on month revenue decline, we have seen successful use of California’s “hardship defense”. The value of this defense is that the entire concept of an unlawful detainer is the landlord asking for vacation of the property as an equitable remedy, grounded in fairness. If the landlord is asking the Court to act fairly and return the property then the court must provide you, by default, with that same level of fairness.

If you are experiencing this month on month decline in your business after you entered into a commercial agreement with specific revenue expectations you have not been able to meet – and where you have not been able to meet those due to the economic climate – then this hardship defense has merit. You did not enter into the agreement on false premise nor did you seek to mislead the landlord in committing to pay this rental amount because as an operator, the business case seemed viable. In this climate where business owners are struggling to keep their doors open, the hardship defense is very relevant and one you should turn your attention to and, where relevant, discuss it with your attorney.

This legal process of eviction is terrifying because it does not deal with overdue collections and summary judgments: Instead, the entire business is at risk. Think laterally and contemplate how you can involve your landlord to your mutual benefit because both parties stand to gain from finding a solution in these circumstances.