Legal options for Hong Kong retail lessees
Hong Kong retail lessees struggling with high rents and stagnant or declining sales have a variety of legal options to ease their pain.
After nearly two years, some retailers are seeking rent reductions or early exits from leases to minimise their losses. Leases in Hong Kong’s historically strong retail market are notoriously landlord-friendly, meaning there is little ability for a tenant to obtain the right to renegotiate terms in the event of an economic downturn. Consequently, retailers are finding themselves tied in to paying rents that are significantly higher than market values, given that retail rents have fallen by up to 30 per cent from their peak in 2012.
Tenants therefore need to look beyond their contractual rights to find a commercial answer. In such difficult circumstances, there are six options retailers can consider…
Start an open discussion with the landlord to negotiate a reduction in rent. Landlords are well aware of the tough retail market conditions facing their tenants and may be sympathetic, preferring to keep a reputable tenant for a lesser rent for the rest of the term rather than being left with an empty store.
Managing the negotiation is key in rent restructuring. Tenants must have a strong understanding of their lease terms and their rent restructure proposals before beginning any discussions with the landlord. Tenants can strengthen their proposals by corroborating them with data about current market rents. They should also ascertain if the landlord has other properties with similar tenants who have sought to restructure their rent.
If the tenant believes the long-term outlook of the retail market is positive, they should try to negotiate a lower rent now, but subject to future increases. For example, they could negotiate for the rent to increase again in three years when the market has recovered. An alternative is to trade a lower rent for a longer lease term.
Assignment or subletting
Propose assigning or subletting the lease – either in whole or in part – to a new tenant. Retail leases generally do not allow the tenant to assign, underlet, share or transfer the whole or any part of the premises, so such proposals can be achieved only through renegotiation.
Landlords will consider this only if, at the very least, they are not out of pocket and their reputation is not damaged by accepting a lesser tenant. This option therefore depends on the good performance of any proposed alternative retail tenant.
Relocating depends upon the willingness of the landlord to co-operate as well as the availability of alternative premises. The landlord may be keen to keep the tenant, even if this involves relocation that gives the tenant the chance to “right size” in a proper (and cheaper) location.
Offer the landlord a buyout to terminate the lease early. Factors such as additional leases with the same landlord can be used as leverage, as well as the likelihood of any future deals with the landlord.
Tenants are often obliged to keep their premises open during specified business hours throughout the year. Any days in which the shop is not open for the specified hours would constitute a breach of the lease.
Tenants can propose “going dark”, which means they close the store but continue to pay rent. This would result in substantial savings for the tenant through reduced running costs while maintaining income for the landlord. Tenants must weigh up the financial consequences of this route, as losses incurred by keeping the store open may be tax deductible.
Another strategy involves partial surrenders, and therefore reduced rent, including using less space by boarding up the back half of the shop.
Default and bankruptcy
Default, and let the landlord claim damages. In common law, the general position is that damages are calculated on the basis of the injured party being reinstated to the position he would have enjoyed had the contract been properly performed, and to compensate for any losses. Losses are recoverable only if they are a direct consequence of the breach and were within the reasonable contemplation of the parties at the time the lease was entered into. Any losses claimed need to have been mitigated so far as possible as the court will take mitigation into account when assessing the level of damages.
Some retailers establish multiple entities so each particular store is separated from all other assets and liabilities. This gives them the option to let any one particular tenant go bankrupt if need be. Bankruptcy would mean the tenant defaults on the lease, and the landlord would have no viable means of securing rent. For this option to be viable, the retailer must have first set up such a structure.
It is a high-risk strategy otherwise, because if the purpose of corporate restructuring was to avoid lease obligations, for example, transferring the lease from a working company with assets as the tenant to a new affiliate shell company. The landlord may seek to pursue the tenant’s parent company in court to effectively negate the restructuring, and claw back losses. This option is also not viable if the lease is guaranteed by either a parent company or any other affiliate of substance. There are, of course, also potential reputational ramifications in choosing this route.
Riding out the storm
Several big-brand retailers have lately been successful in renegotiating their rents, while a few “no-name” tenants are simply leaving their spaces vacant and defaulting on their leases, for which they usually have no further ramifications as landlords are generally unwilling to throw good money after bad.
There have been media reports that Burberry, Chow Tai Fook, Gucci, Kering and Prada are all trying to renegotiate their rents. Also, a large jewellery retailer has negotiated the closure of part of one of its stores on the understanding it would open an extra store at another of that landlord’s properties. These announcements follow the closure of Coach’s Queens Road Central flagship and Tag Heuer’s Causeway Bay store in 2015, as well as the impending closure of Abercrombie & Fitch’s Central store.
While examples of successful negotiations are encouraging, tenants should also take note of when their lease was executed. If it was entered into after the beginning of the economic downturn, a landlord may argue that the tenant cannot use this as a reason to renegotiate because the adverse economic circumstances were within the reasonable contemplation of the tenant at the time the lease was signed.
The big thaw
A total of 56.7 million visitors – equivalent to 7.7 times of the size of Hong Kong’s local population – visited the city last year, with 76 per cent of these tourists coming from Mainland China, says the Hong Kong Trade and Development Council. This was a 4.5 per cent drop from the figures for 2015, with a 13.6 per cent fall in total tourism expenditure, amounting to HK$144 billion (US$18.5 billion) in the first half of last year alone.
Whether the constant depreciation of the Chinese yen makes Hong Kong a less attractive destination, or China’s anti-corruption drive has frozen luxury sales, the past flurry of frenzied shopping by mainland tourists looks unlikely to return.
The silver lining seems to be lower rent from landlords. A more balanced retail landscape means luxury brands benefit from lower rents, and local retailers, fast-fashion brands and lifestyle stores have a chance to open in prime shopping areas, leading to a more diverse retail offering.
With 73 international brands entering into the Hong Kong market in 2015 and underground shopping streets being planned, Hong Kong may have a fighting chance to keep its reputation as a shopping mecca, second only to London on a global scale in its appeal to cross-border retailers.
This story was originally published in the quarterly print edition of Inside Retail Hong Kong magazine. To subscribe in print or digitally, visit our online store.