Retail Lease Issues

Topic Progress:

I.               Lease of Premises.

A.            Landlord leases the Premises subject to any CC&Rs, ground leases, documents of record and governmental rules and regulations.

B.             Representations regarding Tenant’s use.

1.              Landlord’s objective – No representations.

2.              Tenant’s objective – Landlord represents and warrants that Tenant can use the Premises for Tenant’s intended use (this relates not only to CC&Rs, other leases in the Center, and recorded documents, but also to zoning matters).

C.             Tenant’s due diligence conditions.

1.              Tenant contingencies.

a.              Title.

b.              Building permits.

c.              Zoning issues.

d.              Signage permits.

e.              Environmental matters.

f.               Corporate approval.

2.              Landlord requirements – limit contingency period as much as possible and add a “use it or lose it” provision.

II.             Percentage Rent.

A.            Breakpoint – Tenant will pay a percentage of its gross sales once those gross sales exceed an amount called a “breakpoint”.

1.              Natural Breakpoint – Determined the percentage of gross sales that Tenant is to pay as percentage rent and divide the annual minimum rent by the same percentage to determine the natural breakpoint.

2.              Variations – use different percentages for determining the breakpoint and for determining the percentage of gross sales that Tenant is to pay as percentage rent.

B.             Gross Sales.

1.              Landlord’s objective – All sales of all types from the Premises, including cash and credit sales, charges for services, and mail, telephone, internet and in-person orders, even if filled from another location.

2.              Tenant’s objective – Lots of carve outs.

a.              Taxes.

b.              Exchanges.

c.              Returns.

d.              Sale of items outside ordinary course of business.

e.              Gift coupons.

f.               Employee discounts.

g.              Service charges.

h.              Closeout sales.

i.               Bad debt.

C.             Timing of payments.

1.              Once breakpoint is exceeded.

2.              Monthly based on dividing the breakpoint by 12.

a.              Seasonal swings.

b.              Annual true up?

D.            Record keeping and audit rights.

1.              Tenant to provide annual reports.

2.              Method of maintaining daily records.

3.              Period of time Tenant must maintain files.

4.              Landlord audit rights/location of Tenant’s records.

5.              Penalties for under reporting.

a.              Tenant pays Landlord audit costs.

b.              Specified monetary penalty.

c.              Landlord termination right.

E.             Related lease provisions.

1.              Continuous operations.

2.              Tenant’s use of space.

3.              Radius clause.

4.              Assignment and sublease provisions.

III.           Operating Expenses.

A.            Landlord’s objective.

1.              Broad recovery of all expenses in connection with the operation, management, maintenance, repair and replacement of common areas, including a management and/or administrative fee.

2.              Small tenant subsidy of large tenant’s operating expense obligation.

3.              Tenant coverage of vacancy by “grossing up” Tenant’s pro rata share calculation.

B.             Tenant’s objective.

1.              Caps on annual increases.

2.              Exclusions.

a.              capital expenses.

b.              original construction costs.

c.              construction defects.

d.              tenant generation expenses.

e.              financing expenses.

f.               entity maintenance expenses.

g.              hazardous substance remediation costs.

h.              costs of operating specialty facilities.

C.             Audit rights.

1.              Tenant review of Landlord’s books and records to determine if Landlord has included any expenses in the Operating Expenses that are not proper.

2.              Limitations on Tenant’s audit rights.

a.              Limit the time period in which Tenant is required to request an audit (such as requiring a tenant to request an audit within 90 days after the tenant’s receipt of the Operating Expense reconciliation).

b.              Limit the number of audits Tenant may conduct in any year (one).

c.              Only provide Tenant with summary statements of all expenses (rather than copies of each invoice).

d.              Prohibit Tenant from auditing Operating Expenses if the annual increase in Operating Expenses is less than a specified percent (in other words, Tenant will have no audit rights during any year where Operating Expenses increase by 3% or less).

e.              Prohibit Tenant from auditing Operating Expenses if Tenant is then in default.

f.               Condition any audit on Tenant (and its auditor) executing a confidentiality agreement to prevent Tenant (and its auditor) from sharing the results of the audit with others (especially other tenants of the project).

g.              State that if an audit discovers an error, Tenant’s sole remedy is to have the reconciliation corrected monetarily.

h.              Allow Landlord the right to have a third party national accounting firm resolve any disputes Landlord has regarding the conclusions reached in Tenant’s audit.

IV.           Marketing.

A.            Tenant contribution to marketing fund for the Center.

B.             Tenant obligation to spend a portion of Tenant’s gross sales on advertising.

C.             Tenant obligation to name the Center in all advertising.

V.             Use Clauses – Allowed Uses/Prohibited Uses/Exclusive Uses.

A.            Permitted Uses.

The permitted use is the specific activity Tenant is allowed to perform in the Premises.

1.              Landlord objective.

a.              Define the permitted use as narrowly as possible to ensure that Tenant’s use of its Premises does not “evolve” over time.

b.              Avoid allowing Tenant to engage in “ancillary uses related thereto” or clauses of similar import.

c.              Where Tenant has sufficient strength to sign a lease with a very broad permitted use, Landlord can constrain the tenant by including a list of prohibited uses.

2.              Tenant’s objective.

a.              Define use as broadly as possible.

b.              Be aware of implications in assignment and subleasing context.

B.             Exclusive Uses.

Retail Tenants often request the exclusive right to sell a particular item in a project.

1.              Landlord’s objective.

a.              Resist granting such exclusive rights since the granting of such rights:

(1)           Limits Landlord’s flexibility.
(2)           Enforcement risks.
(3)           Administration problems.
(4)           Adverse affects on sale/financing.

b.              To the extent Landlord does grant such rights, Landlord should:

(1)           narrowly define the exclusive use.
(2)           exclude from the “exclusion” prior leases, renewals of prior leases, new leases with existing tenants of the shopping center, “anchor” tenants, and sales of the restricted item in small amounts by other tenants of the shopping center.
(3)           Tenant’s exclusive rights should automatically terminate upon the occurrence of: (a) a default under the lease, (b) an assignment or sublease, or (c) Tenant ceases to use the Premises primarily for the sale of the exclusive use item.
(4)           Exclusive right should not apply to any property acquired by Landlord after the date of the lease.

2.              Tenant’s objective.

a.              Broad exclusive.

(1)           Uses covered.
(2)           Area covered.
(a)            Center.
(b)           Property within a specified radius of the Center owned or acquired by Landlord.

b.              Specific remedies for violation of exclusive, including rent abatement and termination rights.

c.              Record memo of lease specifically mentioning the exclusive.

C.             Prohibited Uses.

1.              Uses which pose environmental risks (for example, auto or boat repair, dry cleaner and lumber yards).

2.              Uses which tend to require significant numbers of parking spaces (for example, movie theaters, meeting halls, and other entertainment centers).

3.              Uses which may degrade the center’s reputation (pornographic sales, bars, bingo halls, pool halls, message parlors and dance halls).

VI.           Opening Co-Tenancy.

A.            Tenant objective – No requirement to open until “critical mass” of co-tenants open.

1.              Co-tenancy requirement.

a.              Named major tenants or comparable replacements.

b.              Percentage of “small shop” tenants.

2.              Remedies.

a.              Percentage rent until condition cured.

b.              No obligation to open.

c.              Termination right.

B.             Landlord objective – Avoid.

1.              “chicken and egg” problem.

2.              Major lender concern.

3.              Definition of “center” may be critical.

4.              Definition of “co-tenants” critical (allow for replacement tenants).

5.              “Use it or lose it” provision.

VII.         Operating Co-Tenancy.

A.            Tenant objective – No requirement to continuing operating if “critical mass” of co-tenants is not open.

1.              Co-tenancy requirement.

a.              Number of anchor tenants or comparable replacements.

b.              Percentage of “small shop” tenants.

2.              Remedies.

a.              Percentage rent until condition cured.

b.              Right to cease operations.

c.              Termination right.

B.             Landlord objective – Avoid.

1.              “Domino” problem.

2.              Major lender concern.

3.              Definition of “center” may be critical.

4.              Long cure period (12 months).

5.              Stagger Tenant’s remedies (12 months to cure; 12 months of percent rent, then allow termination (but try to get tenant to pay a termination fee))

6.              No remedy if no drop in tenant’s sales by at least a specified percentage or if Tenant in default of lease.

7.              Does not apply for casualty, condemnation or a remodel.

8.              “Use it or lose it” provision.

VIII.       Operating Covenants

A.            Landlord’s objective – a vibrant Center

1.              Continuous operations.

2.              Consistent hours of operation.

3.              Operation in entire premises.

4.              Windows lit at all times.

B.             Tenant’s objective – Maintain flexibility

1.              Store may not be profitable.

2.              Tenant’s use may require different operating hours (for example, restaurant uses).

C.             Recapture right.

1.              Landlord termination right if Tenant goes dark or reduces hours or portion of premises Tenant uses.

2.              Long lead time until termination for Landlord re-leasing efforts.

3.              Limit Tenant cure rights.

4.              Obtain a termination fee payment from Tenant.

D.            Covenant to open — Require tenant to fully staff, fixture and stock and open by date certain for specified use.

E.             Covenants of Tenant if cease operations

1.              Maintain security.

2.              Maintain lighting.

3.              Keep utilities working.

4.              Radius clause.

5.              Revert to payment of monthly base rent if on percentage rent pursuant to other provisions of the lease.

IX.          Radius clause

A.            Landlord’s objective – Prevent competition from Tenant

1.              Distance of radius clause.

2.              Cover related entities.

3.              Include provision in guaranty, if guarantor.

4.              Remedy — collection of percentage rent.

B.             Tenant’s objective – Limits flexibility.

X.            Relocation Rights

A.            Landlord’s objective — Maximize flexibility in multi-tenant center to accommodate new tenant; remodel.

B.             Tenant’s objective – Interrupts business.

1.              Limit scope of relocation area.

2.              No down time.

3.              Landlord pays all direct and indirect costs of relocation.

XI.          Kick Out re: Gross Sales

A.            Landlord’s objective – Kick out non-performing Tenant

B.             Tenant’s objective – Get out of bad store

1.              Landlord requirements:

a.              No Tenant default.

b.              Tenant continuous operations.

XII.        Mandatory Refurbishment

A.            Landlord’s objective – Keep Center modern.

B.             Tenant’s objective — Avoid Landlord control over condition of storefront and fixtures.

XIII.      Alteration and Maintenance of Common Area.

A.            Landlord’s objective – Maximize flexibility and profitability.

1.              Ability to reconfigure, modify, supplement, relocate, etc Common Area.

2.              No Tenant consent required.

3.              Kiosks and carts.

B.             Tenant’s objective – Prevent any changes to Common Area which affects business, access or visibility/Maintenance failures which affect ability to use Common Area.

1.              Tenant control areas.

2.              Limitation on locations of kiosk, carts or other improvements within certain area of Premises.

3.              Protection of parking near Premises.

4.              Protection of access driveways.

5.              Protection of access to loading docks.

6.              Remedies

a.              Self-help.

b.              Abatement of rent.

c.              Termination.

C.             Parking ratio requirements.

D.            Employee parking.

1.              Landlord’s right to dictate location.

2.              Security concerns.

E.             Sidewalk sales/parking lot sales

XIV.      Signage.

A.            Consistency in the Center.

B.             Prior Landlord approval.

C.             Compliance with laws.

D.            Compliance with CC&Rs.

E.             Limit duration of temporary signs.

F.             All signs (including interior signs) professionally made.

G.            Limit interior signs within certain area of storefront.

XV.        Tenant Self-Help Remedies.

A.            Tenant’s perspective.

1.              Tenant wants self-help remedies because Tenant fears that without such rights it may be difficult to force Landlord to perform Landlord’s obligations under the lease.

2.              Broad self-help rights enable Tenant to remedy a problem where Landlord does not believe a problem exists.

3.              Self-help remedies are especially important with respect to repairs. For example, a roof leak may cause significant disruption to a tenant’s business. By obtaining broad self-help remedies, Tenant will be able to quickly repair the roof on Landlord’s behalf without incurring significant business losses.

4.              A request for self-help remedies typically is accompanied with a request for rent offset rights. Tenant will seek offset rights to obtain a sure method of reimbursement for any self-help costs incurred by Tenant.

B.             Landlord’s perspective – Landlord will object due to:

1.              By granting self-help remedies, Tenant will exercise Tenant’s self-help remedy in circumstances where Landlord believes no Landlord obligation exists.

2.              Landlord wants to control repairs. Landlord wants an opportunity to cure any Landlord default.

3.              Tenant will not pursue cost-effective remedies.

4.              Landlord will not want to allow Tenant offset rights since it will adversely affect Landlord’s cash flow and offset rights may also violate the terms of Landlord’s financing documents.

C.             Compromise solution.

1.              Limit Tenant’s self-help remedies to repairs and only to those repairs that are necessary to prevent a material adverse affect on Tenant’s business.

2.              Require prior written notice of the need for any repairs and prohibit Tenant from exercising Tenant’s self-help remedies unless Landlord has failed to make the repairs within an adequate time period (consider an exception for narrowly defined emergency repairs).

3.              Require Tenant to invoice Landlord for the repair work and provide itemized receipts.

4.              Landlord should have 30 days to make the payment.

5.              Limitations on offset rights include: (i) limit the offset rights to base rent (specifically exclude offsets of percentage rent, operating expenses, taxes and other types of additional rent), (ii) limit the percent of a month’s base rent subject to offset, and (iii) limit the number of months during a calendar.