In our prior article, The “Art” of the Commercial Real Estate Lease Term Sheet, we discussed the importance of an accurate term sheet reflecting the material terms of the proposed commercial lease, and how in the absence of such a term sheet the risk of the lease transaction being delayed or additional costs being incurred, and even the risk of the transaction being terminated, during the lease negotiation process is heightened considerably.
As noted in our prior article, determining the “material terms of the lease” to be set forth in the term sheet for a lease is an art, not a science. In particular, it is not practical to attempt to cover every aspect (not even every material aspect) of a lease within the term sheet.
With that said, there are certainly basic terms applicable to any commercial lease (regardless of the asset class) which, invariably, will be included in the lease term sheet, as they represent the threshold material terms of the lease. Those basic terms include identification of the landlord and tenant, identification of the space to be leased, the fixed rent (and any free rent or abatement periods), the lease term, and any landlord work obligations (or tenant improvement allowance). In addition to those basic terms, there are other material provisions of any commercial lease that a landlord and tenant will commonly cover in the term sheet, such as additional rent, assignment and subletting rights, lease term extension options, rights of first offer/refusals on expansion space, security deposits and required guarantees, and permitted alterations. Those material provisions were discussed in our prior article.
In the context of a retail lease, further consideration needs to be given to additional provisions which could be particularly material for retail landlords or tenants, especially if the leased premises is within a mult-tenant retail center. These material provisions specific to retail leasing include the following: (i) exclusive use restrictions, (ii) continuous use operating covenants, (iii) co-tenancy conditions, and (iv) tenant’s signage rights. A general discussion of these four material provisions is set forth below.
Exclusive Use Restrictions
A retail tenant leasing space in a multi-tenant retail center should consider whether they want (and have the leverage) to negotiate an exclusive use right in order to protect against competition for their products or services within the retail center. In some circumstances, the tenant may even need to consider requiring the landlord to recognize the exclusive use right in neighboring properties owned by the landlord or its affiliates. If possible, the tenant would want to keep this exclusive use right as broad as possible (e.g., no other tenant in the shopping center may sell any beverages for on or off-premises consumption, as opposed to no other tenant in the shopping center is permitted to sell brewed coffee products for on-premises consumption), to cover a wide variety of competitors and to allow for future changes in the tenant’s business model.
To the extent the landlord is willing to agree to any requested exclusive use rights (and has the leverage to negotiate limitations on the requested exclusive), the landlord will want to focus on both keeping the exclusive as narrow as possible (e.g., no other tenant in the shopping center is permitted to sell any brand labeled brewed coffee products for on-premises consumption), and allowing other tenants to sell the product and service on a limited bases (e.g., no other tenant in the shopping center is permitted sell any brand labeled coffee products for on-premises consumption, other than on an ancillary basis), in order to protect the landlord’s ability to lease to future tenants and minor infractions of the exclusive use right. Depending upon the tenant and its requested exclusive, there are many ways for the landlord to achieve this protection, including by negotiating that no other tenant in the center will use its space “primarily” for the exclusive use, a maximum square footage or percentage of another tenant’s premises that may be utilized for the exclusive use, and that the exclusive simply be a covenant to not permit certain specifically named competitors in the center. Related concepts, such as potential remedies for a breach of the exclusive, are most often left to be covered in the lease itself.
Continuous Use Operating Covenants
Landlords want a robust and active retail center to drive potential sales for its tenants, which, in turn, will drive rents. To that end, landlords leasing space in a multi-tenant retail centers should consider whether they want (and have the leverage) to negotiate imposing a covenant on a tenant to operate its store during certain hours, on certain days.
In the event a tenant needs to agree to a continuous operating covenant, the tenant should be mindful of certain exceptions to negotiate, such as closure periods that may be needed to make renovations, repairs and alterations, and to re-stock inventory, as well as periods of closure due to casualty, condemnation and force majeure. In some instances, the tenant may need to negotiate its hours of operations, where its business hours differ from the landlord’s required hours of operation (e.g., Chick-fil-A, which is closed on Sunday, day care centers, which are closed on weekends, and after-hours urgent care, which is only open at night), or where the tenant may be operating a seasonal business which does not operate full-time, all year (e.g., a summer patio furniture or water sports store may not desire to be open for business during the winter months).
Potentially, a tenant should consider negotiating landlord’s remedies for tenant’s breach of the continuous operating provision at the term sheet stage. A tenant may determine, at some point, that a particular store is not profitable to operate (or worse) and will want to protect against a specific performance action or a damage claim for its failure to operate in such instance. Accordingly, the tenant may want to negotiate in the term sheet that it’s breach of the continuous operating covenant, which continues after a certain period of time, gives the landlord the right to terminate the lease as landlord’s sole remedy.
Co-Tenancy Conditions
Whereas landlords want a robust and active retail center, as detailed above, tenants are often relying upon certain larger anchor-type tenants, or having a certain minimum percentage or portion of the retail center, being open and operating in order to attract customers to the center and, accordingly, to the tenant’s store. A tenant should consider the need (and whether it has the leverage) to negotiate this type of condition, and what the applicable remedies should be if the condition is not met. Most typically, the remedy is reduced rent and, at some juncture, a termination right (and, in the context of an initial co-tenancy condition, a right to postpone acceptance of delivery of the leased premises).
In response, the landlord will want to negotiate flexibility to protect itself from a failure of the on-going co-tenancy. For example, with respect to a co-tenancy obligation based upon a specific grocery store being open and operating, the landlord may negotiate the ability to meet the condition by substituting any nationally or regionally recognized grocery store; or negotiate the ability to substitute any tenant on a pre-approved list of substitute tenants. Similar to the continuous operating covenant discussion above, the landlord should be mindful of certain exceptions to the co-tenancy condition to negotiate, such as closure periods that the co-tenant may need to make renovations, repairs and alterations, and to re-stock inventory, as well as periods of closure due to casualty, condemnation and force majeure. Last, the landlord may want to negotiate a deadline for the tenant to make a decision on whether to terminate the lease due to the failure of co-tenancy (and if the tenant does not exercise its right to terminate, the obligation to pay full rent is restored), rather than allowing the tenant to simply continue to pay reduced rent throughout the lease term.
Signage
For many retail tenants, their exterior store signage is a critical element of their branding. Tenants who want or require the right to have their signs placed on the building, or on a pylon or monument, or other location in a retail center certainly need to consider raising this requirement at the term sheet stage.
In response, landlord’s need to consider the location (and positioning) it will permit the tenant to maintain on its signs, particularly in light of the need to offer signage rights to future tenants of the retail center. And certainly, the landlord needs to provide that the content of the signs will requires landlord’s approval. Some landlord also need to consider requirements for uniform sign bands and style.
If possible, the tenant is advised to obtain pre-approval of its sign content at the term sheet stage, but if that is not feasible, the tenant should certainly attempt to have its sign content pre-approved by the execution of the lease. Other related details, such as the obligation to maintain the signs and at whose costs, and the ability to replace the signs, is most typically addressed in the lease.
