Leasing Nightmares: The Dangers of an ‘Open Relationship’ with Your Landlord

Note:  Blackacre LLP is a boutique fixed fee real estate law firm with a restaurant leasing specialty.  From its experience serving as counsel to numerous restaurant clients, Blackacre’s attorneys know that a good lease is crucial to a restaurant’s success, while a bad lease can doom an otherwise successful restaurant to failure.  In the coming articles, Blackacre’s attorneys will write on how to prevent a restaurant lease from becoming the next “Leasing Nightmare."

The start of the landlord-tenant relationship is a very exciting time for both parties involved.  The tenant is excited to launch a restaurant in a new location and the landlord is thrilled have a new restaurant paying premium rent and attracting more customers to its shopping center.  At this stage of the relationship, many restaurant tenants do not even consider the possibility that their landlord may one day install a competitor in extremely close proximity, much less in the shopping center at all. Whether it occurs days, months or years after a restaurant opening, many tenants are mortified to discover the nature of their relationship with their landlord was not in fact an exclusive one, with a new competitive business opened nearby. 

As outlined below, to prevent this Leasing Nightmare, it is important to negotiate an exclusive use clause with the landlord that adequately and specifically describes a restaurant’s use and prevents the landlord from leasing space to a competing restaurant (or otherwise permitting a competing restaurant to operate), as well as providing the restaurant tenant with sufficient remedies should a landlord violate such exclusive use restriction.

Why Many Landlords Resist Exclusive Use Rights

 In order to understand how to negotiate an exclusive use clause with a landlord, it is first important to understand some key points regarding why landlords resist granting exclusive use clauses. The points below are the primary reasons on why exclusive use clauses are often rejected:

1. Exclusive use clauses are often too vague. For example, suppose a landlord grants a broad exclusive use such as “Mexican restaurant use”. Does that cover sit down, quick service and fast casual restaurants? Does it preclude leasing to fusion concepts that draw inspiration from Mexican cuisine?  What about restaurants that serve some Mexican items, but not as a primary use?  If an exclusive use provision is too vague, it can be fertile ground for litigators at tremendous cost to the landlord.
2. Exclusive use clauses often cannot predict the future. For those who were granted an exclusive use on “sushi”, does their exclusive now evolve to include all pokéitems? Does an exclusive use on “protein bowls” preclude a landlord from leasing space to a restaurant that serves ethnic bowls containing proteins such as teriyaki bowls?
3. Exclusive use clauses often do not allow for other restaurant tenants to have sufficient business flexibility. It may seem sensible to provide a “smoothie” exclusive, but what about the new vegan restaurant prospective tenant that finds out it cannot serve smoothies even though smoothies are a critical part of its menu?
4. Exclusive use clauses prevent competition. Especially in premium shopping centers, tenants often become lazy and stop investing in their businesses when they realize there will always be an unlimited flow of customer traffic regardless of the quality of the establishment.

Proposing an Exclusive: Be Precise While Understanding Landlord’s Needs

The best way to propose a palatable exclusive is to precisely define the restaurant’s primary use (or the critical components of the primary use) in a way that will not cause concern for unintended consequences and allows flexibility for other concepts to have non-competitive overlap.  For instance, simply stating that no other business in large shopping center could sell seafood items would be unreasonable and would be rejected by any sensible landlord, but a seafood restaurant could instead propose that no other restaurant would sell over a certain percentage of certain specified seafood items (based on a percentage of gross sales or menu items), with specific exceptions for pokéand sushi concepts.  Such a proposal may be a lot more palatable to a landlord that wants to maintain flexibility to lease to new pokéand/or sushi concepts, while not necessarily infringing on the tenant’s more general seafood use. 

Another option is to define what constitutes an “incidental use” that would not be covered by the exclusive use.  For example, a coffee shop having an exclusive use for “coffee, tea and baked goods” should be able to accommodate a fast casual or sit down restaurant serving coffee, tea and baked goods among a full menu of other items, as long as the sale of such items constitute less than a certain percentage of their gross sales (such that they don’t realistically compete with the primary use of the coffee shop).

Exclusive use provisions may also be tailored to apply to certain areas of the shopping center only, such that landlords can have flexibility to lease to competitors in far flung areas of the center only. 

As restaurant concepts have become less well defined and draw upon multiple varieties of cuisine, it becomes impossible for some clients to define their concept in any sort of specific manner. For these concepts, an alternative approach is to simply provide a specific list of prohibited competitors from leasing in the shopping center.     

Remedies For Landlord Violation

A good exclusive use clause must include a specific and meaningful remedy in order to ensure landlords abide by the exclusive use restriction.  The market standard solution is to (while the violation is continuing) allow the tenant to pay 50% of base rent for one year and, after a year, give the tenant the option to terminate the lease (with such termination coupled with a reimbursement of unamortized tenant improvement costs).  Many landlords will insist that, if a tenant does not terminate the lease after one year, base rent will resume to the full amount otherwise required, although many tenants will object to that requirement.  In any event, such remedies force the landlord to act quickly to resolve the issue, or incur substantial financial penalties.

Many exclusive use clauses do not contain an explicit remedy for landlord violating an exclusive, giving tenants no option for immediate relief other than pursing remedies at law or in equity (at great cost and with no guaranty of success).  Without the explicit remedies such as the rent reduction remedy set forth above, tenants face two problems.  First, they must spend thousands of dollars on attorneys’ fees to pursue a judgment against the landlord in order to enforce their exclusive use rights. Second, the tenant must prove damages to its business, which is often problematic given the myriad of factors which define the success of a restaurant business in a given time period. 

Conclusion

During the initial exciting phase of negotiating a shopping center lease with the landlord, the last thing on any party’s mind is the possibility of installing a competitor in the future.  All restaurant businesses should carefully consider what competing businesses within a shopping center (if any) would cause concern and should specifically and clearly define its unique use that it seeks to protect, or otherwise designate competitors it wants to preclude, in a way that would be palatable to a landlord. Obtaining the exclusive commitment of the landlord during the initial exciting phase of the relationship should go a long way toward avoiding the Leasing Nightmare of an “open relationship” if the landlord decides to lease space to a competing operator.