COVID-19 Lessons Learned for Restaurant Tenants
3 Min Read By Iryna Ivashchuk
Stay-at-home orders and closures of non-essential businesses as a result of the COVID-19 pandemic have had significant economic implications for restaurant tenants. Going forward, while negotiating new leases, restaurant tenants should consider adding specific provisions that may potentially lessen the effect of governmental closure orders, pandemics and similar events on their operations.
Premises Delivery Date. In the event the leased premises are under construction and will not be delivered by the landlord to the tenant upon signing of the lease, the lease should include a deadline by which the landlord must deliver the premises to the tenant and a related tenant’s termination right. Tenants may want to clarify in the lease that such deadlines cannot be extended by a force majeure event, such as a pandemic, since the tenant may not want to sit and wait indefinitely until space can be delivered by the landlord.
Co-Tenancy. When negotiating leases in shopping centers, tenants should try to push for a co-tenancy provision in their leases pursuant to which they will not be required to open and/or to operate their business or may pay reduced or no rent, if a certain major tenant (a large department or grocery store, as an example), or a certain percentage of all tenants in the shopping center, are not open for business and operating.
Force Majeure. While a force majeure clause (excusing a party from performing under a contract during unforeseen circumstances which are beyond such party’s control) is typically found in many lease forms, it typically does not excuse tenants from paying rent. When negotiating leases, tenants should ensure that pandemics are expressly included in the definition of a force majeure event. In addition, given the severe economic impact of COVID-19, tenants can try to negotiate rent abatement in the event their business has to be closed as a result of the pandemic, asserting the argument that the economic risk of a pandemic should be shared between landlord and tenant. If the landlord pushes back on the rent abatement, consider proposing a waiting period before the rent abatement kicks in or putting a cap on the length of the rent abatement period.
Percentage Rent. Percentage rent calculations are typically driven off what is known as a “breakpoint”, which is a dollar amount of tenant’s sales above which a negotiated percentage of sales is paid to the landlord. Tenants should negotiate for a higher breakpoint during the duration of a force majeure event, which would reduce or eliminate the tenant’s obligation to pay percentage rent during the time when the tenant may struggle because of lower sales (or if a restaurant tenant has to discontinue its sit-down service and instead be restricted to pick-up services or delivery services). In general, tenants should also pay close attention to what is included in the definition of gross sales for the purposes of calculating percentage rent and should negotiate various exclusions from gross sales, such as gratuities and insurance proceeds.
Gross Sales Termination Right. When negotiating a new lease, tenants may also try to include a tenant’s right to terminate the lease if the tenant’s gross sales fall below a certain threshold. This request may be more acceptable to a landlord if the tenant takes over a prior tenant’s business that failed as a result of low sales (due to unfavorable location or otherwise).
Caps on Operating Costs. If the tenant has to contribute towards the landlord’s operating costs, it should negotiate a maximum amount (a “cap”) it would pay to the landlord as tenant’s share of all of the landlord’s operating costs, or at least the landlord’s controllable operating costs (which in general mean all operating costs other than insurance, utilities and taxes that landlord has to pay). A cap may lower the tenant’s share of operating costs during a pandemic when the landlord’s operating expenses may increase significantly due to the implementation of enhanced cleaning procedures, higher security costs, and reduced service costs.
Landlord’s Lien on Tenant’s Personal Property. Tenants may also want to ensure that the lease does not include a landlord’s lien on tenant's equipment and other personal property. If the lease provides that the tenant’s obligations under the lease are secured by a landlord’s lien on a tenant’s personal property, that tenant may not be able to obtain a secured loan or sell equipment to generate cashflow at the time it needs cash the most.
While the early lessons for restaurant tenants as a result of COVID-19 have begun to emerge, those lessons will be refined as the effects of the pandemic on commercial businesses are fluid and evolving. As the stay-at-home and business closure orders are lifted, restaurant operators need to consider what changes they may need to make to their existing leases or what provisions should be included in the new leases to most efficiently operate in the new world that has forever been changed by COVID-19.