Lease issues can trip up even the most experienced retailers. Therefore, it is vital that retailers’ leases properly address significant legal issues. This article discusses a number of these issues.
1. Zoning/Permits/CC&Rs–Due Diligence and Contingencies
Prior to negotiating a lease, a tenant should confirm that local land use and zoning regulations allow the intended retail use and, if so, what permits (including building permits) will be required. If permits are required, a tenant may seek to include a permit contingency allowing the tenant to terminate the lease if it cannot timely obtain the necessary permits. If the landlord does not agree to include a permit contingency, the tenant will need to conduct a thorough due diligence review prior to lease execution. As part of its due diligence investigation, the tenant should carefully review all “prohibited” uses and exclusive use rights applicable to the center and any recorded CC&Rs and other agreements to ensure that the tenant’s proposed use (including any intended outdoor displays and uses of the common areas) will be allowed.
2. Use Clause/Exclusive Uses
The “use” provision spells out the allowable uses of the premises under the lease. A landlord will want the provision drafted narrowly (to only allow the specific use) and a tenant will want it drafted broadly (to allow flexibility for current and future uses). Both parties should ensure that the intended use is defined with some specificity and that the provision anticipates how the use may change in the future. If a tenant is unable to negotiate a very broad use clause, the lease should at least provide that the landlord will not unreasonably withhold consent to a request for a change in use in the future.
A related provision (particularly for a tenant with negotiating strength in a multi-tenant building/center) is an “exclusive” use provision providing that the tenant is the only tenant in the center that can operate as the specified use. Not all leases contain exclusive use provisions, so a tenant will need to determine whether this is an important concept to address during negotiations.
3. Operating Covenant
Landlords often will want the tenant to remain open during all agreed-upon times so rented space is not left vacant and the tenant maximizes sales from the premises–particularly if the tenant will pay percentage rent (a percentage of gross sales). As a result, many leases include an “operating” covenant. This covenant provides that a tenant will remain open during certain hours. If the tenant closes, the landlord can collect set amounts (which may be imposed daily and even hourly) and declare the tenant in default under the lease. Operating covenant issues to negotiate include operating hours, remedies for non-compliance, and carve-outs (i.e., times a tenant can be closed) for force majeure events, construction of tenant improvements/remodeling and conducting inventory.
4. Compliance with Laws
For many tenants, the lease provisions requiring compliance with laws are among the most significant and highly negotiated provisions. The lease will of course require a tenant to comply with all applicable permitting and other requirements–but who is responsible if capital or structural upgrades are necessary to comply with local, state or federal requirements (including ADA compliance)? The negotiated allocation of responsibility often depends on the condition of the building and the length of the lease. No matter what, the parties will need to carefully and clearly define who is responsible in the event compliance obligations arise during the term.
5. Assignment and Subletting
Assignment and subletting provisions often provide that a tenant may not assign or sublet the space without landlord’s consent. If consent is required, the tenant should make sure the lease language provides that landlord’s consent will not be unreasonably withheld. Moreover, sometimes parties fail to anticipate what might happen down the road–a well negotiated lease will contain carve-outs to the basic landlord approval requirement so that a tenant does not need to obtain landlord’s consent in every instance, such as if the tenant recapitalizes, sells all of its assets or ownership, or transfers the lease to a related entity.
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It is vital that all issues (including the key business terms and other items like parking, access and signage) be discussed between the parties early and be included in the letter of intent. A well thought out letter of intent will often make lease negotiations quicker and smoother. Effort spent on negotiating a clear, concise and fair lease will pay benefits down the road in the landlord/tenant relationship and will help create a stable business foundation.
Dan Myers, a partner in the Real Estate Practice Group at Wendel, Rosen, Black & Dean LLP, represents parties in retail, office, commercial and industrial lease and purchase and sale transactions.