Although commercial leasing and rental rates are coming back in Chicago, new tenants are still able to negotiate certain benefits from their landlords. Among these benefits are exclusivity provisions, which limit a landlord’s ability to lease space to a tenant’s competitors.
Smart Business spoke with Andrew D. Campbell, a partner at Novack and Macey LLP, about exclusivity provisions.
What is an exclusivity provision?
An exclusivity provision in a lease protects a tenant by prohibiting a landlord from leasing space to others engaged in the same line of business as the tenant. These provisions are especially common in leases for retail tenants, but they can be applied in many contexts.
There are two basic ways to create an exclusivity provision:
1. Expressly identifying the types of businesses to be excluded, or the types of goods that may not be sold in the landlord’s other spaces.
2. Creating an implied exclusivity provision.
An implied exclusivity provision arises when a lease provides that a tenant will have ‘exclusive’ rights — for example, ‘tenant shall have the exclusive right to operate a restaurant with a liquor license.’
Exclusivity provisions restrain trade — are they enforceable?
Yes, exclusivity provisions restrain trade, but this does not render them unenforceable. Courts enforce exclusivity provisions where they do not unreasonably restrain trade. If an exclusivity provision is reasonably necessary for the tenant, reasonable in duration and territorial scope, and does not unduly prejudice the interests of the public, they are generally enforceable.
But because exclusivity provisions restrain trade, some courts construe these provisions strictly. So, if an exclusivity provision is susceptible to two reasonable interpretations, courts often will choose the interpretation that imposes the least restraint on trade.
What should an exclusivity provision say?
To avoid disputes, exclusivity provisions should be as clear and specific as possible. For instance, suppose a McDonald’s restaurant is leasing space in a mall and it wants an exclusivity provision. A provision that excludes all other ‘fast-food restaurants that sell hamburgers’ would probably be too vague. It leaves questions unanswered such as to what constitutes ‘fast food’ and what it means to ‘sell hamburgers.’
A better limitation would be to specifically describe the types of businesses to be excluded — for example, excluding ‘restaurants that do not have table service and that derive 30 percent or more of their gross sales from the sale of hamburgers.’
An even better limitation would give specific examples of restaurants to be excluded — Burger King, Wendy’s, Five Guys, etc. A catchall provision at the end of this list, such as, ‘all other similar restaurants,’ may also be useful in case a relevant competitor was inadvertently omitted from the list. Although catchall provisions lack specificity, courts generally will apply them, but only to the extent the ‘other’ restaurant is similar to those listed.
What are a tenant’s remedies if a landlord violates an exclusivity provision?
While remedies will vary based on the specific terms in the lease, and the governing state law, tenants’ remedies for violation of an exclusivity provision can include repudiating the lease — that is, walking away from any remaining lease obligations — or suing the landlord for injunctive relief and/or damages. So, a tenant may file a lawsuit seeking to preclude a competitor from opening in the landlord’s space and/or the tenant may seek monetary damages that may have resulted from the opening of the competing store.
To minimize this risk, landlords should be sure to check the exclusivity provisions in other tenants’ leases before signing a new tenant.
Andrew D. Campbell is a partner at Novack and Macey LLP. Reach him at (312) 419-6900 or email@example.com.
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Many times landlords and tenants don’t realize that their commercial lease is unclear, contradictory or out of date until it comes time to resolve a claim, whether it’s a case of liability or property damage.
The payout is then delayed as the insurance companies review the entire lease to try and determine responsibility, liability and how the policy should respond.
“The real world is this — when the landlord and tenants go to renew an option, they just want to renew it. They don’t want to look at anything else because they don’t want to open up opportunities for negotiation that could be detrimental to either party,” says Phil Coyne, vice president at ECBM.
Smart Business spoke with Coyne about how knowing what’s in your lease and fixing problems now will save you a headache later.
What is one of the biggest risk exposures involved with a commercial lease?
You can avoid significant risk by making sure the lease language doesn’t expand, broaden or increase the liability and exposure to the point where your insurance coverage either doesn’t apply or would be limited. Therefore, each party — tenant and landlord — needs to have an understanding of the intent of the lease and its language.
Also remember that it’s not only the insurance provisions that have an effect on the outcome of a claim, but also definitions, maintenance, landlord/tenant obligations, use of premise and indemnity provisions. The insurance section alone only outlines limits and coverage; it’s the other sections of the lease that outline responsibility and ownership.
If two insurance companies review the same lease, and there are questions, it delays the claim process. For example, who is responsible for or owns the improvements and betterments to the space? Is that the responsibility of the tenant or the landlord?
How can tenants and landlords best mitigate risk when drafting and negotiating commercial lease provisions?
By understanding the intent of the lease and its language, the tenant and landlord can mitigate a potential problem prior to a loss and have an understanding of how their policies will respond.
Therefore, both insurance brokers should have an opportunity to review the entire lease during negotiations. He or she can explain what each party is accepting and not accepting, and how your policy will respond in the event there is a claim.
Some important areas for discussion are:
- Who is responsible for what, such as common area, tenant space, maintenance and repairs.
- Who is responsible to insure these items?
The commonly discussed issues in the insurance section are limits, coverage, indemnity provisions and specific wording, but policies respond to the entire lease and its language in sections other than the insurance section.
How should a lease be updated when up for renewal?
Many times lease options are renewed without re-examining the entire lease’s language. There could be simple items such as a name change or an increase in the square footage, other times it can be a change in use and occupancy and therefore changes in various other sections need to be amended and addressed.
Although the landlord and tenant likely just want to sign a quick renewal, it is important that all parts of the lease are carefully reviewed and understood. This will ensure each side is in agreement on the terms prior to a loss instead of after a loss, as the latter could lead to delays or restrictions in coverage.
Phil Coyne is a vice president at ECBM. Reach him at (610) 668-7100 or firstname.lastname@example.org.
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As a company weighs its options between signing a short-term and a long-term commercial lease, there are many things it must consider.
“Organizations need to weigh the benefits of locking in historically low lease rates long-term (seven to 10 years) or having the flexibility of a short-term lease,” says Steve Kim, a senior associate, Transaction Management, with Plante Moran CRESA. “Each comes with benefits and risks.”
Low real estate costs can help increase your competitive advantage. However, there are potential downsides to entering into a longer contract that need to be realized and hedged against to create maximum flexibility for your company.
Smart Business spoke with Kim about lease terms and how to negotiate the right conditions to suit your business needs, both today and in the future.
What crucial areas should a lessee consider when choosing real estate for a long-term lease?
When considering a long-term lease, a business should first determine whether the real estate is aligned with its strategic business plan. For example, does the space have room to accommodate your long-term growth plans? Does the building fit with your company’s image and brand? Conducting a space program is essential versus adding a percentage to your current square footage. This exercise will categorize and assign a square footage to all of your space, including conference rooms, executive offices, staff work spaces, common areas and storage, as well as account for future growth.
In addition, with building values at historic lows, purchasing real estate may be a viable option to consider, giving you the ability to lease out space until you need it.
What conditions would signal to a business whether a short- or long-term commercial lease is a more favorable option for a business?
Short-term leases offer a company the most flexibility, but they do have a downside. Lessees often don’t have as much room to negotiate terms and conditions in a short-term agreement as they do in a longer-term one. Also, landlords know all too well the cost of moving a business and could raise your rent at renewal, betting that you will not want to relocate. In addition to potential rate increases, there is no guarantee that you will be able to renew a short-term lease, especially if a large or long-term tenant needs your space.
Long-term leases will typically offer higher tenant improvement allowances, while short-term leases may require out-of-pocket costs by the tenant. But long-term leases also carry risks. Business conditions may change while you are locked into a long-term agreement, making it difficult to expand or contract your business based on a change in your strategic direction. However, an early termination option can be negotiated into a long-term lease to offer some flexibility while maintaining the security and extended savings.
What is an early termination option?
An early termination option allows you to opt out of your lease at a certain point in the contract, which reduces some of the risks that can come with being locked into a long-term agreement. It also offers an opportunity to renegotiate with your landlord midway through your agreement.
A company could work out an option to extend a short-term lease to hedge against losing the space or being hit with a rent increase, but the protections are not guaranteed, as those that accompany a long-term agreement would be.
When trying to negotiate a termination right in a lease, it is helpful to understand the landlord’s potential challenges in providing this option. The situation varies from building to building in regard to ownership structure and the debt situation, for example, and investigating these facts prior to the request is mission critical. Furthermore, the ability to terminate a lease may also be less advantageous if the termination fee is equaled to an amount that is perceivably unlikely to be paid.
Termination option fees requested by landlords are typically for the unamortized portion of the costs based on the market value of the transaction made when the lease was signed, along with an interest rate factor and a penalty equal to the value of rent for a few months. However, if the landlord receives adequate notice that a tenant is leaving, it should allow that tenant to lease the space and head off any loss of income. Termination fees require time to negotiate and ultimately should reward the landlord for offering additional concessions in exchange for extending the term.
What else can a company do to mitigate risk and reduce costs in a lease situation?
Another option to consider is subleasing, which can help a company recoup a portion of its rental expenses. However, expect to invest time and money on the front end to find a tenant and adapt the space.
If the necessary tenant improvements are financially viable for a company to pay upfront, the landlord has a greater ability to accept the termination option because the initial investment in the transaction has been reduced. Furthermore, a lease rate associated with an ‘as-is’ deal is usually below market and can protect tenants with renewal options going forward. Finally, some of the tenant improvements may be depreciated, ultimately lowering some of the company’s potential tax liability for a given year.
Steve Kim is a senior associate, Transaction Management, with Plante Moran CRESA. Reach him at (248) 223-3494 or email@example.com.
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Business owners might avoid bringing an attorney to the table when negotiating a lease, but the advantages of having an advocate in their corner far outweigh the cost.
“In my experience, when you see a lease where an attorney was not involved on behalf of the tenant, you get a lopsided, landlord-favoring lease,” says Jesshill Love, a partner with Ropers Majeski Kohn & Bentley PC. “The attorney’s job is to think ahead to what happens if something goes wrong to make sure the tenant will be treated fairly.”
Smart Business spoke to Love about the pitfalls a tenant can avoid by partnering with an attorney before signing a commercial lease.
Why should an attorney be present in the negotiations?
Any smart businessman or woman is going to employ both an attorney and tenant broker, because they have different roles. A broker is going to be more focused on lease rates, market factors, square footage allocations and tenant improvement allowances. An attorney is going to focus on protections for the tenant from the point of view of the ‘legalese’ of the lease. This can include indemnification, attorney fees, arbitration and mediation issues. Sometimes an attorney has to interpret multiple provisions together in order to get to the conclusion that the lease actually pushes more of the obligations and expenses onto the tenant than it should. The role of the tenant’s attorney is to make sure that the tenant is well represented and receives the benefit of the bargain in the negotiation process.
What is the role of the letter of intent?
This is often where tenants misstep: they start talking to the landlord about deal points or even move to a draft lease before considering the letter of intent (LOI). The LOI is what will set the tone for future negotiations, and if you don’t drive a hard bargain at the LOI stage, then you’re leaving money on the table when the lease is signed. Once the LOI is established, it’s going to serve as a framework for the actual drafting of the lease itself.
There’s a tremendous amount of standard language thrown into a lease, such as forum selection clauses, attorney fee provisions and indemnification and insurance provisions. All of this is fairly standardized in the industry, but the framework of the main deal points from the LOI is what’s going to set the tone for the lease when it comes to flexible items like tenant improvements, common area maintenance (CAM) expenses and operating expenses, and how they’re defined.
What are some provisions a tenant should push for in a lease?
These can change every couple of years as the market changes. Also, as new case law is handed down, attorneys on both sides of the negotiation will angle to push off certain costs or obligations on the opposing party. The big ticket items now are tenant improvements, free rent, environmental concerns, termination provisions and risk of loss provisions.
It’s still a tenant’s market, so negotiating for free rent up front is something you want to try to do, if possible. Also, try to negotiate a cap for any structural improvements with an absolution period and landlord indemnification of the tenant for any pre-existing structural or environmental problems. Mediation and arbitration as well as attorneys’ fees provisions are additional issues to look out for.
Landlords on triple-net leases will try to define everything as a tenant responsibility: roof, plumbing, sewer line, heating, ventilation and air conditioning (HVAC) and electrical problems. A tenant attorney should push back in an effort to make a major structural problem involving the building envelope the responsibility of the landlord.
Another thing you’ll definitely want to have is a clear definition of default, particularly if you have a letter of credit. You don’t want the landlord to be able to draw down on the letter of credit for something that’s an immaterial default under the lease. Also, when lease rates start to increase, landlords are going to be looking for any type of breach they can in order to cancel the tenant’s lease so they can lease to somebody else at a higher rate. Landlords will attempt to define default broadly to effectuate this purpose. We have seen multiple over-reaching default definitions, such as violation of local zoning and use laws and operating hour violations. The attorney’s job is to make sure that a breach of a lease for which the landlord can actually terminate is material; this should be limited to non-payment.
What should tenants avoid in a lease?
First, tenants should avoid personal guarantees when possible, as well as excessive security deposits. Relocation provisions should also be avoided or, at a minimum, limited. Relocation provisions are common in leases with multiple commercial tenant or office spaces. They allow the landlord to move a tenant if the landlord wants to incorporate the tenant’s space with adjoining spaces for a prospective tenant. The tenant has no choice but to move upon notification from the landlord. Relocation could result in a tenant being buried in the back of the office building, or the franchise in the shopping mall could end up tucked away in a space with little foot traffic. This is obviously not what the tenant initially negotiated for when the lease was signed. The tenant must negotiate relocation preferences and safeguards prior to signing that lease.
Further, some lease agreements require a tenant to continue to pay rent even if the space is rendered unusable. For example, if there’s a fire in the building, and the tenant cannot continue to operate the business, the tenant is still required to pay rent. Although the tenant’s lost business can be covered by business interruption insurance, it is not in the tenant’s best interests to have an open-ended time period for the landlord’s repair of the premises. Most large commercial leases are drafted that way — even if it’s not the tenant’s fault, the tenant is not allowed to terminate the lease pending the landlord’s repair of the premises. Litigation surrounding these matters between landlords and tenants can be company killers. There have to be provisions in the lease that say, if this can’t be fixed within a reasonable time period, the tenant gets to walk.
Jesshill E. Love is a partner with Ropers Majeski Kohn & Bentley PC. Contact him at (650) 780-1611 or firstname.lastname@example.org.
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One of the most important and perplexing decisions for most commercial tenants is deciding upon the duration of a new lease term. Should you lock in a 10-year lease to capitalize on the favorable terms currently being offered over the long term? Or is the flexibility of a shorter-term lease more desirable for your organization? Is there any way to get the best of both worlds?
“While the lease term is one of the more difficult real estate decisions to make, there are effective methods of creating flexibility which can mitigate the risks involved in a long term lease commitment,” says Matt Davis, associate at Guardian Commercial Realty.
Smart Business spoke to Davis about how to best maintain this flexibility in the current economic environment.
What are the risks associated with a long-term lease versus a short-term lease?
First, it’s important to note there are several distinct advantages to most long-term leases (seven to 10 years). Since landlords can amortize their costs over a longer period of time, there is typically a larger tenant improvement allowance, more up-front rental abatement and greater leverage during lease negotiations. And, in a down market, the greatest advantage is locking in lower rent for an extended duration. Given current rental rates are still at their lowest level in years, capitalizing on the market and securing those rents for an extended period can put a company at a competitive advantage should rates increase leaving competitors with higher expenses. Additionally, the security of knowing the space cannot be re-let to a different tenant during the term is also of great value. However, with these advantages come a degree of risk; an unforeseen budget reduction, acquisition opportunity, or corporate restructure could result in significant damages if a tenant is left with too much term and no way out.
If the risks associated with a long-term lease outweigh the benefits, many tenants will simply pursue a shorter term allowing for increased flexibility; however, less apparent are the inherent risks of a shorter-term lease — especially in the current economic climate. There are no caps on rental increases when your term expires, no guarantee the landlord will release the space (e.g., a larger tenant in the building may want the space for expansion) and reduced leverage for renegotiating. To the latter point, there are no loyalty programs in commercial real estate — if a tenant has been in the space for only a year to three years (especially if it has put its own money into improvements), the landlord, knowing full well the cost of relocating, will be less inclined to renew under favorable terms.
How can a tenant balance security and flexibility in its lease agreement?
The best way to maintain the security and extended savings of a long-term lease while retaining a degree of lease flexibility is to secure an early termination option. This option gives the tenant the ability to opt out of its lease at a pre-determined point in time or even at multiple points during the lease term. The risks of a long-term lease are substantially reduced given the ability to cancel the lease mid-term. Conversely, the more common approach of signing a short-term lease with an option to extend may protect a tenant from losing the space or from a reduction in rental rates, but does not protect against a market recovery or secure the additional concessions common with a longer term.
Furthermore, an early termination option can hedge against rental rate reductions by providing mid-term leverage to renegotiate terms. These options can be contingent on the landlord’s ability to provide alternative space that meets the tenant’s needs. Keep in mind securing early termination options can take time to negotiate. Expect the landlord to resist granting this option or propose a significant fee should the option be exercised.
What should the tenant expect to pay for an early termination?
The fee for a termination option is typically contingent on the out-of-pocket costs the landlord incurs when the lease is signed. Landlords typically request a fee reflecting the unamortized portion of these costs (e.g., tenant improvements, free rent and leasing commissions) with an interest rate factor, in addition to several months’ rent as a ‘penalty.’
The landlord’s typical request, however, takes into account far more than the equitable damages to the landlord. With reasonable notice (six to nine months), the landlord should have ample time to release the space, minimizing any interruption in its cash flow. Additionally, the unamortized portion of the out-of-pocket costs should be determined based on the market value of the transaction made at the time of lease execution. For example, if the tenant received at $25 per square foot TI allowance for a seven-year term, but by market standards the same allowance would also be granted for a five-year term, the unamortized costs should be zero if the early termination option is effective month 60.
Securing a reasonable termination fee may require time to negotiate and, when doing so, it’s important to denote its purpose — to reimburse the landlord for costs incurred as a result of providing additional concessions in exchange for the extended term. It’s also suggested to stipulate to a specific amount up front to avoid confusion years down the road if the option is exercised.
Are there other strategies tenants can employ to maximize flexibility?
Depending on a tenant’s particular growth strategy, there are several types of options and, with each, numerous ways to contour them to the tenant’s specific situation. However, these options typically play a greater role when a tenant has a general understanding of its future desire to expand or contract.
Subleasing can also be a viable option for recapturing expenses for unneeded space, but this too can come with its own set of challenges including time, up-front expense and exposure should a subtenant default. An experienced tenant representative can assist in managing a tenant’s expectations when considering subleasing its premises, and is a valuable and cost-effective resource when seeking maximum flexibility in a commercial lease.
Matt Davis is an associate at Guardian Commercial Realty. Reach him at (310) 822-2052 or Matt.Davis@GuardianUSA.net.