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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Once a tenant has signed a commercial office lease it’s generally expected that it will remain in place for the duration of its term. Retail tenants in particular may spend large sums of money to upgrade their leased premises in reliance upon the negotiated terms and the expectation that a unique location will help drive strong revenue.
“These expectations, however, can go horribly wrong if their landlord experiences financial reversals and defaults on its loan obligations,” says Robert Chavez, founder and CEO of Guardian Commercial Realty.
Given the increase in commercial property foreclosures, Smart Business spoke to Chavez about SNDAs and how they pertain to a tenant’s rights in the event of a building foreclosure.
What is SNDA?
SNDA is the acronym for subordination, nondisturbance and attornment. Subordination and attornment provisions are included in most commercial offices leases as they define the responsibilities between a landlord, its lender and its tenants in the event of a default by the landlord and foreclosure by the lender. These provisions can also impact the distribution of insurance proceeds in the event of a casualty or condemnation. Subordination and attornment may be one of the most boring sections in a commercial office lease and is often ignored by tenants because it is so bland and legalese. Just because it is boring, however, does not mean it is not important. Subordination and attornment provisions buried in a lease can cause a tenant to waive very important rights in the event of a foreclosure.
What could happen to a tenant in a foreclosure?
In the event of a foreclosure, the tenant will have a new landlord — the lender. Subject to myriad underlying documents, the lender can either terminate or enforce existing leases within the foreclosed property. The lender may also be excused from funding tenant improvement allowances, as well as honoring rental abatement periods, self help provisions and other concessions that remain unfulfilled due to the landlord’s default. The lender’s objective will be to preserve and/or maximize the cash flow of its property to recover its loan principal and interest. Market conditions will play a large role in the lender’s actions. During strong economic periods with rising rental rates and low vacancies, lenders may elect to terminate existing leases and find new tenants willing to pay higher rents. The lender could also institute eviction proceedings immediately following foreclosure, making it impossible for the tenant to adequately plan for relocation. Aggressive lenders may also use these tactics as leverage to increase the tenant’s rent irrespective of the rent set forth in the lease. During recessionary periods with low rents and high vacancy, lenders will want to keep any above-market rents in place and do whatever else they can to preserve cash flow.
What should a tenant do to protect itself?
In situations where a tenant will make a significant investment in the leased premises, expect to benefit from a premium location, or is confident that its rent will be below market for the term, the tenant should insist upon a nondisturbance agreement. The nondisturbance agreement, executed by the tenant and lender, must be carefully drafted to ensure that the lender will honor all of the tenant’s rights under the lease after foreclosure. Tenants should expect resistance from lenders when seeking a nondisturbance agreement; this is especially true for non-credit tenants with smaller leases.
The scenario typically plays out in stages. First, the lender refuses to execute a nondisturbance agreement as it is under no obligation to do so. Next, if the tenant is persistent and the landlord is persuasive, the lender agrees to execute its ‘form’ nondisturbance agreement, but without any changes. Finally, after much negotiation, the lender and tenant agree to reasonable changes to achieve a mutually acceptable nondisturbance agreement. This process can take four to six weeks, and there is no guarantee that the lender will cooperate.
Sophisticated tenants have walked away from transactions at the 11th hour when the lender has refused to cooperate reasonably.
Should tenants always seek a nondisturbance agreement?
There may be circumstances under which a nondisturbance agreement may not be in a tenant’s best interests. Over time, a property may have become unattractive to the tenant because the rent is above market or the building’s condition is deteriorating. The tenant may also need to downsize or relocate. If so, then the tenant may want flexibility, and the nondisturbance agreement may lock the tenant into the lease, eliminating its ability to terminate in the event of a foreclosure.
It is important to note that this commentary is only the tip of the iceberg as it relates to SNDAs and their related issues. A tenant is well advised to seek the advice of an experienced real estate attorney before executing a lease.
ROBERT CHAVEZ is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardianusa.net or (310) 882-2060.
Leasing space for your business — whether office, retail or industrial — is an important investment for any company. While there are always many factors to consider, it is important to understand what is reasonable for your particular business in the marketplace.
In most areas it is still a tenant’s market, so it may make sense to upgrade, expand and extend leases now. In other markets, the leasing climate has started to change and landlords are able to drive harder bargains. Whatever market your company is in, there are several common leasing issues that should always be considered when negotiating a lease or lease extension.
Smart Business spoke to Sonia Lister and Spring Robinson of Jackson DeMarco Tidus Peckenpaugh about their list of the top 10 most common lease negotiation issues that business owners should address when discussing leasing needs with their landlord.
1. Letter of intent. Depending on the complexity of the lease terms, it is almost always to a tenant’s advantage to have a detailed letter of intent (LOI) as the first step in lease negotiations. The LOI should include all of the business terms of the lease. Even though the LOI is typically a non-binding document, the business terms of the deal are rarely renegotiated after the lease negotiations begin, so all essential terms should be clearly addressed in the LOI.
2. Landlord incentives. Consider asking for incentives from the landlord. A company’s ability to negotiate landlord incentives will vary depending on the vacancy rate in the market, as well as other factors such as the company’s size and financial ability. A long lease term and solid tenant commitment may motivate the landlord to offer generous concessions and incentives. Typical incentives include periods of free rent or discounted rent, landlord contributions to build-out costs or moving costs, limits on future rent increases, free parking and reduced or capped operating expenses.
3. Improvements to the premises. Evaluate which party should construct the improvements to the premises. There are three common options: a) tenant build, b) turnkey (landlord builds the improvements at its expense pursuant to a specific plan), or c) landlord build. The negotiation considerations for each of these scenarios are different and so you should be sure to discuss them carefully with an experienced tenant broker and legal counsel.
4. Condition of the premises. Make certain that the current condition of the premises is acceptable if no improvements are being made to the premises. Taking the premises ‘as is’ exposes the tenant to risk for inadequate or outdated facilities. At a minimum, the landlord should warrant that the space is up to current building, fire, safety, zoning and disability access codes and should warrant the condition of electrical, plumbing, heating and air-conditioning systems (even if only for a limited period of time).
5. Planning for catastrophic events. The lease should provide procedures in the event of any future catastrophic event (i.e. damage to the premises, condemnation, or disruption in utilities). In such events, the lease should clearly provide who is responsible for repairing or restoring the damage, whether the tenant is entitled to abatement of rent, and the right to terminate the lease if such catastrophic event is long lasting or of a significant nature.
6. Limiting the liability of lease guarantors. If a principal of your company is required to personally guarantee the tenant’s obligations under the lease, try to limit his or her potential exposure to liability. The risk to the lease guarantor can be limited by adding provisions that reduce the term of the guaranty to a certain number of months after the lease commencement date, or limit the maximum amount payable by the lease guarantor to a fixed dollar amount.
7. Consider future flexibility or allowances for company growth. Prior to entering into a lease or extending the term of an existing lease, it is important to analyze every aspect of your company’s business plan to make sure that the size of the premises is compatible with existing and future plans for your business, and that there is sufficient flexibility built into the lease in the event that plan changes. Some provisions to include to ensure future flexibility include a lease extension option, space enlargement or reduction option, early termination option and the ability to assign the lease or sublease the premises.
8. Security deposit. Depending on the market and the financial strength of your company, it may be possible to minimize the amount of the cash security deposit. If your company is and has been financially strong, the landlord may waive the security deposit altogether. Furthermore, if it makes business sense for your company, a landlord may accept a letter of credit in lieu of a cash security deposit. If, however, you are required to provide a cash security deposit, consider building into the lease a provision that would allow the security deposit to be decreased over time if the tenant has fully performed its obligations.
9. Hold-over provision. Make certain that any penalty for ‘holding-over’ or remaining in the premises after the expiration of the lease is reasonable. Furthermore, be sure to allow flexibility for negotiations with the landlord at or beyond the expiration of the term to renew the lease without payment of any hold-over penalty.
10. Notice periods and deadlines. All notice periods and deadlines for exercising or enforcing rights should be reasonable. After your company has signed the lease, it is important to periodically review the lease and to calendar all important dates so as not to forfeit or waive any rights, such as an extension option, early termination option or space reduction option.
Sonia A. Lister is a shareholder and member of JDTP’s Real Estate Practice Group. Reach her at firstname.lastname@example.org or (949) 851-7408. Spring M. Robinson is an associate and member of JDTP’s Real Estate Practice Group. Reach her at email@example.com or (949) 851-7474.
Most commercial tenants consider leases to be no more than an administrative hassle. But with real estate overhead the second-most expensive line item for businesses, negotiating leases should not be taken casually, particularly for commercial tenants renewing their commitments for an additional five or 10 years.
New terms driven by market conditions and imposed by aggressive landlords can increase a company’s rent and related expenses by more than 50 percent at each renewal. Landlords attempt to impose all costs, risks and inflated profits to their commercial tenants, and most tenants simply sign on the dotted line.
“Why the haste to sign an agreement that is so clearly weighted in favor of the landlord and not the tenant?” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “Dissecting this phenomenon requires an understanding of the dynamics and relevant issues related to negotiating leases.”
Smart Business spoke to Chavez about five insider tips to successfully negotiating with landlords in a commercial or retail lease.
Why do tenants often end up at a disadvantage in lease negotiations?
Most tenants dread the time and costs related to a corporate relocation. Ironically, in their haste to avoid expense and frustration, they often make the most costly mistake when addressing their lease renewals: they fail to leverage their alternatives.
When negotiating lease extensions, tenants focus on the expenses and logistics that impact their company’s direct profits. They pay close attention to their personal costs related to rent, construction, moving, technology, space planning and lost productivity. Though these considerations should be on the list, most tenants fail to recognize the tremendous cost and risk faced by landlords when a tenant vacates a property. This allows landlords greater leverage to charge inflated rates while offering nominal concessions. In exchange for paying higher rent, tenants accept new carpet, minimal rent abatement and a fresh coat of paint as suitable reasons to avoid moving.
How can tenants approach lease renewal more strategically?
1. Quantify the costs faced by the landlord if the tenant vacates. Consider the time the landlord must expend to lease space to a new tenant as well as the improvement costs necessary to retrofit that space.
Construction costs, including space planning and permitting for a modest retrofit, cost conservatively $20 per square foot. Add the cost associated with the landlord’s time preparing, advertising and negotiating a 10,000-square-foot space, and the immediate cost to the landlord becomes apparent and staggering: it typically ranges from $450,000 to $600,000, or $45 to $60 per square foot. Compare this to the $6 to $9 concession package to which most renewing tenants agree.
A commercial space usually does not produce revenue for nine months after a tenant vacates. The key is for tenants to recognize that landlords are always more nervous about the time, money and risk associated with vacant space than they acknowledge.
2. Ignore bullying tactics. Landlords often approach their tenants early and propose two sets of lease terms: the first proposes a lower rate if the tenant is not represented by a broker; the second imposes higher rent for broker-negotiated deals. The landlord blames the extra cost of the latter on commission fees, but the truth is that brokers can negotiate much better terms than either scenario offered by the landlord.
In fact, hiring an experienced tenant’s broker might save more money than employing legal counsel. Though company lawyers understand the law, they are generally not experts in real estate terms and concessions available in a particular marketplace. Hiring both is best.
3. Conduct due diligence. Even for tenants with no desire to relocate, knowledge of the quality, quantity and cost of relocation opportunities provides leverage for the tenant, as does knowing the length of time commercial spaces generally remain vacant.
Understand the true logistics of your space needs. The intricacies of a floor’s layout can be complicated, so use your broker and architect early in the process to assist in determining which building is most efficient for your needs. In many instances, an appropriate floor size and shape can reduce a tenant’s square footage by 10 to 15 percent. Over five years, this translates to an approximate $180,000 savings for a 10,000-square-foot tenant.
Tenants must also exercise care when selecting a commercial real estate broker to represent their interests. Most firms and brokers derive the bulk of their revenue from representing landlords in the managing, leasing, selling and refinancing processes. True tenant brokers will not accept work from landlords, thereby avoiding a conflict of interests and the appearance of impropriety.
Also, be certain that the broker is more than a marketing expert and will be the broker personally handling your assignment.
4. Consider the true cost. Failure to properly negotiate a lease can cost a 10,000-square-foot tenant $300,000 or more over the course of a five-year lease. In addition to the rental rate, tenants should consider items such as square footage calculations, option language for future expansions and extensions, detailed landlord responsibilities, appropriate base year calculations, tax protection and exclusions from operating expenses. These and other issues can cripple a tenant if not properly negotiated, and are often foreign to most tenants who address leases infrequently.
5. Take the initiative. Conducting the due diligence necessary to effectively negotiate leverage takes at least 18 months. The entire process should be finalized no later than six months prior to lease expiration, which means the tenant should start addressing lease negotiations two years before the expiration date.
Be proactive about negotiating your lease and send a clear message to your landlord: you have committed the time, energy and resources necessary to secure the best terms for your commercial office space needs. This is not the only game in town, and your landlord must consider your needs — or another landlord will.
Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at (310) 882-2060 or Robert.Chavez@guardianusa.net.