ABA Retail – Nuts & Bolts Seminar

Ten of the Most Common Differences Between Office and Retail Leases

October 19, 2011

1:00 P.M. ET

A.Why we chose this topic

  • For those who may be encountering retail leases for first time, with or without experience with office leases. Probably more likely to be tenant representation in first retail lease
  • We wanted to outline a basic checklist and develop a basic understanding of the concepts and the reasons behind retail leasing's peculiarities to assist you in working through retail lease review and negotiation successfully
  • Retail leasing is about knowing how retail works in a mechanical sense. How the space is used to a microlevel. The more you understand exactly what the tenant's business is and exactly what the tenant does in the space and exactly how the space is configured and will function, the better.

B.Ten Most Common Differences

  1. Percentage Rent

Primary difference from office rent

Base rent set plus percentage of gross sales generated at site

Landlord participates in success (or failure) of the business on site

Verified by register receipts and audits

Often needs full description of what included in gross sales – particularly in restaurants (food, drink, alcohol, vending machines, tee shirts/hats for marketing purposes)

Internet sales have complicated the question of what is "on site"

  1. Retail pays and meters own utilities and char and garbage

Retail tenant pays for its own utilities deposits, utilities charges, (restaurants, health clubs, nail salons use more utilities)and garbage collection

Landlord has no liability for interruption of Tenant’s utilities, except for Landlord’s gross negligence. Interruptions of utility services will be allowed for repairs, alterations, inspections; any interruptions are not an event of default and do not relieve Tenant from performing its obligations under the Lease.

  1. Retail pays CAM differently if it is part of mixed use

Retail in mixed use typically occupies ground floor of office building or may occupy its own buildings in a mixed use complex

Because it pays separately for utilities, char and garbage, counsel for a retail tenant wants to carefully examine how the CAM (including real estate taxes) charges are allocated between retail and office. No paying twice!

You will want to examine increases in CAM provisions carefully to make sure the increases do not include increases in what you pay separately

Make sure exact use of your retail establishment is reflected in your CAM. A clothing store does not want to pay pro rata water bills for a restaurant.

  1. Go dark provisions and/or continuous operation required in retail leases
  2. Tenants are required to open for business by a specific date (grand opening dates for new shopping centers)
  3. Continuous operation provisions allow Landlord ability to maximize rent based on percentage of sales
  4. Affects all other tenants in Landlord’s shopping center and their sales (tenants rely on other tenants to bring in more customers)
  5. Landlord wants Tenant to maximize its business by:

(i)Keeping Premises adequately stocked

(ii)Conducting business in the entire Premises during specified hours

(iii)Staffing store with sufficient employees to serve customers

  • If a Tenant is allowed to “go dark,” the Landlord may be allowed to recapture the premises.
  1. Plate Glass Insurance

A sure sign of an inexperienced tenant's retail leasing lawyer is one who balks at plate glass insurance being tenant's responsibility. You see plate glass as part of the building and therefore landlord's responsibility, no? No!

It is traditionally tenant's cost to insure, and almost never optional from the landlord's point of view

So why? Perhaps because tenant is in a better position to secure the premises against burglary or windstorm. Perhaps because tenant insures what is inside the premises if the plate glass shatters. Perhaps because tenant will be there to clean up promptly – or all of the above.

Plate glass on retail breaks much more often than office windows. It is on ground floor. There are burglaries and accidents, or, in the case of a local restaurant in my hometown, a 10 point buck who "saw" a rival in the plate glass, lowered his rack and charged the image.

  1. Lien on inventory/property on the premises
  • Landlord Perspective

(i)Landlord is secured creditor with respect to Tenant’s payment obligations

(ii)Landlord must file a UCC-1 Financing Statement to perfect lien.

  • Tenant’s Perspective

(i)Not ideal for Tenant because it may conflict with other credit facilities Tenant maintains. Tenant’s lender may have a lien on Tenant’s personal property and Tenant may be prohibited from granting other liens. Tenant’s inventory is sold in the normal course of business.

(ii)If Tenant is a credit Tenant, there should not be a need to grant lien.

(iii)Tenant must obtain UCC-3 Termination Statement from Landlord at expiration of Lease to extinguish Landlord’s lien. Make provision in lease that requires Landlord to execute UCC-3.

(iv)Tenant may request a waiver of landlord’s lien rights or a subordination of landlord’s lien rights to the rights of Tenant’s existing lender.

The parties may negotiate the rate at which interest accrues on Landlord’s expenditures.

  1. Very specific use provisions often with radius restrictions and non-competes

Office leases typically have short, predictable use provisions: "office use and no other use" and you can review them in 30 seconds

Use provisions in retail lease need slow careful attention. First they can be very detailed including what can and cannot be sold due to restrictions in other leases: "burgers, fries and shakes only"

Non competes from other tenants: "no burgers, fries or shakes"

Incidental sales of competing inventory sometimes permitted

Sometimes clothing retailers want other clothing retailers for traffic generation

Tag words: "first class, white table cloth"; "family-oriented"

  1. Tailored assignment and sublease provisions, often with strict landlord review of assignee for experienced operator of specific business and financial covenants

Heavily negotiated in retail leases. Landlord’s desire to control tenant mix versus Tenant’s desire to assign/sublease with as few restrictions as possible.

Landlord Oriented Perspective: Landlord wants a mix of quality tenants and merchandise to attract shoppers. Landlord does not want too many tenants with similar uses.

  • Landlord preferred: Tenant has no right to assign the lease, sublease the premises, change tenant’s ownership or voting control or mortgage the leasehold. The Landlord may allow sublease/assignment to affiliates or subsidiaries.
  • If sublease or assignment is allowed, the proposed subtenant or assignee must:

(i)have the same permitted use (not an issue in an office lease – still used for office space); must not violate an exclusive use in the shopping center;

(ii)have financial net worth to meet obligations under Lease

(iii)be comparable to the tenant being replaced and generate comparable sales (Landlord won’t want a national tenant replaced with a local tenant)

  • Tenant remains party liable under Lease because Landlord has evaluated Tenant’s financial condition.
  • Landlord has right to “recapture” Premise; ability to accept reconveyance enables Landlord to capture net gains due to increases in market rents.
  • Landlord receives 100% net gain from transaction (excess rent to Tenant over rent Tenant is paying to Landlord).
  • Only original Tenant has assignment or subletting rights; assignee or subtenant does not.
  • Landlord will seek reimbursement of its attorneys’ fees and administrative fees for any requested assignment or sublease, regardless of whether the assignment or sublease is approved.
  1. Anchor tenants in centers have powerful negotiating powers

Anchor tenants, whether they be groceries, big box retailers or chain department stores have tremendous negotiating leverage in lease negotiating. We would never expect your first retail ease to be for an anchor tenant but you might find provisions in your tenant's lease reflect anchor tenant's presence in the center

Anchor tenants may use own lease form

Anchor tenants may require a certain mix of smaller tenants

Anchor tenants may control parking design, location, availability for the center

Anchor tenants may control signage, entrance design

Anchor tenants may require smaller stores to relocate due to their expansion or configuration change

Their going dark or terminating a lease can destroy smaller tenant's business

Anchor tenants may control insurance and reconstruction of their space in the event of casualty or condemnation

  1. If franchise, franchisor wants right to cure franchisee/tenant default

Franchisor may not want the lease terminated, so the franchisor will request notice of any tenant default and a reasonable opportunity to cure the default.

Franchisor will require that the Landlord agree that, at Franchisee’s option, the Tenant will assign the Lease to Franchisor if the Franchise Agreement terminates or the Tenant defaults under the Lease.

Dorothea Dickerman

McGuireWoods LLP

1750 Tysons Boulevard, Suite 1800

Tysons Corner, Virginia 22102

703-712-5387

David Andress

Brunini, Grantham, Grower & Hewes, PLLC

The Pinnacle Building

190 East Capitol St, Suite 100, Jackson, MS 39201

Post Office Drawer 119, Jackson, MS 39205

601-960-6892

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