Don’t expect cut and paste clauses today because we’re only going to do some conceptualizing. Once it is settled that a tenant will get the benefit of an exclusive use right, its landlord needs to make sure that its own ability to make a living isn’t imperiled. We’re not going to discuss whether landlords should grant exclusive use rights because sometimes that just what needs to be done to get the rent for an otherwise empty space.
To all get on the same page, let’s try to agree that the legitimate objective of an exclusive use right is to protect a tenant’s core business (i.e., the reason its customers come to the store in the first place) against cannibalization from competing tenants at the same property whose customers come to the property, in part, because the very same “protected” tenant is at the property. Tenants with sufficient bargaining power can stretch that protection to nearby properties owned by the landlord or by affiliates of the landlord, although the rationale is a little weaker. Perhaps the strongest economic argument (or more likely, emotional argument) is that the protected tenant doesn’t want its landlord to use that tenant’s rent money to invest in nearby properties occupied by the “protected” tenant’s competitors. Ruminations may return to that subject in the future, but that’s the last you’ll read of “off-site” restrictions today.
Basically, a landlord has to be careful not to “overpromise.” It can’t let itself get in the position where the exclusive use right is violated by existing tenants who, under their own leases, are rightfully selling or displaying the “forbidden” goods or services. That’s not a full expression of the “problem,” so we’ll expand on that later. Also, landlords have to be careful not to get in a position where they can’t lease to a whole range of new tenants who, while not trampling over the “protected” tenant’s legitimate commercial interests, happen to sell a few items that fall within the “protected” tenant’s exclusive use rights. A non-controversial example might be based on an exclusive granted to a book store promising that no other occupant at the property will sell books. [We’re not going into the question of what, in the 21st century, a book might be.] Would a hair salon’s display and sale of a dozen books on hair styles really harm the bookstore?
Here’s what Ruminations is thinking. Landlords (and their to be “protected” tenants) should concentrate on these categories as the basis for exceptions or “carve-outs” to exclusive use rights:
Certain Types of Occupants
Certain Levels of Activity
As to “Existing Occupants,” whether under a lease or not, should (or can) the exclusive use right apply to them. This isn’t only a question of whether an existing tenant’s lease would otherwise permit sale or display of the “forbidden” goods or services. It includes whether the fact of a new lease to the “protected” tenant should change the landlord’s relationship with existing tenants. Also, should such occupants be permitted to have the “unfettered” ability to choose to sell (or not sell) the “forbidden” goods or services, even if they sign a new lease, expand their existing spaces or move to other spaces within the property? Think about the occupant (tenant) untethered from its existing lease (or about a month-to-month arrangement).
As to Existing Leases, if such a lease would permit the tenant thereunder to sell or display the “forbidden” goods or services, its landlord can’t allow itself to be in violation of the new “protected” tenant’s lease right out of the box. That is pretty obvious, although we’ve seen a fair share of leases that have overlooked that situation. In such cases, landlords have to look for court protection. Though the probability of getting a favorable court decision is reasonably high, the costs to get that ruling are also reasonably high. What is more, is that no one thinks about the countless settlements of such disputes that invariably cost the landlord money. Most likely, the reason this situation arises is because landlords looked at what their current tenants were actually selling or displaying (and usually not all that carefully), but didn’t look at what the existing leases will allow. Don’t fool yourselves; the problem doesn’t only arise out of “any lawful retail purpose” use clauses.
Even if a landlord carefully confirms that no existing tenant’s lease contains a permitted use clause that would allow the competing activity, would it also look at whether another lease provision, perhaps the assignment or subletting provision, allows a tenant to change its use with the landlord’s consent, often (by default or express language) with such consent not to be unreasonably withheld? Would it be unreasonable for a landlord to withhold its consent because it had later given away an exclusive use right to another, newer tenant? How would a court balance the equities between a landlord and its “old” tenant? Did the landlord breach its existing tenant’s reasonable expectations when it granted the exclusive use right now in controversy, when most other landlords would have preserved a prior tenant’s expectations under such circumstances? We won’t predict the outcome because of the uncertainty of result related to the particular facts in play and the jurisdiction involved, but we have no uncertainty about the cost of the litigation.
When we write about “existing leases,” we’re not talking about “existing tenants.” That’s because protecting an existing lease means protecting the rights of the named tenant and all of those who hold under that tenant, typically assignees and subtenants, but also concessionaires, licensees, and others so situated. To make that clear, the “carve-outs” might spell that out, if only to avoid later, unpleasant threats from the “protected” tenant.
With an existing lease, we also need to think about possible future amendments (including new leases disguised as “restated” leases). An amended lease is the same lease as before, only changed. “Protected” tenants need to be sure that the amendments don’t serve to defeat their legitimate expectations as to the “protection” they bargained for in the first place. For example, suppose the new “protected” tenant accepted the fact that an existing tenant had a significant business selling the “protected” product, but was willing to move into the property anyway knowing that the existing tenant would be leaving at the end of its lease, two years later. How happy would the “protected” tenant be if it discovered that an even stronger competitor would be moving into the existing tenant’s premises, not under a “new” lease, but under an amended and restated version of the existing tenant’s lease (the one with the “any lawful retail purpose” clause), the only remnant of the existing lease being a passing reference to its existence? Does every “replacement lease” need to indulge in the fiction of being an amended and restated lease? Essentially, the “protected” tenant would see an amended and restated lease saying: “the old lease is hereby amended by deleting all of its text and replacing that text with the following… .”
Further, what about expansions of space under the existing lease? How should the parties with the possible expansion of an existing tenant’s premises from 6,000 square feet to 21,000 square feet?
Clearly, if an existing lease gives its tenant the right to extend (or renew) the lease term, there isn’t anything a landlord can do to avoid such an extension or renewal. Or, is there? Landlords might want to specifically carve out such extensions (or renewals) from the “protected” tenant’s exclusive use right specifically to avoid the following kind of controversy. Imagine, and it shouldn’t be difficult to do so, that the existing tenant’s right to extend or renew its lease is conditioned on that tenant not being in default under its lease. Can the new “protected” tenant argue that the landlord should have rejected an attempted lease extension? You be the judge.
What about when the existing lease is at the end of its term with no additional renewals available as of right. Can the landlord agree to extend the lease term? You might counter that Ruminations has already raised this question when it wrote about lease amendments. Fair enough (maybe). But, what is the status of a holdover tenant? Does that existing tenant go from being covered under the “carve-out” to where it now violating the exclusive use right?
Dealing with carving out “Specific Premises” from the scope of a later-granted exclusive use clause implicates some of the same issues raised above when the existing lease is still in effect, but what about after the tenant under that existing lease moves out? Here’s an example. Suppose a nail salon signs a new lease with an exclusive use clause that recognizes the existence of an existing hair salon with two manicure work stations. If that existing hair salon closes and the landlord finds a replacement hair salon tenant, should that new tenant be allowed to have any manicure work stations? There is no easy answer because we don’t know how the negotiations over the exclusive use right handled that question. Did the nail salon move to the property despite the two manicure work stations because it didn’t consider them to be main stream competition, or did it expect to tolerate the competition until the existing hair salon eventually closed. In the real world, you’d see the original hair salon sold and the buyer negotiating a replacement lease with an extended term, additional renewal options, and other changes. Should this be treated any differently than amending the “old” tenant’s lease and then consenting to a lease assignment? Critical from the landlord’s point of view would be “how important is a hair salon” to the tenant mix at the property? Ruminations offers no answers, only questions. If, however, the answer is that any specific premises already housing a competitor may always house a competitor or may do so if there is no intervening non-competing tenant in that same space, then the “protected” tenant’s lease should say so. At least, that way, the landlord and its “protected” tenant won’t have to fight the amended and restated lease battle.
What about “Certain Types of Occupants”? An exclusive use right barring the sale of milk shouldn’t keep a landlord from subsequently leasing to a drug store or a restaurant or a supermarket. Readers can add to this list of examples. Yes, the carve-outs to a new tenant’s exclusive use rights should contemplate that certain kinds of tenants will be unaffected by the grant of those exclusive use rights. Basically, certain classes of tenants are both: (a) too important to a landlord to lose as potential occupants; and (b) really aren’t direct competitors of the “protected” tenant (in almost all cases). Basically, a “protected” tenant is getting the exclusive use right because it is “known” for that kind of goods or services and customers come to it for the breadth of its selection and expertise. If a general merchandise store is truly a “competitor,” then the “protected” store has no legitimate interest to be protected because lots and lots of merchants “all over town” are its competitors. What difference does it really make that the supermarket sells paperback books? Argue about the “over-broadness” of what we’ve just written, but then do yourself a favor and step back from your current set of clothes (and paycheck) and look at the forest. At a minimum, we think you’ll need to grant that Ruminations hasn’t gone over the deep end.
We’ve left the most commonly written carve-out for last – “Certain Levels of Activity.” This is commonly expressed as allowing an exception for “incidental sales,” however that might be defined. This concept would cover the hair salon that displays and sells a dozen hair styling books in the face of a bookstore’s exclusive use rights. It would allow for the infant apparel store to do the same. The concept is simple – if another store offers a narrow and limited range of competing products and such activity would really harm the “protected” tenant, the “protected” tenant isn’t unique enough in the customer’s eye to deserve protection. Potential customers have to want to shop at the “protected” tenant’s store, not be going there because it is owned by Hobson*.
Incidental sales can be defined by floor area limitations, by gross sales limitations (absolute dollar levels or, more commonly, as a percentage of total sales). Each approach has its benefits and limitations. One can limit the floor area of the displays themselves or (typically) you can count half of adjacent aisle space in a floor area limitation. In those cases where an exclusive use right covers more than a single group of related products, say raincoats and shoes, the “carve-out” might set separate limits for each category or might deal with them in the aggregate. Those are the theories. The devil being in the details, and with Ruminations declining, in this instance, to offer sample lease provisions, that’s all we’re going to say.
If we’ve left out any “conceptual” approaches, let us and our other readers know. If you’ve come across any really clever approaches, please do the same. Comments are best left by clicking the “leave a comment” link just above this blog entry.
* We’re told that Hobson owned a horse stable and, to buy from him, you had to accept “Hobson’s Choice.”
[We cite to Wikipedia]:
According to the Oxford English Dictionary, the first known written usage of this phrase is in The rustick’s alarm to the Rabbies, written by Samuel Fisher in 1660: “If in this Case there be no other (as the Proverb is) then Hobson’s choice…which is, chuse whether you will have this or none.”
It also appears in Joseph Addison’s paper The Spectator (14 October 1712); and in Thomas Ward’s 1688 poem “England’s Reformation”, not published until after Ward’s death. Ward wrote: “Where to elect there is but one, / ‘Tis Hobson’s choice—take that, or none.”