Writing Exclusive Use Rights Provisions Is Tricky. How So?

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Ruminations is on record as taking no stance on whether a tenant is “entitled” to the benefit of an exclusive use restriction in a lease. Similarly, we don’t believe that landlords have an absolute “right” to narrowly restrict what a tenant may do in its leased space. Each should be an outcome resulting from the bargaining process. Yes, there may be a market expectation depending on the type of business involved or the size of the overall project or the nature of the tenant or landlord, but the bottom line is that each outcome results from the bargaining process.

Today (and next week), we’ll muse about what a tenant should reasonably expect if it is agreed that it will benefit from an exclusive use right. Also, we’ll point out a few common ways that leases inadequately describe such an exclusive use right. Yes, this will be another “words matter” posting.

The law disfavors restrictions on the use of real property. One corollary of that principle is that courts will generally (but not always) interpret (or construe) restrictive covenants (such as restrictions against engaging in certain activities at real property) in the narrowest of ways. Basically, if a restriction doesn’t clearly bar a tenant from selling or displaying something (lawful) in its leased space, the tenant can go ahead and do so.

When a tenant wants the exclusive right to sell something at a shopping center it doesn’t want anyone else to sell the same thing. As obvious as that statement is, we still see leases that promise no more than that the landlord will only place such a prohibition in future leases. That’s not what anyone could reasonably think the deal to be. The tenant seeking protection isn’t interested in how other leases are written.

What a tenant wants or should want is an agreement from its landlord that no one will sell the prohibited items or furnish the prohibited services. So, even an agreement by a landlord that no other tenant will sell those goods or services doesn’t cut the mustard. It would allow subtenants to do so. It would allow concessionaires to do so. It would even allow the landlord itself to do so (and there are court decisions that say so). So, a lease should say that the landlord won’t permit the sale (or display) of the prohibited goods or services by tenants or occupants of the shopping center.

Even that isn’t enough to protect what tenants want. Landlord should not lease any space for such purposes and more importantly shouldn’t suffer the sale of the prohibited goods or services.

We’ve alluded to prohibitions against displaying the prohibited goods (that would cut off internet sales from terminals where the actual sale is made from a remote location), but we haven’t mentioned a prohibition against rentals of goods (if that’s of concern to a tenant, such as a furniture tenant). Now, we have.

At this point, landlords and those who generally speak for landlords might be asking: “Why,” meaning why should it be my problem if some other tenant sells the prohibited item. Why should I have to be active and not “suffer” the sale of that item? Ruminations thinks it is because that was the inducement to the new (protected) tenant to sign a lease. It is because only the landlord has the ability to enforce the exclusive use right. [That isn’t always strictly a correct statement of law, but as a practical matter, the landlord has many more tools to stop another tenant or occupant from trampling on the protected tenant’s exclusive use right.]

Another very, very common issue arises when identifying the prohibited items or class of items. It would be a fool’s errand to list all of the possible ways to go wrong. For the purpose of rare (for Ruminations) brevity, we’ll direct today’s readers to the troubles that the common word “groceries” brought to light and also the variety of views when it came to “sandwiches.” For “groceries,” click HERE; for “sandwiches,” click HERE. Use of descriptions such as “Chinese” or “Italian” foods or restaurants raises obvious issues. What really is a family restaurant or a junior or discount department store? There is a California court decision expounding on the breadth of a “martial arts” prohibition. [Kickboxing is a martial art.]

Unless the tenant is a pioneer, meaning the first tenant at a project, there will already be tenants at the shopping center and those tenants may already have the right (or the freedom) to sell the prohibited item or service. That’s an economic reality and tenants need to “carve out” that situation and not hold the landlord liable if the earlier tenant rightfully sells the item or service. But, that’s generally not the basis for a carte blanche exception for all existing tenants or successors to those tenants holding under the same lease. The carve out should only be to the extent that the earlier tenant’s lease, as it read on the day the exclusive use right becomes effective, permits sale of the prohibited item or service. The landlord should be barred from giving consent to any expansion of the earlier tenant’s rights to sell the prohibited item or service. In some cases, a landlord might be justified in preserving the existing use of a leased space even if the earlier tenant moves out. For example, if the new convenience store tenant comes in when there is an existing bakery at the shopping center, a landlord may be justified in insisting that it can replace the bakery if it goes out of business. That’s an issue for bargaining.

An earlier lease may have given its tenant the right to extend the lease’s term. New tenants have to concede that point. A fair question is whether a landlord should be permitted to extend the earlier tenant’s lease term beyond that point. Ruminations thinks that, in the normal situation, a landlord should be permitted to do so. In special cases, such as where the new tenant was induced to come to the property because an existing, competing seller of the prohibited item, only had a year left on its lease, our opinion would be different.

Should a landlord allow an earlier tenant to expand its leased space? We think: generally yes, but only if the exclusive use right in the later tenant’s lease is added to the earlier lease when the expansion takes place. For more about how to deal with existing tenants, click: HERE.

That’s a good segue into general “carve-outs.” Some specialized businesses lend themselves to absolute prohibitions, such as a pharmacy seeking an exclusive use right that would bar anyone else from selling or dispensing prescription drugs. But others, such as bookstores, need to be realistic. It is one thing to be the only bookstore at a shopping center, but another to be the only retailer that sells a book. Fundamentally, a bookstore isn’t challenged by a hair salon selling a few poetry books or hair styling books or a men’s store selling some fashion books.

Whether you “buy” that explanation or not, everyone in this business knows that most leases granting the tenant an exclusive use right will allow for “incidental” competition. The problem is that many leases are not well written or conceived. A common approach is to limit the floor area within which the prohibited item can be displayed. Drawing a line around that “sales area” is a whole different challenge. What does one do with aisle space? Does one care about high the goods are stacked? Often, those who write these provisions “picture” that the merchandise in question will be picked from the shelves by the customer. What if the competing store only showed samples and fulfilled the orders from its stockroom. You could sell a lot more items in 500 square feet of sales area that way. We’re not going to offer any one size fits all suggestions. All Ruminations can do today is to urge those who negotiate these provisions to think about the products themselves. What would be reasonable?

That’s all Ruminations wants to say for today. There’s a lot more to say, but this will be a two-parter. Same time, same place – next week. If any reader wants to influence (meaning have us revisit what we’ve already prepared for part 2), just let us know. That’s one of the things for which we have the comment feature.

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Comments

  1. It seems to me that I recall many years ago (40?) that the SIZE of the retail property was taken into consideration when the developer/owner was ruminating on a prospective tenant’s request for exclusivity and that the developer/owner was concerned that the FTC might construe an exclusive use provision in a LARGE property as anti-competitive (where there ostensibly might be a large enough customer base to support more than one merchandiser offering similar goods or services – as compared to a smaller property catering to a smaller market which might not support multiple purveyors of similar goods or services.)

    Part of the problem with the way in which many exclusives are written is that the aggrieved party has few stated, meaningful remedies for a breach of the exclusive. In order for an exclusive to be worth anything, there must be some consequences with which the landlord are burdened in order to encourage his/her compliance with the terms of the lease.

    As with any lease provision, the devil is in the details (that are often NOT stated).

  2. Randall Gunn says:

    In many instances, the stability of the retailer who holds the exclusive can impact the interpretation. I am aware of one grocer who faced challenges to their market share. They started filing actions against landlords for allowing the video store to sell popcorn and candy at check out counters. They went after the party and gift card store. One retailer has been able to exclude from the out parcels almost every use except banking. In Florida we are burdened with Winn Dixie v 99 Cent Store that had the good judge divine the meaning of grocery from Webster’s Dictionary. This allowed exclusivity for paper towels, napkins, matches and anything sold by the grocer.

  3. Diana Hodge says:

    Speaking on behalf of landlords, the most important thing to remember when drafting an exclusive use clause is to be clear, specific and limited. Think about how it will be to administer the lease years down the road when you may be scrambling to fill vacancies. Only give an exclusive for the specific products/services that would directly compete with the tenant. Define incidental sales based on % of gross sales instead of sales area. Make sure the tenant loses their exclusive if they are no longer selling the products, if they go dark, or if they are in default beyond cure periods. With anchor tenants that will insist on express remedies, be sure to address Rogue Tenant violations separately from landlord violations. A landlord should not be penalized immediately if a tenant is violating the exclusive without its knowledge. Lastly, landlords should not be quick to accept an alternate rent remedy that is a low percentage of the tenants’ sales. Determine what that figure might be and see if that amount is a reasonable reduction given the violation. Try to get at least 50% of minimum rent as a an alternate rent and don’t allow a reduciton of NNN charges. If you can, try to get in a “fish or cut bait” provision that requires Tenant to go back full rent or terminate the Lease after 12 months of paying reduced rent. Just a few thoughts from the landlord’s side.

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