Crafting Exclusive Use Provisions Is No Simple Task Unless You Want To Ignore The “Why” Behind Them

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On their faces, this week’s blog posting (and last week’s as well) are about exclusive use rights. Actually, they are about setting ourselves free of the handy formulations we all lean on when negotiating leases. Handy as the “same old, tried and true” lease clauses may be, sometimes we should step back and spend some serious thinking time about the subject matter in front of us. The topic of exclusive use rights is a perfect one to remind us of that approach. One has to think of the actual goods or services to be protected. One has to understand the “principle” behind every single “stock, standby, old friend” lease clause. As to those that grant a tenant an exclusive use right, Ruminations suggests that what a tenant is “entitled” to have protected is the good will that very tenant creates at a particular location. On the flip side, Ruminations doesn’t think that a tenant is entitled to protection against competition in general.

If a particular retailer has a business that attracts customers to its store by reason of what it sells and how it sells it – what makes it “special” – it is reasonable for that retailer to insist that it doesn’t become a “showroom” for later-arriving tenants at that shopping center. It shouldn’t pay rent to a landlord who allows other tenants to “cherry pick” the first retailer’s customers. By example, a book store shouldn’t have to lose sales to another store that sells only bestsellers. A secondary reason is that some projects aren’t big enough to sustain more than one of that kind of store. Basically, some shopping centers aren’t big enough for more than one specialty seller of the same product.

A corollary is that some retailers are benefited by the presence of competitors. For example, in a large (or even a relatively large) shopping center, having multiple shoe stores (or specialty fashion stores) actually benefits each of those retailers. Basically, the “good will” in those situations is created by the landlord, not by any individual retailer, because it is the shopping center that has created the “marketplace.”

Last week, we signed off right after raising the topic of allowing for “incidental” sales of verboten goods or services. The concept is that if the tenant seeking protection through an exclusive use restriction is “really” in the “business,” a neighbor at the shopping center with a limited selection and small stock of competitive or overlapping items really doesn’t pose a threat. Is a “category-killer” really threatened by a specialty store? In our view, not very often at all. So, if true, what’s the big deal? On the other hand, many items offered for sale aren’t unique to one kind of store. A shopping center may have a retailer of health and beauty products and if that retailer had a matching, broad exclusive, the shopping center couldn’t have a hair salon.

There are two common approaches for allowing other stores to engage in “incidental” sales. One is a size limit and the other is a sales dollar limit. Last week, we poked some criticism at the “500 square feet or 10% of floor area, whichever is less” approach. For a more detailed posting covering some of the issues raised by this very common approach, click HERE.  Conscious of the shortcoming behind allowing incidental sales based on a store’s floor area, some negotiators turn to a sales dollar test, e.g.: “but sales of the restricted goods may not exceed 10% of the total sales in that store.”

So, what’s wrong with that approach? For one, how can the protected tenant tell whether the neighboring store’s sales of the restricted goods exceed 10% of that’s store’s total sales? Does anyone really think that anyone will ever know the sales figures for a given product or group of products when stores don’t track sales on an item by item basis? Why would any major retailer be willing to disclose its sales on a product by product basis?

Ruminations has no universal suggestion to solve this problem. That’s because, “it depends.” It depends on the nature of the goods or services that are being “protected.” As we suggested last week, there are some items that are unique to particular retail categories and, for those, it seems reasonable to bar all competitive sales. We gave the example of prescription drugs. Perhaps it would similarly be acceptable to bar anyone else from selling diamonds or selling jewelry that includes diamonds. That would protect a high-end jewelry store, but would permit hair salons and others to sell jewelry without really, really competing with that high-end jeweler.

Another approach would be to allow certain kinds of retailers, but not others, to sell the otherwise restricted products. Doubling down on our hair salon examples, a retailer of health and beauty aids might have an exclusive for those products, but would accept a carve-out in its lease allowing hair salons to sell hair and nail products. If one were paranoid and feared that a direct competitor might think that it could open a large store and put in one hair cutting station, its lease could require that the hair salon have at least (say) four stations.

Another approach could be placing a limit on the number of stock keeping units (SKUs) of the restricted products that a neighboring store could sell.

Basically, Ruminations thinks that we all have to think beyond the “floor area” or “percentage of dollar sales” approaches and start thinking about the actual goods or services being protected. Basically, a balance needs to be made between not hurting the tenant (with unfair competition) and not hurting the landlord (by tying its hands in the leasing of stores).

Another type of carve-out is one that excludes all stores larger than a given floor area from the exclusive use restriction. Also seen is one that allows for the existence of certain kinds of retailers, such as supermarkets or department stores or club stores. Both approaches are addressed to the same point: if the protected tenant, one that specializes in a narrow area, can’t compete with a large, generalized retailer, it doesn’t deserve protection. If you specialize in the sale of olive oils, you shouldn’t fear the supermarket as a competitor. If you specialize in floral arrangements, you’ll only survive if you can generally compete against supermarket sales of cut flowers. Basically, as Ruminations sees it, a tenant shouldn’t insist that its landlord protect it against all competition, just parasitic competition – against stores that live by riding on the backs of their hosts, those hosts being the retailer with the exclusive use rights.

No one said it would be easy. Crafting exclusive use rights is not a matter of perfecting one’s “cut and paste” skills. It certainly isn’t a matter of fiercely defending the form’s “standard” language. Here’s a “do it at home” exercise for readers. Take off your uniforms. Don’t be a landlord or a tenant. Be an academic – a philosopher. No one is watching and your conclusions will be your “secret.” Assume that a coffee house deserves to be the sole “coffee house” at a shopping center. Yes, assume that the shopping center is of that “size.” Now, should that mean that no one else can sell coffee? From a tenant’s standpoint, is that “fair” (whatever that means)? From a landlord’s point of view, is that even close to “workable”? If you conclude, as most readers will, that barring the sale of coffee just ain’t goin’ to happen, how do you figure out what would work – what kind of exclusive would work? If you’ve read today’s posting all the way down to this point, you might start with the understanding that what needs to be protected is the “coffee house” business, not the easier to deal with: the “sale of coffee” business.

If you’ve worked through that exercise to your satisfaction, try other food scenarios such as protecting a pizzeria, but allowing general restaurants, Italian restaurants, and bars. Or, handling quick service restaurants, such as considering whether what needs to be protected in a given instance is the QSR’s menu or its existence as the only “go-to” place for a quick meal.

Let’s have a discussion. Doing leases is not a mechanical task. One size does not fit all. Getting the deal done requires individualized decisions that work for both landlords and tenants.

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Comments

  1. Great topic, Ira. This discussion could go on forever.

    Few tenants or landlords – or lease negotiators like me – REALLY know how to properly parse the details of this issue. The old “percentage of sales” or “percentage of floor area devoted…” is still what most people reach for when attempting to establish an exclusive use provision. And few (landlords OR tenants) think in terms of protection just from parasites. Instead, their focus is on ANY competitor, which is where it gets sticky, as you so aptly describe.

    One difficulty that arises (from a specialized tenant’s perspective) concerns the provision of certain services for which there is a (relatively) finite market. As my work revolves principally around negotiating for dentists, this issue is prevalent in EVERY deal. Most (but not all) people land on a specific dentists and don’t “shop around”.

    Dental demography is a very sophisticated science these days. And there are some very commonly accepted “rules of thumb” which many dentists rely upon when attempting to determine the viability of a market and location. One such “rule” is stated as a ratio that relates the number of practitioners (in that given dental specialty) to the number of potential patients – for that specialty – in that “market” (however that “market” is defined.) And, as dentists commonly make a very large investment in leasehold improvements (averaging $150/sf, not counting fixtures and equipment), they are very concerned about competition in their face in the same property. I try to explain to them that, even if they can get exclusive protection from their landlord, they have no control over a competitor who might go in right next door or across the street. But they are totally focused on what happens in THEIR property. Maybe their concern is justified. Where two shoes stores in the same property may both benefit by the synergy generated by their “dueling banjo” existences, it doesn’t work that way for dentists.

    Many start up consultants in the dental industry beat the exclusivity drum loudly. And that’s what many of these start up dentists hear and respond to. Irrespective of whether or not there may be merit in the tenant’s argument (in negotiation) in favor of exclusivity, my experience is that SMART landlords DO NOT grant exclusive use protection but in only the most unusual of circumstances, as doing so merely reduces their leasing flexibility and options.

    The other side of the coin is that smart landlords write very restrictive use clauses for the simple reason that they want (i) to be able to present the most open merchandising playing field possible to prospective tenants; and (ii) to establish maximum leverage over the tenant who may seek someday to broaden its rights. So when a tenant pushes for exclusivity, they may well box themselves into a more restrictive use clause than they otherwise get had they not sought exclusive use protection.

  2. It seems to me the most important aspect mentioned thus far is that each deal is unique and so is the request for an exclusive; dictating an honest, open conversation and not just a cut and paste of standard lease language.

    Each time a leasing consultant brings in a LOI with an exclusive it becomes the responsibility of the asset manager/decision maker to start probing to better understand the tenant’s business. There are several poignant questions to ask; “What products and/or services actually make this tenant unique?; “What product or service, if offered by someone else in the center, would jeopardize their success?” Getting answers from these two questions lays the groundwork for a positive discussion and resolution. Tenant’s recognize the landlord is sensitive to the uniqueness of their business yet the decision maker is limiting the impact an exclusive might have on their ability to bring other new, innovative concepts to the shopping center.

    In addition, another concept to consider when crafting exclusives is considering the difference between a landlord covenant and an outright exclusive. The landlord covenant protects the tenant from actions taken by the landlord while limiting the landlord’s liability as judge and jury between tenant disagreements. In other words, the landlord agrees it will not lease, approve assignments or use changes for other tenants who violate the defined exclusive. However, should a rogue tenant create problem, the landlord is not placed in the heat of the debate. Of course, this dictates identifying remedies within the lease should a rogue tenant create a problem – a discussion for another day.

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