Continuous Operation: 24-7 Or Bust

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Two words that strike the heart of man: Continuous Operation. Well, not all men’s hearts are at risk. Big strong ones can get away with stating, at the outset: “No, we won’t go there.” Weaker, but not weak ones, can offer a compromise, such as the one day trick pony. Sadly for the rest, the weakest, most vulnerable ones, they acquiesce.

To be fair, landlords don’t insist that a tenant be open and operating its business “during normal business hours,” for no good reason. There are a lot of good ones, and not just ones that directly benefit a landlord, such as optimizing percentage rent recovery from the burdened tenant. Business begets more business. Shopping centers that are “buzzing” with activity, ones that look like the place to be and be seen, draw customers; customers draw tenants and robust demand for leased space means higher rents (plus higher percentage rent recovery).

Even tenants know that business begets business. That’s why those who can do so, insist on co-tenancy clauses in their leases. They know that, as good a retail operation they may run, dead properties get corpses as customers. Ironically, it is those very same tenants, the ones who “get” co-tenancy clauses that refuse to agree to keep their own stores open.

Setting aside the general desire to avoid being told how to run their businesses, why do tenants of all sizes legitimately despise being bound to a continuous operation covenant? They know that empty stores are “bad” for business, but what is good for the community isn’t necessarily good for the individual. Most people like the idea of their government having a military, but chafe at paying taxes. We call that the desire for benefit without burden. Basically, every other tenant at the shopping center should be obligated to remain open and operating, but not themselves.

So, what’s the burden of operating a store during times your shopping center neighbors are doing the same? Well, simply put, staying open for business doesn’t always equate with making money. Not many retailers want to operate at a location where they lose money just so that their retail neighbors can make money. But, what does it mean to “lose money”? Which would cost more, incrementally – paying rent and covering other occupancy costs for a non-operating location or operating there at a “loss”? To understand why we’ve placed the word, loss, in quotes, one needs to think about an income and expense statement. [No, wise guys, it isn’t because Ruminations puts every “third” word in “quotation” marks, as “true” as that “might” be.] For example, is the store burdened with a corporate overhead charge or for part of a roving manager’s personnel costs?

Let’s say that a tenant’s statement shows $100 in income and $105 in expenses, for a net loss of $5. Suppose, too, that the statement shows an expense for “corporate or general overhead” equal to 10% of sales, which, with $100 of income, means $10. Without that charge, the store would have shown a profit of $5. Is the store losing money? Well, “yes and no.” Yes, because that’s what the bottom line shows. No, because it is actually supporting (with $5) the parent company whose “headquarter’s” operating costs are not going to go down by closing this money-losing store. To give this way of looking at such a situation a name, let’s call the $5 profit/non-profit: a contribution toward overhead. The parent company, i.e., the overall enterprise, is better off having this money-losing store than closing it. We didn’t really make up the concept of “contribution toward overhead.” Readers can do an internet search to get a better understanding of its implications.

Now, if rent and fixed occupancy costs (pass-throughs, insurance, etc.) amount to $20 a year, what would be better – close the store that is losing $5 a year and continue to cover the rent and fixed occupancy charges of $20 for a $15 a year greater loss, or suck up the $5 annual loss (assuming it isn’t really a profit making, overhead contributing location in the first place)?

Now, assuming with great accuracy, that the preceding several paragraphs will make no tenant any more comfortable accepting a continuous operation provision in its lease, we’ll proceed to Ruminate about the poor folks who have no choice. Are there any protections that can be requested as part of a continuous operation lease provision with a reasonable chance of hearing a “yes”?

We think so.

Even if one wanted to remain open and operating, outside forces sometimes intervene. Rather than arguing “impossibility of performance,” the obligation to operate continuously should expressly give way to forced closings by reason of fire or similar events. Labor issues, whether that means “strikes” or, as could be more common for a small business, and employee’s illness or accident, should also excuse the tenant from being open (at least for some grace period reasonably designed to allow replacement “coverage”). How about letting a small store proprietor close for vacation or holiday? How about religious holidays? Every tenant should be able to close its store to remodel or redecorate or even close a day or two to set up for a “big” sale. One approach is to allow the tenant to be closed for “x” number of days a year, but not for more than “y” number of days in a row – for example, for 10 days, but not for more than 5 days in any 30 consecutive day period. As to remodeling, allowance can be made for such a purpose, but not more often than once every “z” number of years and for not longer than a set number of days.

Where a tenant has the obligation to pay percentage rent, economic fairness might either “excuse” a certain number of days a year or might deem that the sales revenue on the days the store is closed be the same as the tenant’s average daily sales revenue for that year. Let’s not get hung up over this. There is no perfect analog for lost days. Just like horseshoes, hand grenades, and dancing, close is good enough.

Tenants without bargaining power may not be able to get a co-tenancy provision in their leases, but should try to get relief from a continuous operation obligation if the rest of the shopping center falls below a certain level of occupancy or if a key anchor store stops operating. This doesn’t have to be “all or nothing,” “obligation or no obligation.” For example, a pizzeria might negotiate to be able to close on one or two specific days of the week while this “kind of” co-tenancy failure exists. A restaurant might be able to close for dinner or open only for dinner if the shopping center becomes “dead.” After all, the premise and attraction of the shopping center is the draw that a cluster of stores creates. Basically, it is the landlord’s obligation (or at least, its promise) that by taking space at the center, you’ll have more business than if you were at the end of a dirt road all by your lonesome. Economically, that is supposed to justify paying a higher occupancy cost.

Let’s not forget that “continuous” needs to be defined. Leases should state the time of day by which a store must open and the earliest closing time for the store. It should deal with holidays. It isn’t fair (assuming that “fair” has any role in lease negotiations) to tie operating hours to those used by a given anchor store. That anchor store might, in any given season, operate 24 hours a day. Not a lot of pizza is sold at four in the morning.

Yes, Ruminations knows that all landlords are reasonable and if a store owner gets sick or if the shopping center becomes a ghost town, they would never try to enforce a lease’s continuous operation provision. That is, until the landlord has another real or imagined grievance about its tenant. Then, it will search it memory and its records to make a list of every day the tenant’s store was closed over the past 20 years and declare a default on that basis. To us, that pretextual approach is wrong, wrong, wrong, but common. If there are legitimate, current grounds to evict a tenant, then use them. Piling on old “defaults,” ones that were actually waived (if not under law, then surely by common understanding), is wasteful and expensive and when the parties finally settle the real issues, the distaste remains.

Next week, if the Creeks don’t rise, we’ll return to this continuous operation topic and Ruminate about “open for one day” and what does one do when a continuous operation obligation isn’t met.

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