Last week, we put forth the view that tenants with limited bargaining power will have little choice but to accept a continuous operation obligation (assuming they really want to be at the property). We offered some suggestions that could protect a tenant, otherwise acting in good faith, from uninvited consequences that could result from an unintentional violation of such an obligation. Is there anything left to write on the subject? [That was a rhetorical question.]
Warning: Today’s blog posting will wander a bit. Hopefully, by its end, it will “all add up.”
Tenants with significant bargaining power almost never sign a lease with a continuous operation obligation. Are there exceptions? Sure. The most common is where, in effect, a shopping center developer “gives” land at the project to an anchor tenant to build its own store. The understanding is that this “gift” is being made with the belief that a shopping center with one or more solid anchors will attract smaller tenants, and those smaller tenants are the “real” tenants whose rent goes to the developer. The anchor stores understand that bargain and agree to operate, BUT (usually) only for a given number of years, say 20 or 25. This won’t be a persuasive explanation, but we think readers will get the idea: the anchor tenant will have spent its own money to build a 150,000 to 250,000 square foot store at a cost of $15 million or more. How likely is it that such a tenant will close that store and write down the cost of its construction?
Other tenants with significant bargaining power will frequently agree to a somewhat conventional compromise: the “we’ll open for one day” solution. For the handful of readers unfamiliar with that concept, we’ll elaborate by presenting a common lease formulation:
Within 180 days after the Rent Commencement Date, Tenant must open for business in at least 90% of the Floor Area of the Leased Premises for the Permitted Use fully stocked and staffed for a period of at least 10 consecutive hours on one day. Thereafter, nothing in this Lease or otherwise will require Tenant to keep the Leased Premises open for business.
Before we dissect this language and concept, let’s address the question: “Why would this be an acceptable substitute for what a landlord really wants and why would a tenant agree to such an obligation?”
Not every one of a party’s expectations can be reduced to contract language. That’s the case here. The “open for one day” concept is founded on the principles of good faith and common business sense. On the tenant’s side, it has researched the location and is signing a lease because it believes that the chosen location is “the place to be.” It isn’t making that decision 10 years ahead of time. It plans to open at a time still in sight of the day it signs the lease. So, it has no intention not to open its store and knows of nothing that will make it change its mind. It has already budgeted for the store. So, the risk of a sudden business change is remote (though not impossible). Basically, there isn’t much risk at all.
Landlords, on the other hand, know everything we’ve stated above and also know that once a tenant has built-out its store, hired staff, and put merchandise in place, it will use more than reasonable business efforts to protect that investment. Moreover, landlords know, though possible, it is extremely unlikely that a tenant will invest its time and money with the intention of opening for ONLY one day. Experience supports that confidence.
So, what happens if the tenant doesn’t open and operate for the promised one day? Well, it would be a default under the lease and the landlord could seek damages or terminate the lease or both. Let’s think about how unsatisfying those remedies would be. For one, if the landlord really, really wants an operating store in the space, terminating the lease only means it needs to find another tenant for the space. That puts the landlord right back where it was before it signed the defaulted lease. But, can’t the landlord get more than just the lost rent it would get had there been a different default that resulted in a terminated lease? Well, not really. How would a court measure the damages that flowed from the tenant’s failure to open for one day? Basically, the damages are unforeseeable and unpredictable, speculative. Yes, we can imagine facts arising out of failed co-tenancy obligations in other leases, but that’s not a common fact pattern.
What about getting a court to order the defaulting tenant to open for that promised day? Fuggedaboudit. You can rarely, rarely get a court to enforce a full continuous operation requirement because courts just don’t want to “monitor” or “supervise” these situations. This isn’t a public policy or social issue such as desegregation. How much less likely would a court want to involve itself in deciding what constitutes “fully stocked or staffed”? On top of that, courts aren’t likely to require someone to burn cash in the gutter, meaning that courts realize that the landlord gets little benefit from having a tenant, one who already “declared” that it won’t operate at the property, opening for JUST one day and then closing. They won’t order an “economic waste,” i.e., they won’t require a tenant to spend money for no benefit to anyone. That would be punitive, and although the landlord might like to punish the defaulting tenant, courts have no such interest.
Does all of that mean that a landlord can’t negotiate to protect itself if its tenant doesn’t open for business as promised? Certainly not. Common approaches include the imposition of enhanced rent to pay for the privilege of operating a “dark” store, and provisions that would allow the landlord to “retake” the space so that it can try to fill it with a tenant that will operate the store.
What does it mean to be fully staffed or to be fully stocked? We don’t know. Neither do you. And, if the lease doesn’t spell out what the tenant needs to do in order to adapt the space to its needs, why wouldn’t neat rows of open cartons constitute outfitting the store? Oh, you say, what about requiring: “fully fixtured”? What does that mean?
Yes, a lease can incorporate standards for staffing, stocking, and fixturing, but if the tenant is already reluctant to agree to be bound to operate, how much effort is it worth to fight over whether there needs to be six salespeople or 15 salespeople? Can they be hired from a temporary agency the night before opening? You get the idea.
Why, then, do leases even have a one day opening requirement? Ruminations speculates that’s because, after all the sophisticated theories are bandied about, it makes landlords feel they “got something” and tenants believe they “gave nothing.”
Whether a lease has a full or partial operating covenant, tenants shouldn’t agree to be required to go it alone at a property. Last week, we commented on suspending or modifying a continuous operation obligation when a shopping center is barely open for business. That’s not very relevant when it comes to a one day obligation because the tenant isn’t intending to be at a “dead” property and very often tenants with such a lease obligation are the ones that bring life to the shopping center. Nonetheless, if it isn’t the “deal” that the “one day open and operating” tenant is to be the sole pilot light for the entire (shopping center) stove, then that tenant will want to condition “when” it opens for business on concurrent (or nearly so) store openings by other key tenants. This is a complicated concept, and we’ll leave it right there (for now).
Here’s one last thought or caution. The “one day” operating covenant is not an orphan, unrelated to any other business agreement within the lease. Every deal is a different one, but here is a common example. Imagine a landlord’s ire when it pays a large tenant allowance triggered by the tenant opening for business and then, shortly thereafter (think, the next day), the tenant closes. That’s not generally consistent with the landlord’s expectation that a tenant which is obligated to open for at least one day will have an economic incentive to remain open thereafter. So, as Ruminations continues to preach, every lease provision, whether analyzed by the landlord or the tenant, needs to be “walked through” in our minds, always asking, “What if? Or “And then what?”