How Do I Lose An Exclusive Use Right? Let Me Count The Ways

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If you operate a liquor store at a shopping center, would you like to be the only one there? Of course, you would. It isn’t like a dress shop where other stores would have different styles and price points and those other dress shops will bring you business as well. But, when it comes to wine and liquor, everybody carries the same core items. Some will skew their wine offerings in one direction; others may have a different wine focus. But, when it comes to wine and liquor, all merchants have the same merchandise available to them and all can sell whatever everyone else sells.

So, it will come as no surprise that a large-scale liquor store at a shopping center negotiated and was granted some exclusive use protection. This is exactly what its lease provided:

So long as Lessee continues to operate in the Premises in accordance with the Permitted Use, as stated in Article 1.01(I), and Lessee is not in default of any term contained in this Lease, Lessor agrees that during the Term of the Lease, it will not lease any premises within the Center to a tenant whose primary business is the sale of packaged liquor. Notwithstanding anything contained herein to the contrary, Tenant’s exclusion shall not apply to any tenant within the Center existing prior to the date of execution of this Lease, including any renewal options that such tenants may have under their existing lease agreements, however, no such existing tenant shall be granted any new use rights in a new lease agreement permitting them to operate a business at the Center in violation of this exclusion.

Broken down into its key components, the landlord agreed not to lease to any subsequent tenants if they would operate a business primarily selling packaged liquor. Existing tenants whose leases would permit the sale of packaged liquor could operate a business primarily selling packaged liquor. But, the landlord could not amend an existing lease to permit such a primary business.

Before we tell the sad tale of the tenant with the cited lease clause, we feel the need to ask: “What is meant by packaged liquor?” We understand the “packaged” adjective. It is a limitation that would permit a tavern or bar at the shopping center. But, what is meant by “liquor”? On a technical level, its definition included all alcoholic beverages. On a “street” level, it excludes wine and beer. What would a court have ruled had the landlord leased space to a merchant selling only wine? We don’t know, but isn’t the question obvious? So, why did the landlord and tenant settle on “packaged liquor”? We would have written “alcoholic beverages” had the broadest protection have been intended.

Now, let’s reflect on the “carve-out” for existing tenants. That’s what today’s “story” will do.

A supermarket, an existing tenant, was not selling liquor at the time the liquor store lease was signed even though it had the right to do so under a very broad use clause. Eleven years after the liquor store moved in, the supermarket decided that it would begin to sell liquor. Under state law, to do so, the supermarket needed to physically separate its “wine and spirit” shop from the rest of the grocery store. So, it and the landlord amended the supermarket’s lease to add more space for this separate “store.” Notably, the additional space was taken on by the supermarket-tenant and, as such, it was a pre-existing tenant when the liquor store’s lease was signed eleven years earlier.

The liquor store, relying on its exclusive use right, cried foul. As it saw the situation, the landlord had leased “premises within the Center to a tenant whose primary business is the sale of packaged liquor.” Was that actually the case? Certainly, to the consuming public, it looked like a new store had opened and that there were now two stand-alone liquor stores at the shopping center. Unfortunately for the original liquor store, that’s not how a United States District Court in Kentucky saw it. It is also not how Ruminations sees it.

Restrictive covenants, and that’s what exclusive use right clauses are, will be strictly construed. That’s because there is an important, long-held principle under real property law holding that owners should be as free to use their own land as they wish, and that restrictions, while permissible and enforceable, must be seen as ‘limited’ exceptions to that general principle.

Here, the words of the exclusive use right expressly allowed pre-existing tenants to sell packaged liquor. The supermarket was a pre-existing tenant. The supermarket would have been permitted to add a liquor department within its existing four walls. That was a risk the stand-alone liquor tenant took when it signed its lease. After all, the supermarket’s use clause allowed the sale of liquor.

The addition of space to the supermarket’s lease, by way of amendment, would always have been unobjectionable. Had the space been a mere floor area expansion to add an in-store dining area, no issue would have arisen. If the added space was a pad space for the supermarket to operate a gas station, no one would have blinked an eye. In each case, it would have been the same supermarket expanding its sales area and adding product choices for customers. That’s how the court saw it, and to us that makes sense.

So, with the court seeing this as a pre-existing tenant adding space and not a change to its use clause, the question became: “Did this change in the supermarket’s operation create a situation where a competing tenant was now engaged in the “primary business” of “the sale of packaged liquor?” Once you accept that this was the existing supermarket now selling liquor, the answer has to be, “No.” The supermarket remained the entity that signed the lease as the tenant. It now had a main store and two satellite locations at the shopping center, a liquor store and a free-standing gas station (yes, it already had that). The main store measured about 96,000 square feet in size; the liquor store was only about 2,000 square feet in size. The wine and spirit shop was projected to contribute only about 1% of the supermarket’s revenues.

Basically, there was no new lease agreement. No new use rights were granted to the supermarket, a pre-existing tenant. To us, though it did, the court didn’t need to look into the question of “primary.” What we learned from the court’s doing so was that it considered both sales volume and floor area.

Could the tenant have negotiated a “better” exclusive use right? We don’t know anything about the bargaining dynamics at the time it signed its lease, but we do know that only excluding pre-existing tenants or pre-existing leases is not adequate to fully protect a tenant against future competition at the same property. Certainly, a landlord should not be asked to bar pre-existing tenants under existing leases from selling whatever those leases would already permit. But, incoming tenants who negotiate for exclusive use rights should not be exposed to “new” situations, ones that effectively expand the possibility that a competitor will appear at the project.

Basically, only existing premises for as long as leased under leases already in effect should be protected, and then only if the then-existing permitted use rights under those leases, as written on that day the “new” lease is executed, should be “excepted.” Further, the “carve-out” should only run for as long as that existing lease could have been in effect without any amendment adding extension terms beyond what was already included in those existing leases. Landlords will want to see just the opposite. They would like to reserve the right to lease for a competing use in those same spaces where, on the day a tenant’s exclusive takes effect, the competing use would be permitted, even if the then-existing tenant or lease no longer exists. The game, then, is to think about the “space” within which a competing use can exist, not “who” can compete.

[To read the court’s decision, click: HERE.]



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