Both landlords and tenants are well served to begin discussing exclusives early in the lease negotiations.
An exclusive use clause is a valuable and often heavily negotiated provision in leases. An “exclusive” prohibits a landlord from leasing space to another tenant that will operate a similar business or sell similar products at the shopping center or beyond. For example, a gym tenant may seek an exclusive to prevent the landlord from leasing space to other gyms, or a donut shop may seek an exclusive to prevent another tenant from selling baked goods. Consider the following tips when negotiating an exclusive use provision on behalf of a landlord or tenant.
Define the Scope of the Exclusive
Will the donut shop’s exclusive prevent the landlord from leasing to a diner that serves its well-known croissants?
Negotiating the scope of the exclusive is key. The ultimate goal of both landlord and tenant should be to arrive at a well-defined exclusive that can be understood and implemented. To protect its business from competition, a tenant is interested in negotiating as broad an exclusive as possible. Landlords, conversely, want to preserve their flexibility to bring in additional tenants, even if some of its tenants’ products or services will ultimately overlap.
The scope of an exclusive can take different forms. An exclusive can limit the type of business conducted or the specific products offered. The exclusive may allow the sale of similar products, but only up to a certain monetary limit (“Landlord shall not lease to any tenant whose gross sales of donuts exceed 5 percent of its overall gross sales from its location at the shopping center”) or a floor space limit (“Landlord shall not lease to any tenant whose sale of donuts utilizes more than 10 percent of the sales floor area of such tenant’s premises”).
Furthermore, if a landlord owns multiple properties in the surrounding area, an exclusive may be crafted to prevent the landlord from leasing to a similar tenant within a certain distance, such as a mile from the outer boundary of the shopping center. When negotiating an exclusive related to distance, because landlords often operate separate properties through separate single purpose entities (SPEs), the exclusive will need to apply to the landlord’s affiliated SPEs in order to be meaningful.
Tenants with a broader range of products or services, such as grocery stores or convenience stores, will likely find it more challenging to protect all aspects of their businesses through an exclusive. Smaller tenants, or those with less negotiating leverage, should focus on what makes their business unique or special and shape an exclusive around that feature. The donut shop, for example, may want to focus on securing an exclusive for donuts, its biggest selling item, even if it also sells other pastries. Nevertheless, the donut shop may strategically begin negotiations with the landlord by requesting an exclusive for all baked good before ultimately “accepting” an exclusive limited to donuts.
A landlord must conduct its own analysis of whether to agree to an exclusive. Granting an exclusive effectively shrinks the pool of eligible tenants, thereby making it more challenging to find a tenant for vacant space. Additionally, exclusives may prohibit a landlord from approving a tenant’s request to change its use in connection with an assignment or otherwise, or an exclusive may require that the landlord refuse an existing tenant’s request to change its use. A landlord may prefer that tenants agree to a limited number of permitted uses. This approach offers the landlord more control over the makeup of its shopping center while offering tenants some protection from direct competition.
Provide Notice of Exclusives
Both landlords and tenants must be cognizant of existing exclusives early in the lease negotiations. Landlords want to avoid the consequences of violating an existing exclusive. Likewise, a prospective tenant wants to ensure its proposed use is permissible. Although a prospective tenant should consider whether its immediate business would violate an existing tenant’s exclusive, it should also assess whether any future expansion of the business would cause complications. For example, the donut shop successfully secured a donut exclusive, but it is interested in expanding to muffins and bagels in the future. Its business plan could be significantly impacted if the landlord has granted an exclusive for muffins or bagels to another tenant. To confirm the existing exclusives, the donut shop should require that the landlord provide a list of exclusives affecting the property and require that the list be incorporated into the lease.
To provide notice of a tenant’s exclusive use rights, a tenant should record a memorandum of lease in the public records against the title of the shopping center.
The donut shop has now secured a donut exclusive and opened shop. The diner begins marketing its own donuts. How may the donut shop enforce its exclusive?
When drafting exclusives on behalf of any party, it is important to specify the available remedies. A common remedy provides the landlord with a period of time to cure the violation of the exclusive, after which the tenant may abate rent. The rent abatement may be 50 percent or more or the tenant may only pay on gross sales if the landlord fails to resolve the violation. If the violation remains uncured, some leases provide that the tenant may terminate the lease. It is important for the lease to establish a clear process, including time frames, to enforce any violation of an exclusive and provide the remedies available to the tenant if the violation is not cured.
A tenant that is violating an exclusive without the consent of the landlord is commonly known as a “rogue tenant.” In the case of a violation by a rogue tenant, a lease may grant a landlord additional time to resolve the issue or may step up the consequences more gradually.
Determine the Duration of the Exclusive
Another key consideration of an exclusive use clause is its duration. The purpose of an exclusive is to protect a tenant’s specific business. If the tenant ceases to conduct that specific business, either by “going dark” or transitioning to a different type of business, a landlord may want the exclusive to terminate so as to allow it to lease additional space to other tenants without the restriction. A landlord may also negotiate the right to terminate an exclusive if the tenant assigns or sublets the premises for a different use. Alternatively, a landlord may want to recapture a premises that is no longer being used for an exclusive so it can relet to another operator.
Both landlords and tenants are well served to begin discussing exclusives early in the lease negotiations. With careful consideration and precise drafting, both the landlord and tenant should be able to agree upon a well-defined exclusive.