Let’s say you own a regional system of franchised stores. Your newest franchisee has just handed you a draft lease for the store he intends to operate. What are the six most important changes you can negotiate to protect your interest in the new location – and the associated goodwill – in case the franchisee defaults under the lease, the franchise agreement, or both? In order of importance, here are six critical goals to shoot for:
- Notice of default. Insist the landlord agree to give you written notice of any lease default by the tenant, even if the lease does not require that the tenant be notified. Keep in mind the lease may make certain events (e.g., nonpayment of rent or failure to maintain required insurance) automatic defaults without needing to notify the tenant. If the lease does require notice as a precondition to default, insist the landlord agree to copy you on the notice sent to the tenant. It is essential that you learn about your franchisee’s failure to pay rent (or otherwise perform under the lease) in enough time to decide upon – and implement – an effective response. Without this most basic of protections, the eviction process could be well under way or even complete before you learn of the tenant’s failure to perform. Although some landlords resist the administrative burden, a prudent one will recognize that bringing you into the process early on will enhance prospects of a quick resolution without substantial legal costs or prolonged interruption of the rental stream.
- Right to cure. Having the right (but not the obligation) to cure any lease default by the tenant goes hand-in-hand with the right to receive notice of that default. Ideally, the period permitted for your cure will exceed that allowed for the tenant’s cure; among other things, the lease may permit the tenant only a short period, or none at all, to cure matters such as a monetary default, failure to insure or a prohibited assignment. You can expect the landlord to try to limit the number of times you will be permitted to cure during the lease term; you can also expect the landlord to try to keep the cure period to 30 days or less.
- Consent to lease amendments. If the landlord and tenant are permitted to amend the lease without your consent, any protections you succeed in building into the lease can disappear with a stroke of a pen. Moreover, the way will be cleared for the tenant to leave your franchise system (or join a competing system) and retain control of the store by negotiating necessary lease changes (such as a modified use clause or rent structure) directly with the landlord. Having the right to approve any amendments to the lease (or, at a minimum, those that affect your rights and interests as franchisor) before they become effective is critical to your ability to protect your interests and preserve locational control. For similar reasons, you should seek to prohibit the tenant from having the right to renew or extend the lease term, assign the lease or sublease the premises without your consent; all are mechanisms for the tenant to attempt to exit your system, join a competing system or bring in a competitor to operate in the store location.
- Limit permitted uses. The uses permitted under the lease should be limited to operation of the franchised store under the parameters of the franchise agreement. Not only will this impede the tenant from assigning the lease What are the six most important changes you can negotiate to protect your interest in a new location? Franchise & Distribution News Summer 2012 7 to a competing operator (or anyone else who does not intend to operate the franchised store), it will also help ensure the lease can be transferred only to you or another franchisee in the event of the tenant’s bankruptcy.
- Conditional assignment of the lease. Consider requiring the tenant to conditionally assign the lease to you. Such an assignment would give you the option (but not the obligation) of taking over the lease and operating the store (or possibly transferring the lease and store to a another franchisee) in the event of the tenant’s default under the lease and/or the franchise agreement. Conditional assignment language can be inserted in the lease itself or in a separate document. However the assignment is documented, the landlord’s consent (given up front, upon execution of the lease) is essential. You can expect the landlord to seek your agreement to completely cure any existing default by the tenant if you choose to exercise your assignment rights.
- Cross-default with franchise agreement. Including a clause that makes a default under the franchise agreement an automatic default under the lease will give the tenant/franchisee another incentive to perform, and it will increase your leverage in the event of nonperformance. However, the landlord may be concerned about the risk of lease termination because of a technical default under the franchise agreement. Be prepared to identify which of the tenant/ franchisee’s obligations under that agreement are important enough to justify termination of the lease in the event of a violation.
Your financial standing and track record, the size and prominence of your franchise system, and the importance of the lease to the landlord will all impact your success in securing these changes. Ideally, negotiated concessions are set forth in a rider or addendum to the lease, which you would sign as a party along with the landlord and tenant.
Alternatively, language can be added to the lease naming you as a third party beneficiary of the negotiated concessions. This is a less desirable approach, however, because your rights to enforce the lease as a third party beneficiary may not be clear. In any event, obtaining these six changes – or most of them – will afford you much greater protection than the typical landlord form lease.