Tenant Leasing Illustrated – September 2018 – Ducking Exclusivity Issues

They say a picture is worth a thousand words, and that is doubly true if you are trying to decipher any of my thousand words.

Take a gander at the picture below of the uber momma duck and her 76 ducklings from a recent NY Times article.

Yes, that’s right! 76 ducklings!

That has got to be one exhausted momma; raising three boys practically bankrupted me and one can only imagine the psychological damage that I inflicted!

I expect that many of these 76 will be looking at duckling therapy down the road (I also understand that ducklings 32 through 44 tend to be problem middle children).

Actually, it turns out that this momma did not have 76 babies; it is just that some birds raise their babies with birdie day care called a “creche” – a system in which young mothers literally get their ducks in a row and leave their babies in the care of one hotshot grandmomma experienced duck.

“You never loved me, you went off to molt and left me with grandma!” Oy, more duckling therapy.

Although these ducklings may feel starved for attention, tenants can sometimes feather their nest with lots of focus by requiring an exclusive clause in their commercial lease (you knew I would get here somehow!).

An exclusive clause is a covenant from a landlord providing a tenant the exclusive right to operate a particular business on the property, usually a retail business selling certain merchandise or services, but sometimes an office use.

Exclusive clauses are most common in shopping centers where landlords and tenants are both concerned with the proper composition of uses and businesses to maximize the various tenants’ sales and the landlord’s profit.

Exclusive rights are less prevalent and less valuable for city street retail. Even if you have the exclusive right to operate a bakery in your city building, there is nothing to stop three other bakeries from opening next door and across the street in other landlord’s buildings.

And although even less common, it does occasionally happen that a large office tenant wishes to be the only tenant operating a particular business in its building; clearly this is not a universal viewpoint since some city neighborhoods become known as an area of concentration for particular businesses who find the proximity productive.

Certain office tenants, such as co-working businesses, look for exclusivity to avoid having a direct (tenant or landlord) competitor within their own building.

Any discussion of exclusivity requires great specificity about the tenant’s use that is being granted this privilege.

As you might expect, landlords look to describe the exclusive use as narrowly as possible while tenants look for the broadest possible latitude.

Make sure your exclusive clause is all it is quacked up to be by following the six suggestions below:

  • Address early. An exclusive right is very valuable yet difficult to obtain so it is important to raise the issue early in the negotiation process, preferably at the term sheet stage.
  • Define exclusive use broadly. Your permitted use may be to operate a restaurant, but your landlord may want to rent to other restaurants so will limit your exclusive use to a particular type of restaurant (e.g., Italian, French, etc.). You can define your exclusive use broadly and in a mutually acceptable manner, but you will need to pay careful attention to the specifics.
    • Your lease can use percentages to define “a restaurant selling or serving chicken as a principal menu item” (e.g., a restaurant deriving 25% or more of its gross sales from the selling or serving of chicken).
    • Your provision might prohibit leases with a “direct competitor”. This can include categories such as “an athletic footwear and apparel retailer” but may also be illustrated by listing a series of the tenant’s competitors. This list ideally should be illustrative and not limited since your competitors are likely to change over the lease term. You should also have the right to update the list at stated intervals.
    • Your lease might tie exclusivity to a specific standard being used elsewhere either by you or a competitor, such as “a dignified casual restaurant similar in appearance, quality and manner of operation as the restaurant known as “X” currently located at “X””.
    • Understand that shopping center anchors and major retailers are generally not subject to exclusive rights provided to others.
  • Pay attention to restrictions. Some leases will grant the exclusive but clarify what is not covered and you must again pay careful attention.
    • A lease may grant the exclusive right to operate a supermarket, but then clarify that adjacent establishments shall not be prohibited from operating a sit-down restaurant, a health food store, ice cream or frozen yogurt store, doughnut shop, pizza parlor, etc.
    • Many restaurant exclusives will prohibit the tenant from operating a “fast food” or “chain” restaurant and many retail exclusives will allow more high end or more low end establishments by others that would not be true competitors, again often with a laundry list of examples. Defining such prohibited or excluded categories can be difficult but can avoid disputes later on (e.g., “chain” can be defined to mean “an entity operating under the same or similar brand names that have at least “X” locations in the “X” area”).
  • Do not limit restriction to leases. The exclusive restriction should cover leases, licenses, and all other occupancy agreements and uses. Subleases present a particular problem since your landlord may not be able to withhold consent to competing subtenants under other existing leases (i.e., it may be obligated to be reasonable), but you can create this consent restriction going forward. Many co-working businesses also require covenants that their landlord not directly operate, or enter into a partnership or management arrangement for, a similar co-working use in the building.
  • Provide enforcement rights. Your lease should indicate that the exclusive is a material inducement to your entering into the lease and specifically allow injunctive or other equitable relief in addition to other remedies at law. You may also wish to provide for a reduced rent for violations of the exclusive that continue in excess of an agreed upon period of time.
  • Be aware of termination rights.
    • Many exclusive clauses include as a prerequisite that the tenant not be in default, but as with all such clauses try to limit to monetary or material non-monetary defaults after the expiration of notice and cure periods.
    • Some exclusive rights will permanently terminate if the tenant ceases operating its premises for the exclusive use for an agreed upon period of time (e.g., 180 days, 270 days), but be sure to exclude casualty, condemnation, force majeure and repairs or remodeling.
    • Some leases also allow a landlord to terminate the exclusive if it is found to be invalid or illegal by any court with jurisdiction (e.g., on an antitrust basis).

That great duck analyst Sigmund Freud once said “a man who has been the indisputable favorite of his mother keeps for life the feeling of a conqueror.” Now we know why there are few conquering ducks (Daffy and Donald being, of course, the exceptions that prove the rule). Follow the six suggestions above and you can avoid being a sitting duck and conquer your commercial lease exclusive use clause.