Expand Prospective Tenant Pool by Narrowing Scope of Restrictive Covenant

When negotiating a retail lease, a prospective tenant may demand that you agree not to rent space at your shopping center to any other store that fits the same general description or category as the tenant's store. For instance, an electronics store may want you not to rent space at your center to another electronics store, fearing that competition with other tenants may severely hurt its business.

But agreeing to such a restriction—also known as a “restrictive covenant”—may prevent you from renting space at your center to more types of tenants than you realize, warns Chicago attorney Carole L. Pechi. For example, you may think that, say, an electronics store restriction prevents you from renting only to another store that calls itself an electronics store. But the tenant may say you can't rent to any store that sells consumer electronics—even if those items are sold at only one of several departments within the store. And a court may agree with the tenant.

Bakery Restriction Snags New York Owner

Look what happened to a New York owner: A lease clause restricted the owner from renting space at the center to “any other bakery.” The owner later rented space to a supermarket tenant with several food departments—including one that sold fresh-baked breads and other bakery products. The tenant claimed that the owner violated the restriction by renting space at the center to a supermarket that sold bakery products. The owner argued that the supermarket wasn't “any other bakery.”

A New York appeals court ruled that the owner violated the “any other bakery” restriction by renting space to a supermarket that operated a bakery department. The court ordered a hearing to determine the damages the tenant suffered because of the violation [Bubba's Bagels of Wesley Hills, Inc. v. Bergstol].

Two Ways to Narrow Tenant's Restriction

To avoid finding yourself in the same situation as the New York owner, narrow any similar restriction you give a tenant in these two ways:

Set restriction by primary use, not by category. Don't agree not to rent space to another store that fits the same general description or category as the tenant's store, advises Pechi. Instead, agree that you won't rent space to another store whose “primary use” will be the sale of the items that the tenant wants to protect—such as fresh-baked goods, in the New York case, says Pechi. A primary use should mean that more than 50 percent of the other store's gross sales will be derived from the sale of those protected items, she explains. That way, you won't be barred from renting space to another store that incidentally sells those items, she says.

Department must exceed certain size for restriction to apply. Make sure the restriction won't apply if the other store will sell the protected items only in a department that's smaller than a specified number of square feet, says Pechi. You and the tenant will have to negotiate the size limit. The bigger the size of the department, the better for you, because few stores could exceed that size. But if the size limit is too small, many prospective tenants could exceed that limit, even if their projected volume of sales from the department wouldn't pose a threat to the tenant requesting the restriction, she warns.

Here's language you can adapt and add to the lease if the tenant agrees to limit the restriction, says Pechi:

Model Lease Language

a. Landlord will not rent space in the Center to another store whose primary use will be the sale of [insert description of protected items] (“Exclusive Items”); provided, however, that this restriction shall not apply if such store intends to sell the Exclusive Items solely within a department at its store in the Center and such department is less than [insert #] rentable square feet.

b. For purposes of this Paragraph, “primary use” means that more than [insert #, e.g., fifty (50 percent)] of such other tenant's gross sales are derived from the sale of the Exclusive Items.

Practical Pointer: To further protect your interests, say that the restriction will be null and void if the tenant stops operating or selling the protected items; violates the lease; or assigns the lease or sublets its space, suggests Pechi.

CLLI Source

Carole L. Pechi, Esq.: Senior Counsel, Holland & Knight, LLP, 131 S. Dearborn St., 30th Fl., Chicago, IL 60603; (312) 715-5879; carole.pechi@hklaw.com.