Limit New Tenant's Sales of Items Subject to Existing Tenant's Restrictive Covenant

Here’s a creative solution to “exclusive” restrictions.

How many times have shopping center landlords had to walk away from a lucrative lease opportunity because the prospective retail tenant wants to sell items for which an existing tenant already has exclusive rights? Juggling tenants’ various exclusives and restrictions on what other tenants can sell is particularly challenging in food courts where overlap in menus is so difficult to avoid. But with some creative leasing, you can resolve these problems. Just ask the New York shopping center landlord who actually found a way to make it possible for two different tenants to each sell burritos in the same shopping center. Here’s a briefing of the strategy and a Model Lease Clause you can use to implement it at your own center for not only burritos, burgers, etc., but also non-food items.

What Would You Do?

Here’s the situation. A new tenant wants to sign a lease in a mall to operate a general dinner restaurant that serves a broad range of cuisines. One of those cuisines is Mexican. And that’s a problem because one of the mall’s current tenants is a major Mexican restaurant chain whose lease contains a restrictive covenant barring the landlord from entering into a lease with another tenant whose principal business is the sale of burritos, tacos, or fajitas.

The Restricted Items Sales Limitation Clause

Not to be deterred, the landlord went forward with the new general restaurant tenant while protecting the existing tenant by inserting special language into the lease barring the latter from deriving its principal revenue from burritos, tacos, and fajitas. Being a general restaurant made it easier for the tenant to accept these restrictions; curbing sales of burritos, tacos, and fajitas could very well be a deal breaker for a Mexican restaurant. But there’s another reason the approach worked and continues to work—namely, the clarity, precision, and enforceability of the actual lease clause. In adopting this approach, ensure that the lease clause you use includes seven key items:

1. Definition of restricted items. The first thing you need is a clear and specific definition of the items that are subject to the clause’s sales restrictions (a.k.a., “Restricted Items”), in this case burritos, tacos, and fajitas [Clause, par. a].

2. Cap on sales of restricted items. The most essential business term is the “Sales Limitation,” or cap on the amount of revenue that the tenant can derive on the sales of the Restricted Items. After extensive negotiation, the landlord and tenant agreed to a burrito/taco/fajita cap of 10 percent of the combined annual total revenue for all products, foods, and drinks sold in the leased space during a calendar year [Clause, par. a].

3. Consequences of exceeding cap. To satisfy the existing Mexican restaurant tenant, the landlord had to ensure that the new tenant would face significant consequences for deriving more than 10 percent of its annual revenue from sales of Restricted Items. Accordingly, the provision stipulates that any violation of the clause will “constitute an incurable material event of default” under the lease triggering the landlord’s right to terminate, seek injunctive relief, and/or sue for damages, including consequential damages to the Mexican restaurant for breaching its restrictive covenant on sales of burritos, tacos, and fajitas. Moreover, these remedies aren’t subject to any grace period or the requirement of notification from the landlord [Clause, par. a]. 

4. Tenant’s duty to report sales of restricted items. Recognizing that strong remedies alone wouldn’t be enough to establish accountability, the landlord included language requiring the new tenant to submit annual reports of its total sales and sales of restricted items. The lease further states that the annual reports must be:

• Delivered by the tenant to the landlord, without the need of notice or demand, within 30 days after the end of the calendar year; and
• Signed and certified as accurate by a senior officer of the tenant [Clause, par. b].

5. Tenant’s duty to maintain auditable sales records. A tenant in the Mexican restaurant’s position might still have legitimate concerns about the new tenant’s seeking to conceal its sales of Restricted Items. So, to prevent the new tenant from cooking the books, the clause requires it to:

• Record all sales on cash registers equipped with devices or features that allow for tracking each sale or revenue source with the items that accounted for them; and
• Maintain sales records that are suitable for auditing in accordance with generally accepted auditing standards (GAAS) [Clause, par. b].

6. Landlord’s right to audit tenant’s sales records. To further ensure compliance and accountability, the clause gives the landlord or an accountant it designates the right to audit the tenant’s sales and other records. In addition to giving the landlord access to a broad range of documents, the tenant must make those materials available at the landlord’s office. While the landlord would normally conduct audits at its own expense, the clause says the tenant must pay the costs of the audit, as additional rent, if:

• The tenant’s sales or revenue statements are found to be inaccurate; or
• The tenant doesn’t meet its obligation to maintain records that are auditable in accordance with GAAS; or
• The landlord doesn’t receive the tenant’s annual sales statement by its due date—that is, 30 days after the calendar year to which the statement pertains [Clause, par. c].

Note that the landlord will be justifiably suspicious and eager to audit tenants that submit skimpy, sloppy, and incomplete sales records—or no sales records at all.

7. Clarification that terms survive lease expiration. Last but not least, the provision specifies that the terms of the clause will remain in effect if the lease expires or is terminated early. The survival clause ensures that the tenant’s liability doesn’t end when the lease does. Without such a clause, a tenant breach that occurs before the end of the lease will be deemed waived and the tenant will be deemed released from liability arising from the breach [Clause, par. d].