Maximize Percentage Rent by Closing Nine ‘Gross Sale’ Loopholes

By Glenn S. Demby

Many retail leases require tenants to pay two types of rent: minimum fixed rent and a percentage of the “gross sales” they generate from the property above a specific dollar amount (called the “breakpoint”). Which tenant revenues count as “gross sales”? With so much money on the line, it’s not surprising that the issue is hotly contested. Owners will try to define “gross sales” as broadly as possible; tenants, naturally, will seek the exact opposite. What usually emerges from the negotiation is a compromise reflecting the bargaining power of each side.

Once the parties reach agreement, all they have to do is put it in writing. But drafting a lease definition of “gross sales” isn’t so simple. If it were, the clause wouldn’t spawn so many disputes and lawsuits. And because owners typically do the drafting, courts don’t give them the benefit of the doubt if the clause is the least bit ambiguous. Bottom line: It’s incumbent upon owners to ensure that the “gross sales” language is specific and unambiguous so that tenants and courts don’t twist its meaning.

Spot the Loopholes

There are nine common loopholes in “gross sales” definition clauses. We’ve rolled them all into one sample clause—call it the clause from hell. See if you can spot all nine. Use the inserted numbers to find where in the clause the loophole is and which section of the article explains the loophole and how to plug it.

What’s Wrong with This Language?

Gross Sales are defined as revenues earned (1) by the Tenant (2) on the Leased Premises (3)(4) as a result of in-store (5)(6) customer purchases (7) of goods or merchandise (8)(9) sold by the Tenant in accordance with the conducting of its business.

We’ll also give you an airtight Model Lease Clause: Define ‘Gross Sales’ Broadly to Maximize Percentage Rent, which you can have your attorney adapt for your leases.

1. Basing Gross Sales on Earnings Rather than Purchase Price

Loophole: The phrase “revenues earned” opens the door for the tenant to deduct amounts included in the purchase price that don’t actually enhance its income or profits, such as:

• Sales and other taxes that tenants merely collect and remit to the government;
• Interest and financing fees the tenant charges customers who buy on credit; and
• Amounts built into the sales price of goods bought on credit to protect the tenant in case it can’t collect from the customer.

How to Plug It: Negotiate for a definition of “gross sales” as “the actual sales price” of all goods, merchandise, and services sold, without any kinds of deductions, whether the customer pays cash, credit, or via some other mechanism such as gift certificate [Clause, Sec. 1].

2. Limiting Gross Sales to Sales by Tenant Named in Lease

Loophole: The phrase “earned by the Tenant” sounds pretty harmless, but it cost one New York owner tens of thousands of dollars in percentage rent. A court interpreted the phrase “of the Tenant” as including the receipts of only the tenant named in the lease and not the pharmacy it sublet to [45-02 Food Corp. v. 45-02 43rd Realty LLC, Feb. 2007].

How to Plug It: Define gross sales to include sales of not only the tenant but any of its successors that may occupy the leased space during the term, including subtenants, assignees, licensees, and concessionaires [Clause, Sec. 1].

3. Limiting Gross Sales to Sales from Leased Location

Loophole: “On the leased premises” opens a huge loophole, as we’ll see in the next two sections. First, it enables the tenant to minimize gross sales by siphoning sales to nearby locations not covered by the lease. For example, a Mississippi auto dealer was able to avoid percentage rent on car sales exceeding 100 per month by moving its sales office to another location just a couple of hundred feet away. The owner cried foul but lost because the lease based percentage rent on sales “on the” property [Facilities, Inc. v. Rogers-Usry Chevrolet, Inc., June 2005]. 

How to Plug It: Add a radius clause that either: (1) bans the tenant from opening the same or similar business within a certain radius of the leased location; or (2) makes sales from those locations part of “gross sales” for purposes of calculating percentage rent [Clause, Sec. 1(a)(i)-(ii)]. Caveat: Courts don’t like radius clauses because they thwart new business and will enforce the clause only if you can show that it’s:

• Necessary to protect your percentage rent revenues (or serve another equally legitimate business purpose); and
• No broader in geographic scope, duration, and goods and services covered than it has to be to protect that legitimate interest.

4. Limiting Gross Sales to In-Store Sales

Loophole: While it may sound pretty clear, the phrase “sales on the leased premises” is ambiguous enough for a court to interpret it as applying only to sales that are both received and processed by the tenant at the leased location. This could create a huge loophole since there are so many large retailers that receive and fill customer orders from separate locations.

How to Plug It: Define “gross sales” to include not only all in-store but phone, mail-order, gift certificate, catalog, facsimile, email, or other orders originating from or filled at the leased premises, or filled at the Tenant’s other stores or locations [Clause, Sec. 1(a) and (b)].

5. Not Specifically Covering Online Sales

Loophole: Like many retail leases, our clause from hell omits any mention of online sales. That might have been okay a couple of decades ago when online sales were just beginning. But in today’s world where the power of e-commerce is universally recognized (online sales currently make up about 7 percent of all retail sales and that percentage is growing fast), silence on the issue is almost sure to be interpreted as an implied agreement to exclude them.

How to Plug It: If you want to count online sales as part of gross sales, your lease better say so. Be prepared for tough negotiations. Tenants are apt to resist paying percentage rent on online sales. And some of the country’s largest retailers refuse to even discuss the issue. If you do have the clout to command percentage rent on Internet sales, you need to be clear about which of the tenant’s online sales to include. This can be tricky, especially if the tenant has multiple stores. Options include counting Internet sales made (and/or fulfilled):

• Within the leased location’s Zip code;
• Within a specific radius of the leased location;
• From the leased location’s sales region or district (if the tenant is a national chain); or
• On particular types of goods and services [Clause, Sec. 1(a)].

6. Failing to Cover Goods Purchased for Off-Site Consumption

Loophole: The phrase “in-store purchases” could be interpreted as excluding goods and services that the tenant delivers to customers off the premises. This can create a gaping loophole with restaurant, catering, and other food delivery service tenants.

How to Plug It: Specify that “gross sales” include goods and services purchased or prepared on the leased premises for off-premises use or consumption [Clause, Sec. 1(c)].

7. Limiting Gross Rent to Sales Revenue

Loophole: Basing gross sales on “customer purchases” may be interpreted as not including the often substantial revenues generated by non-sales transactions with customers.

How to Plug It: Try to include the following revenues in your definition of “gross sales”:

• The full amount of customer deposits that are forfeited or never refunded [Clause, Sec. 1(f)];
• The full amount of restocking or other fees the tenant collects from customers for returning purchased goods or services [Clause, Sec. 1(h)];
• The fair market value of customer trade-ins [Clause, Sec. 1(g)]; and
• The sales price of gift and merchandise certificates.

8. Failing to Include Vending Machine Revenues

Loophole: Limiting gross sales to revenues from customer purchases of “goods or merchandise” is probably not specific enough to get you percentage rent on tenant vending machine revenues.

How to Plug It: Negotiate for a definition of gross sales that includes revenues from on-site vending machines, video or arcade games, newspaper machines, pay phones, ATMs, and any other automated source of goods and services [Clause, Sec. 1(d) and (e)].

Practical Pointer: Lottery and other ticket sales are another potentially significant source of tenant revenue that you may not be able to collect percentage rent on unless you specifically include them in gross sales [Clause, Sec. 1(i)].

9. Failing to Include Fees for Related Services

Loophole: The other source of revenue not covered by the phrase “goods or merchandise” is fees for services the tenant provides in connection with those goods and merchandise. Even adding the word “services” to the definition probably isn’t good enough.

Exhibit A: A New York court ruled that a lease defining gross sales as income generated by the tenant’s business on the leased premises “including income derived from the sale of all services and all products” wasn’t clear enough to establish the owner’s right to collect percentage rent on lucrative cell phone service contracts; all it could include in gross sales were the commissions the phone store tenant received from the phone company for those contracts [Bombay Realty Corp. v. Magna Carta, Inc., April 2002].

How to Plug It: Identify and specifically include sources of related fee revenue in the definition of gross sales. Examples:

• Service contracts and warranties on cell phones, computers, and other goods sold;
• Commissions received for securing such service contracts;
• Slotting or placement fees paid by manufacturers or suppliers to tenants for displaying goods in their store; and
• Catering and delivery fees paid to restaurant and other food store tenants [Clause, Sec. 1.1]

About the Author

Glenn S. Demby is a corporate attorney and award-winning legal journalist who specializes in explaining the law in plain English and helping business leaders overcome their regulatory challenges. He can be contacted at glennsdemby@gmail.com.