Strategies to Reduce Scope and Impact of Tenant's Exclusive

In today's sluggish leasing market, you may have to give a tenant the exclusive right to sell a certain product or provide a special service at your center to get the tenant to sign a lease. Although an exclusive is very desirable from a tenant's point of view, it creates many problems for you. For instance, even if you violate a tenant's exclusive only inadvertently, the tenant may have a wide range of legal rights it can pursue against you (such as suing you for damages or terminating the lease).

But giving an exclusive to a tenant doesn't have to be an all-or-nothing proposition or create many problems. There are lease strategies you can use to reduce the scope and impact of an exclusive and so reduce the number of problems an exclusive can create for you.

These lease strategies include:

• Setting four limits on the scope of the exclusive;

• Exempting seven types of tenants from the scope of the exclusive; and

• Voiding the exclusive in eight circumstances.

We'll tell you about these lease strategies with the help of Mary Beattie-Binder, senior portfolio counsel of General Growth Properties, Inc., Ohio attorney Abraham Lieberman, and Toronto attorney Stephen J. Messinger. There's a Model Lease Clause on p. 5 that you can use or adapt in your lease that reflects all of these strategies.

SET FOUR LIMITS ON EXCLUSIVE

Reduce the scope of the exclusive with the following limits:

* Limit Exclusive to Tenant's Primary Use

Give an exclusive only for a tenant's primary use, says Binder. If you give a tenant an exclusive for a use that's only a small or incidental part of its business, you may deprive another tenant of a use that could be a key source of business for it. You may even lose a potential tenant that's unwilling to forgo that use.

How do you define “primary use”? As a percentage of gross sales, a percentage of space dedicated to the use, or a combination of the two, says Lieberman [Clause, par. d]. Lieberman suggests that at least half the tenant's gross sales and/or floor area be dedicated to the exclusive use.

Practical Pointer: An alternative to limiting the exclusive to a primary use is to limit it to a general description or category of space or store, says Messinger. For instance, you might agree only that you won't rent space to another “consumer electronics store” or “appliance store” if the tenant with the exclusive primarily sells consumer electronics or appliances, he says. This gives you leeway to rent space to prospective tenants that don't fit the description or category but do sell merchandise that would otherwise violate the exclusive, he explains. For example, you could rent space to a furniture store that sells appliances, without violating the appliance store exclusive.

* Limit Exclusive to Portion of Center

Have the exclusive apply only to a specific portion of the center, rather than the entire center, says Binder. For example, if the tenant is located in a certain wing of the center, make the exclusive apply only to the stores in that wing, she explains. This way, the exclusive doesn't limit the pool of available prospective tenants for your center as severely.

You and the tenant will have to choose the part of the center where the exclusive will apply, says Binder. Our Model Lease Clause refers to that part as the “protected area” [Clause, par. a]. If the tenant's exclusive applies just to the protected area, you'll violate the lease only if you rent space in the protected area to a “competing business” (a business that engages in a use that's covered by the tenant's exclusive), she explains [Clause, par. b(ii)].

* Limit Duration of Exclusive

Try to limit the duration of the exclusive so that it doesn't outlast its purpose, advises Messinger [Clause, par. a]. Tenants often seek an exclusive to establish themselves in a new market. Past that time, it's no longer needed.

A tenant may be willing to give it up during the later part of the term. It may insist on keeping the exclusive only as long as it thinks it needs it to get established, Messinger explains.

* Limit Remedy for Exclusive Violation to Lower Rent

Give the tenant only one remedy—lower rent—if the exclusive is violated, Binder recommends. And say that the tenant is entitled to a lower rent only until you cure the violation, she adds [Clause, par. a]. This way, the tenant can't terminate its lease in response to the violation or ask a court to force you to correct the violation.

How low should the rent go? This is a figure to negotiate, the experts say. For example, you may agree to let the tenant pay a certain percentage of its minimum rent while the violation continues, says Messinger.

Practical Pointer: Consider requiring the exclusive tenant to prove it was harmed by the violation of its exclusive use before it can resort to the lower rent remedy, says Messinger. This will take into account the beneficial effects that a violation might have on the exclusive tenant if the tenant violating the exclusive brings more customers to your center. If that traffic increases the exclusive tenant's gross sales, the exclusive tenant won't be able to prove that it was harmed by the violation. So it won't be entitled to the lower rent remedy, he explains.

EXEMPT SEVEN TYPES OF TENANTS

The exclusive will apply only to a “competing business.” So you can reduce the impact of the exclusive by exempting the following tenants from the definition of a “competing business”:

* Existing Tenants

Exclude all existing tenants from the exclusive, whether they currently engage in the business covered by the exclusive or not, says Lieberman. This is important because an existing tenant's lease may be vague in detailing how the tenant can use its space. So the existing tenant may be able to change its product line in the future and sell the same product as the exclusive tenant—thereby violating the exclusive.

You also want all existing tenants' spaces to remain exempt from the exclusive even if they decide to relet their spaces when the current lease term ends, says Lieberman. It doesn't matter whether or not they have a renewal option in their leases [Clause, par. b(ii)(A)]. Otherwise, the exclusive could prevent you from keeping a desirable tenant in its space, Lieberman explains.

* Assignee or Subtenant of Existing Tenant

Exempt all existing tenants' assignees or subtenants from the exclusive, even if they're in a different business from the existing tenant, says Lieberman [Clause, par. b(ii)(A)]. This allows an existing tenant who doesn't engage in the exclusive use to assign or sublet its lease to someone who may compete with the exclusive tenant. If you don't do this, you would have to police existing tenants to limit their assignment or sublet rights. But if you try to do this unilaterally, the existing tenant could claim that you're violating its lease by cutting back its existing rights.

* Replacement for Existing Tenant that's No Longer a Competitor

You may have an existing tenant that uses its space primarily for the exclusive use that you granted the newer tenant. If the space occupied by the existing tenant is no longer being used primarily for that exclusive use (because the existing tenant changed its use, moved out, or closed down), you'll want the flexibility to maintain the center's current tenant mix. So say that in these circumstances, one new tenant will be exempt from the exclusive and can use its space (which may be located anywhere in the center) for the exclusive use, says Lieberman.

To make this exemption acceptable to the exclusive tenant, agree to replace the exempt tenant with a smaller new tenant. For instance, a 10,000-square-foot exclusive tenant may not feel threatened if a 2,000-square-foot existing tenant is replaced by a tenant of a similar size or smaller, Lieberman points out [Clause, par. b(ii)(B)].

* Anchor Tenants

Exclude any anchor, variety, specialty or other large store above a certain size (in square feet) from the exclusive, says Binder [Clause, par. b(ii)(C)]. Since these stores typically are unwilling to limit the wide variety of products they sell, an existing exclusive may prevent you from adding a new big store to the center, she warns.

* Small Tenants

Exempt tenants below a certain size (in square feet) from the exclusive [Clause, par. b(ii)(D)]. Small spaces are typically the toughest spaces to rent in shopping centers. And tenants in these spaces shouldn't pose a competitive threat to larger tenants. Lieberman recommends exempting tenants with less than 1,000 square feet from the exclusive.

Practical Pointer: Consider getting the right to exempt tenants in spaces that are less than 25 percent of the size of the exclusive tenant, even if they're bigger than the 1,000-square-foot limit, says Lieberman.

* Tenants for Whom Exclusive Use Is Incidental

Like small tenants, tenants that engage in the use prohibited by the exclusive on an incidental basis should be exempted from the exclusive. These tenants shouldn't pose a competitive threat to the exclusive tenant because their volume for that use is small scale, says Messinger. Without this exemption, you could have trouble renting space to tenants who engage in the exclusive tenant's use only as an incidental sideline to their businesses but consider the use important.

Define an incidental use on the basis of a percentage of gross sales or space dedicated to the use, or a combination of both, suggests Lieberman. Our clause uses a combination [Clause, par. b(ii)(E)].

* Rogue Tenants

Some tenants may violate the use restrictions in their own leases as well as another tenant's exclusive, says Binder. To protect yourself, exempt these rogue tenants from the exclusive [Clause, par. b(ii)(F)]. Otherwise, even though you're not at fault, the exclusive tenant can still resort to its remedy against you.

Practical Pointer: A savvy tenant may balk at this exemption unless you agree in the lease to try to stop the rogue tenant from continuing to violate the exclusive, says Lieberman. You'll have to negotiate this point with the tenant.

VOID EXCLUSIVE IN EIGHT CIRCUMSTANCES

The tenant may do something during the lease and no longer be the type of tenant that deserves an exclusive. So make sure that you get an “out” if this happens. You'll further reduce the impact of an exclusive by having the lease say it's automatically void if any of the following eight circumstances occur:

* Tenant Defaults in Any Way

An exclusive should go only to a desirable tenant, says Lieberman. But once a tenant defaults, it's no longer desirable and should no longer get the lease benefits it got before, he explains [Clause, par. c(i)].

Practical Pointer: Expect the tenant to demand that you limit this provision to defaults that are monetary (for example, failing to pay rent) or major (in legalese, “material”), Lieberman says. Also, some tenants may argue that they shouldn't lose the exclusive unless they've defaulted more than once, he adds.

* Tenant Sets Up Competing Business Nearby

Make it clear that the exclusive is dead if the tenant defaults on the lease's radius restriction, says Messinger [Clause, par. c(i)]. Otherwise, the tenant could open another store nearby—and compete with itself. So while you're forced to comply with the exclusive to help the tenant's business, the tenant is free to hurt your center by drawing business away from it.

* Tenant Sublets or Assigns

End the exclusive if the tenant sublets the space or assigns the lease, says Messinger [Clause, par. c(iii)]. The exclusive is personal to the tenant. You gave it to the tenant based on its clout. There's no reason a subtenant or assignee should also get this benefit, he explains.

Practical Pointer: Expect a tenant to balk at this provision. The tenant will argue that automatically voiding the exclusive after an assignment or sublet severely hurts the value of the lease—because it makes it tougher to find an interested subtenant or assignee. A possible compromise: Say that the exclusive won't end if the subtenant or assignee continues to use the space for the exclusive use, Messinger suggests.

* Tenant Doesn't Continuously Operate

End the exclusive if the tenant doesn't “continuously, actively, and diligently” operate its business in the entire space, says Binder [Clause, par. c(ii)]. A tenant that's gone dark or is using a small portion of its space shouldn't get the benefit of an exclusive, she explains.

* Tenant's Gross Sales Fall Below Set Amount

Void the exclusive if the tenant's gross sales fall below a set amount over a set period of time, says Messinger [Clause, par. c(iv)]. You'll generally give an exclusive only to a tenant with substantial negotiating clout—which generally means a retail tenant with significant gross sales. A tenant with a less-than-successful business shouldn't be entitled to an exclusive, he explains.

Practical Pointer: You and the tenant will need to negotiate the amount below which its gross sales can't fall, says Messinger. You'll also need to agree on how long gross sales must be below this floor amount before the tenant loses the exclusive, he adds.

* Tenant Changes Ownership

Say the exclusive ends if the tenant changes ownership, says Lieberman [Clause, par. c(v)]. You gave the tenant an exclusive because of its unique characteristics. But if a majority of the tenant's corporate shares or partnership (or limited liability company) interests are transferred in a sale, takeover, or merger with another company, these characteristics may change or disappear. The new entity running the tenant may not have the same reputation, drawing power, or clout.

Practical Pointer: You may have to compromise if the tenant argues that this provision restricts the salability and market value of its business, notes Messinger. You can agree to let the tenant keep the exclusive if, in your sole discretion, the quality of its new ownership is similar to or better than its original ownership, he says. Since this is a subjective test, it still may not fly with the tenant.

* Tenant Discontinues Exclusive Use

Void the exclusive if the tenant stops using its space primarily for the exclusive use, says Lieberman [Clause, par. c(vi)]. Without this protection, your center may be left without an important retail use, he warns. For example, suppose you grant a pizzeria tenant an exclusive right to sell pizza in your center. The exclusive is meant to shield the pizzeria tenant from damaging competition. But if the pizzeria stops selling pizza, you can't replace its use unless you have a right to terminate the exclusive.

Practical Pointer: Expect the tenant to demand that it can temporarily stop the exclusive use, says Lieberman. If you agree to this compromise, you and the tenant will need to negotiate how long any temporary stoppage can last. Also, make sure to cap the number of times the tenant may temporarily stop the exclusive use, adds Lieberman.

* Tenant Doesn't Send Notice to Exercise Remedy

Kill the exclusive if the tenant doesn't notify you by a certain deadline—say, 30 days after the start of the exclusive violation—that it's planning to exercise its remedy under the exclusive use clause, says Binder [Clause, par. c(vii)]. If the tenant misses the deadline, it's out of luck.

CLLI Sources

Mary Beattie-Binder, Esq.: Senior Portfolio Counsel, General Growth Properties, Inc., 110 N. Wacker Dr., Chicago, IL 60606; (312) 960-5799; Mary.Binder@generalgrowth.com.

Abraham Lieberman, Esq.: Member, Baumgartner & O'Toole, 5455 Detroit Rd., Sheffield Village, OH 44054; (440) 930-4001; alieberman@b-olaw.com.

Stephen J. Messinger, Esq.: Partner, Minden Gross Grafstein & Greenstein LLP, 111 Richmond St. W., Ste. 700, Toronto, ON M5H 2H5 Canada; (416) 369-4147; smessinger@mindengross.com.