Use Landlord Leasing Covenant as Compromise at No-Exclusives Center

An exclusive use clause is a highly valuable clause in a tenant’s lease because it will grant the tenant the sole right to sell certain products or operate a certain type of business in the shopping center where it rents space. Because the right to an exclusive may be so beneficial for tenants, its terms are often highly negotiated—especially when the exclusive that the tenant is asking for will substantially limit the types of other tenants you’ll be able to rent space in your center to, or prevent your other tenants from selling specific products and services that would be precluded by the right. Don’t allow a tenant to back you into a corner by insisting on an exclusive if you think it’ll come back to bite you later. Especially if you have a desirable center in a prime location, consider making your center free of exclusives—for any tenant.

But what if a strong tenant isn’t willing to lease space at your “no-exclusives” center without an exclusive? Instead, offer a compromise: a “landlord leasing covenant.” This concept, which has been increasing in popularity among commercial real estate owners over the last few years, means that you’ll promise the tenant that you’ll set some restrictions on your ability to rent space to the tenant’s competitors in the future. This covenant is beneficial for you because it’s not as comprehensive as a tenant exclusive. That’s because it applies only to you, and not to any of your other tenants. However, the tenant may view the covenant as the next best thing to getting an exclusive, and agree to rent space at your no-exclusives center.

We’ll explain how you can draft your landlord leasing covenant properly, so that it doesn’t severely limit your ability to rent space to prospective tenants—as an exclusive could. And we’ll give you a Model Lease Clause: What to Say in Landlord Leasing Covenant, that you can adapt and use in your leases. 

Set Conditions Tenant Must Meet

Neither a deadbeat tenant nor one that hasn’t opened for business should benefit from a landlord leasing covenant that restricts your ability to rent space to other tenants, says Atlanta real estate attorney R. Robinson Plowden. He advises owners to agree to the terms of the covenant, but only if the tenant meets these two conditions: (1) the tenant isn’t in default of the lease past any applicable grace period; and (2) the tenant is open for business, and fully stocked and staffed [Clause, par. a].

Define Tenant’s Primary Business

The landlord leasing covenant makes you agree not to rent space to a new tenant that has the same primary use as the tenant getting the covenant, explains Plowden, who on behalf of a national developer, has put leasing covenants in tenants’ leases at centers in North Carolina and Alabama.

Therefore, you should define “Tenant’s Primary Use.” Plowden recommends defining the primary use by the type of store the tenant will operate—for example, a modern toy store. Avoid using the more restrictive approach often found in exclusives aimed at preventing competition in the specific products that the tenant will sell—for example, toys, children’s clothing, and other items used by children [Clause, par. a].

Terminate Covenant Near Lease’s End

If the tenant’s lease term is about to end and it’s going to leave your center, you shouldn't remain bound by the landlord leasing covenant and barred from leasing to whomever you wish. Make it clear that the covenant will terminate several months before the lease term ends, says Plowden [Clause, par. a]. Six months is usually a reasonable time period.

Don’t be surprised if a tenant balks at this early termination of the covenant, especially if its biggest sales season is near the end of its lease term. Depending on the tenant’s bargaining power, you may have to reduce the number of months that the covenant will end before the lease, or eliminate that requirement.

Don’t Bar Leases with ‘Open’ Use Clauses

Make it clear that the covenant will not bar you from signing a lease with an “open” use clause—such as a clause that lets a tenant use its space for “any lawful use,” says Plowden [Clause, par. c]. Typically, strong tenants want open use clauses because they may decide in the future that it makes financial sense for them to switch to another use, he explains.

And agree only to not “knowingly and intentionally” sign a lease with a competitor. Some tenants will balk at letting you sign another tenant’s lease with an open use clause. They fear that the tenant with the open use clause could switch to a use that directly competes with them. As a compromise, agree that you won’t “knowingly and intentionally” sign a lease with a new tenant with the same primary use as the tenant getting the covenant [Clause, par. a].

This way, if you didn’t know at the time you signed the other tenant’s lease that the new tenant intended to operate a competing store, you will not have violated the covenant, explains Plowden.

If this sounds as if it could lead to a policy of “don’t ask, don’t tell,” that’s a possibility. However, Plowden cautions against being “willfully ignorant” of a new tenant's proposed use, because doing so might create liability under the landlord leasing covenant. That is, the tenant that’s benefiting from the leasing covenant could claim that you “should have known” that the new tenant was planning to use its space in violation of the covenant, he explains.

Set Conditions for Application of Covenant

Make sure that the landlord leasing covenant applies only to:

Tenants with big spaces. Don’t let the landlord leasing covenant block you from renting space to small or midsize tenants—even if they have a use that competes with your existing tenants. Make the covenant apply only to tenants of a certain size—for example, at least 5,000 to 10,000 square feet, says Plowden [Clause, par. a].

Parcels you own. The landlord leasing covenant should not apply to parcels at your center that you don’t own, such as those owned by big-box retailers. After all, you have no control over how those parcels are used. State in the lease that the covenant applies only to parcels that you own, advises Plowden [Clause, par. a].

Specify Non-Exclusivity

Expressly state in the lease that the landlord leasing covenant is not an exclusive, nor will it bind any other tenants, says Plowden [Clause, par. b]. This way, the tenant shouldn’t have any expectation that it’s getting an exclusive, he explains. Plus, stating that the other tenants won’t have to comply with the covenant further drives home the point that the covenant isn’t an exclusive.

You should also make the covenant personal to the tenant. “Make it clear that the landlord leasing covenant is personal to the tenant,” says Plowden [Clause, par. b]. That means that only the tenant can enforce the covenant against you. The tenant can’t transfer the covenant to anyone else.

Don’t Restrict Changes to Other Tenants’ Uses

State in the lease that the landlord leasing covenant won’t restrict any other tenant from changing its use to one that competes with the tenant’s primary use. Nor will the covenant bar another tenant from subletting its space or assigning its lease to a competitor of the tenant getting the covenant [Clause, par. c]. And don’t let the covenant bar leases with new tenants that sell the same items. State that the landlord leasing covenant won’t bar you from renting space to a new tenant selling items that the tenant getting the covenant sells, as long as the new tenant won’t operate the same type of store as the existing tenant. For example, if the tenant benefiting from the covenant is a toy store, state that you can rent space to another tenant that sells toys, as long as it doesn’t operate a toy store, explains Plowden [Clause, par. c].

It’s also crucial to specify that the covenant will end if the tenant defaults or stops its primary use. If the tenant breaches its lease, stops paying rent, or stops using the space for the specified primary use, make sure that it can no longer benefit from the landlord leasing covenant, advises Plowden [Clause, par. d].

Prepare for Modification Requests

Expect a savvy tenant to demand certain modifications to the landlord leasing covenant. For example, it may want you to promise three things. The first is that you don’t intend to grant exclusives.The tenant may require you to represent that you have not nor do you intend to agree to give any other new or existing tenants an exclusive. Try to avoid giving this representation, because you may decide later that giving exclusives may make sense to attract very desirable tenants.

It may also want you to promise that you won’t consent to use changes that could create competition. The tenant may demand that you represent that you won’t consent to letting an existing or a new tenant change its use, or assign or sublet, so that it (or its assignee or subtenant) can operate a competing store. Keep in mind that giving in to this demand could hurt you if a use change, sublet, or an assignment can occur automatically under a lease. For example, if an existing or a new tenant’s lease lets it assign its lease without your consent to an affiliate that operates a toy store—and that assignment actually occurs—you could end up violating the covenant, and that would be unfair.

Some tenants may also request that owners agree to “springing” exclusives. Expect a tenant to demand that you put a “springing” exclusive clause in the lease, notes Plowden. This clause says that if you decide to grant exclusives to future tenants, then this tenant will also get its exclusive. In essence, the tenant’s exclusive “springs” into effect when the first exclusive is granted to a future tenant. Owners typically have to agree to give a springing exclusive to a strong tenant, Plowden points out.

Insider Source

R. Robinson Plowden, Esq.: Partner, Sutherland Asbill & Brennan LLP, 999 Peachtree St., NE, Atlanta, GA 30309; www.sutherland.com.