Use Radius Clause to Protect Your Percentage Rent from Tenant

Making a profit from tenants at your shopping center or mall depends on many factors—one of which is the key percentage rent arrangement. Percentage rent allows you to collect not only base rent, but also a percentage of the tenant’s gross sales done at the space it leases from you. But percentage rent doesn’t exist in a vacuum. It can be diminished by variables like the tenant’s success—not just with you, but wherever else it is doing business. That is, if a tenant operates other outposts that do well nearby, shoppers might choose those locations instead of yours, which turns a profit for those other center or mall owners, leaving your “percentage rent” provisions much less beneficial.

It’s possible, though, to keep gross sales high, if you negotiate a radius restriction, also known as a restrictive covenant, with certain key items that will stop the tenant from, in essence, competing with itself by opening another location nearby. Here’s how to negotiate a radius clause like our Model Lease Clause: Consider Four Key Items When Negotiating Radius Clause that will protect you from a diversion of gross sales.

Importance of Negotiating Covenant

A radius clause restricts a tenant from operating within a certain radius from your center. But it’s not enough to just say that the tenant can’t open a store nearby. You’ll have to include specifics, such as the distance that the restriction covers, which could be heavily negotiated depending on the type of tenant.

It’s important to understand the dangers of not taking other locations into account. Radius clauses are common in shopping center leases because the goal for a shopping center owner is to not have a store in its center competing with itself by drawing away customers to another location. The whole point of using a radius clause is to prohibit a tenant from opening another or similar business within a prescribed radius from its present location.

This is especially important if the store is a “destination center”—that is, shoppers will travel to that center because that particular store is there. Having another of the same store closer to a customer means that she doesn’t have to go to the center you own to shop at the tenant’s store. And that’s very bad for your business.

Without a radius clause, your percentage rent can be affected. But should you be less concerned about negotiating a radius clause with a tenant that doesn’t have a percentage rent clause in its lease with you? The answer is no. The store’s other location will impact the foot traffic in your shopping center, cutting into the business you have and making your center less successful. Whether you have a percentage rent situation or not, it’s never a good thing to have a tenant competing with itself.

Practical Pointer: Office building owners don’t need to be as concerned about radius clauses as shopping center owners must be. So, typically, there aren’t radius restrictions on office tenants. Unless it’s a mixed-use office building that includes retail stores, a radius restriction doesn’t matter. Because an office building owner is concerned about collecting rent and not foot traffic, its tenants’ other locations don’t matter. The kind of traffic generated by an office use won't be the same as the traffic generated by a retail property.

Consider Four Key Items in Negotiations

Radius restrictions can get complicated, but there are basic items owners should include in such a clause. There are four items that you should consider.

Item #1: Specificity of restriction. First, decide what it is that you’re restricting. In other words, make sure you define the type of operation you’re restricting the tenant from setting up in another location. For example, if the tenant’s name is important to your center, make sure that it’s not involved in a store with the same or similar name elsewhere [Clause, par. 1].

“Similar” is important. If you don’t prohibit this, your tenant would be able to open another store by simply adding a new word or number to the name, without breaching its lease with you. To prevent this, use language banning not just the tenant’s current name, but also the use of a name “similar to” the store at your center, or that includes “any part of that name” in its name. This extends to franchises, too [Clause, par. 2].

Item #2: Broadness of restriction. You’ll have to use a broad enough definition of what your tenant is prohibited from doing. A narrow clause, like one that says simply that a tenant can’t open a new store with the same name, will leave wiggle room for the tenant to say that its other location is permissible—even though it sells exactly the same competing items—because its name is different.

However, your clause shouldn’t ban the tenant from opening another store altogether, as long as that store won’t compete with its store in your center. You can’t generally ban another business, because that’s too restraining. For example, your auto parts store tenant might want to open another business that’s related but not competitive, like an auto servicing center. Don’t ban the servicing center—it won’t cut into the auto parts business.

What if a tenant wants to open a store within the radius that sells mainly items not featured in its store at your center, but also sells a small amount of the items for sale at your location? You could indicate that the owners shall not own directly or indirectly any business “a substantial part of which” is the sale of the item it offers at your center.

And make sure that your clause specifies exactly what types of sales the tenant is prohibited from selling if it opens a store within the radius. You can list specific items to make sure that they’re covered.

Item #3: Other parties with interest in tenant. It’s not enough to simply ban the tenant from opening a competing store within the restricted area. That’s because, behind the scenes, many tenants have other parties that control them or have a financial stake in them. And you don’t want those parties opening another location. Make sure that the people who are controlling the entity that is your tenant, or the majority ownership interest in the tenant, or their directors, or people that have a significant interest in your tenant, don’t start another entity that competes. Whether you can negotiate to prevent the tenant’s other interested parties from competing with you is an important consideration [Clause, par. 1].

Item #4: Distance of radius. Find out exactly how much of a radius you need in terms of distance [Clause, par. 1]. If you’re a neighborhood strip shopping center, 10 miles may be too big a radius. You have to judge whether shoppers will come to your center if they have to travel 10 miles for that particular tenant. If not, reconsider the area. On the other hand, a mall or a destination center is a different matter. It also depends on what kind of a draw that store is. Ask whether your tenant is going to draw shoppers from however many miles away you want to set your restriction for. A radius restriction needs to be reasonable. Distance is a major part of that.

Typically, a radius extends in all directions from the center. (Make sure to set the radius from the perimeter of the center itself, not from the store.) Depending on your area, you may need to be more specific by denoting neighborhoods or streets that are covered by the radius you’ve set. Look at the geography surrounding your shopping center, especially if the particular neighborhood you don’t want to compete with is important—for example, Georgetown, in Washington, D.C. Instead of a radius in terms of just pure distance, you could specify that the tenant must have “no other store in XYZ area.”

Future Expansion Is a Factor

As with most lease terms, bargaining for a radius clause will mostly come down to leverage. If you have a strong tenant, such as an anchor tenant, it’ll resist any sort of radius clause, but most other tenants will accept a reasonable restriction.

Whether a tenant will agree to certain terms in a radius clause also depends on what its plan for future expansion is. That is, if the tenant doesn’t see it as profitable to put a store within a few miles of its existing current store, it’s more likely to agree to a radius that covers that distance.

Don’t be surprised if a tenant wants to negotiate terms in its radius clause that leaves it the option of expanding its business by selling some of the same items it does at your center. If the tenant sells a common item, this might be unavoidable. For example, a store that sells a common item may say that since that item is so common it wants the right to have at least a part of the inventory at its other store be made up of that item.

A good compromise if you want to allow the tenant to have another store within the radius is to make it agree that the sale of that item won’t exceed more than a small predetermined percent of its sales [Clause, par. 4].

Set Up Option for Recourse

If your tenant violates the radius clause, there are two types of damages that owners usually include for radius restrictions [Clause, par. 3].

Damages method #1: Add competing sales. Get the right to add a portion of the sales from the competing location to your location if you’re collecting percentage rent. Your argument is that those are sales that should have been made from the tenant’s store at your center but were made at a different location instead. Therefore, you should be able to add them to your percentage rent. To make this work, it’s important to negotiate an audit provision that gives you the right to audit the tenant’s gross sales from both your center and its other locations. It’s critical to get the right to review and get information about and inspect the books and records of a competing location within the radius you’ve set.

Damages method #2: Injunctive relief. The biggest clout you have is to get an injunction to stop the tenant from operating. A tenant that isn’t paying percentage rent won’t be affected by a right to add competing sales, but having a court stop it from operating is very damaging to its bottom line.

What if a tenant accuses you of letting your shopping center become run down or says that vacancies in the center are making it unable to survive in that location and that, therefore, it has to open other locations within the radius? Point out to the tenant that if it wanted an “out” based on that, it should’ve negotiated an occupancy clause providing that if the occupancy falls below a certain number of retail stores, it would have the right to put up a competing store or get out of its lease.

Compromise to Get Fair Clause

When determining what you want to include in your radius clause, you should think about what’s fair and unfair to restrict. You want the tenant to be able to stay in business, and it might need to open additional stores to do this, but you also have to protect the profit you make directly from percentage rent or indirectly by having a lot of foot traffic that results in sales at the center. It’s always key to start off a landlord-tenant relationship by establishing good will, and there’s a middle ground to avoid a clause that’s too narrow or too broad so it’s a win-win.

Compromise should be centered on not being overly broad with the distance. For example, don’t try to set a 20-mile radius just because you think you can; think about what you really need and go for that. But you should also avoid using terms that are narrow enough for the tenant to get around.

For example, defining the restriction as “XYZ tenant shall not operate a store doing exactly the same type of business under exactly the same name” would be too narrow. This leaves room for an argument from the tenant that the new store isn’t under the same ownership (if a different corporation has been set up) or that it sells additional items that make its inventory different from its location at your center. Remember from the outset that the best-drafted radius restriction should take care to be reasonable, but not too lax.