The Sales Volume Termination Clause: Protecting the Landlord's Interests

Second, the parties need to agree upon the appropriate period during which the tenant's sales must not exceed the sales volume threshold to permit the tenant to exercise its sales volume termination right. Generally, this measuring period is a 12-month period and is often the third or fourth lease year in the case of a lease with a 5-year term, and may be during the fifth or sixth lease year for a lease with a 10-year term. The landlord will not want the measuring period to occur too soon during the lease term because the tenant should have sufficient time to develop its customer base and brand identity at the project to generate optimal sales at the store. Similarly, the landlord will want to have sufficient time to fully lease and open the shopping center and implement appropriate marketing strategies in an effort to develop strong sales for all project retailers. On occasion, the tenant may seek to have the measuring period be more open-ended ' perhaps any 12-month period after the third year of the lease term ' thereby shifting the risk of poor store operations to the landlord. While the landlord should not agree to such a nebulous measuring period, if the tenant's initial lease term is of a sufficient duration, two discrete measuring periods 3 years apart could be offered.

Mechanics

Once the parties have agreed upon an appropriate sales volume threshold and measuring period, a number of mechanics will need to be established. Such mechanics are often not considered during the initial discussions concerning the sales volume termination clause, but should be carefully considered and included in the final letter of intent.

The sales volume termination clause should be drafted to require the tenant to notify the landlord in writing of its election to exercise the sales volume termination right within a short window of time ' perhaps 30 to 60 days ' after the end of the measuring period. This will focus the tenant's attention on determining whether the store is economically viable, notwithstanding that the store's sales were below the threshold. Having a window will also reduce the tenant's ability to leverage the threat of the exercise of termination at any time during the remainder of the lease term to gain a concession from the landlord with respect to some other matter in the lease.

The sales volume termination clause should provide that the tenant's failure to exercise the termination right prior to the expiration of the window is deemed a waiver of the termination right.

If the tenant values the sales volume termination clause, then the tenant should bear the responsibility to determine whether and when to exercise its termination right; it should not be the landlord's responsibility.

The sales volume termination clause should prescribe an effective date for any such termination. Ideally, the effective date should be tied to the end of the measuring period, rather than being tied to the date on which the tenant notifies the landlord of any exercise of the termination right. By establishing the effective date of the termination with certainty, the parties avoid any confusion as to the actual date on which the lease terminates. Additionally, the landlord can engage in meaningful re-leasing efforts because it will know the date on which it will regain possession of the space if the tenant exercises its termination right. On the other hand, if the effective date of the termination were 30 days after the date tenant notifies the landlord of its exercise of the termination right and the tenant has an extended period during which it may elect whether to exercise its termination right, then the tenant controls the effective date of the termination by coordinating delivery of the termination notice, leaving the landlord to guess as to the actual date of termination until such time as the tenant delivers its termination notice.

Additional Considerations

With the mechanics in place, the landlord should then turn its attention to a number of frequently overlooked items that can lessen the potential impact of the sales volume termination clause for the landlord.

1) The landlord should consider negotiating a termination fee. Presumably the calculus employed to establish the tenant's minimum rent rate included the landlord's transaction costs for the lease, including improvement allowances, brokerage commissions and attorneys' fees, with the expectation that such costs would be recovered over the entire term through the tenant's payment of minimum rent. If the tenant terminates the lease early, then a portion of such transaction costs would not be realized. Requiring the tenant to reimburse the landlord for the unamortized portion of such transaction costs, however, allows the landlord to recoup such costs. To avoid disputes as to the unamortized amount of such costs, the landlord should establish a termination fee in the sales volume termination clause based on the anticipated improvement allowance, brokerage commissions and attorneys' fees to be expended in connection with the lease and based on the negotiated effective date of any termination pursuant to the sales volume termination clause. Any such termination fee should be included in the final letter of intent. Tenants will often resist the payment of a termination fee equal to the unamortized amount of such transaction costs, in which event the landlord can agree to accept a percentage of such amortized costs. Alternatively, the parties can agree to the payment of minimum rent and additional rent for a period of time, thereby allowing the landlord to generate income from the space during the re-tenanting process.

If the tenant agrees to the payment of a termination fee, the landlord should require that fee to be paid concurrently with the tenant's delivery of the exercise notice. If the tenant objects, the landlord should require that the fee be paid no later than the effective date of the termination as a condition to the effectiveness of the termination. Moreover, the lease should provide that if the tenant fails to pay the termination fee in a timely fashion, then, at the landlord's election, the tenant's exercise of the termination right is voided and the lease remains in full force and effect.

2) If the tenant is not open in the entire premises during the entire time prior to and during the measuring period, the tenant should not be permitted to exercise the sales volume termination right. Inasmuch as the tenant's core concern in negotiating a sales volume termination clause is to secure the right to terminate the lease if the tenant fails to generate sufficient sales at the store, the tenant should have the responsibility of undertaking the necessary effort to develop such sales. If the tenant operates in less than all of the premises, or if the tenant is closed for any meaningful period of time, then it is not fulfilling its responsibility to maximize its sales from the store. Absent a provision to the contrary, such reduced occupancy or such closure increases the likelihood that the tenant will be able to take advantage of the sales volume termination right, and the tenant should not be permitted to take advantage of a situation it helped to create by having the ability to exercise its termination option. Of course, the landlord can make exceptions for limited closures for holidays and inventory/merchandising purposes.

However, an elite cadre of national tenants often rejects such a view, requiring that the landlord look simply to the amount of sales generated during the measuring period, without reference to whether the tenant has been open during or prior to the measuring period. In such cases, the landlord should require that the sales volume threshold be adjusted downward to account for any time during the measuring period that the tenant is not open for business. Recognizing that any meaningful closure will likely have a disproportionately adverse effect on average daily sales, and to discourage closures during the measuring period, any such downward adjustment should be at an accelerated rate – perhaps on a double straight-line basis. For example, a sales volume threshold of $3.65 million equates to $10,000 in sales per day. If the tenant is closed for a period of 30 days during the measuring period, the sales volume threshold would be reduced by $600,000, which is twice the product of the number of days of closure during the measuring period and the per diem sales volume threshold amount.

An additional concern arises in the event the tenant is not open prior to or during the measuring period because of a casualty on the premises. The casualty clause will likely require the landlord to rebuild the premises for the tenant following the occurrence of certain casualty events. The occurrence of such a casualty event during or just prior to the measuring period greatly diminishes the tenant's prospect of generating sufficient sales to satisfy the sales volume threshold and greatly increases the potential for the tenant to terminate the lease shortly after (or during) the landlord's reconstruction of the premises. To address this issue, the casualty clause should be revised to condition the landlord's reconstruction obligation upon the tenant's waiver of its sales volume termination right. For tenants objecting to a requirement to waive the benefit of the sales volume termination clause altogether, the landlord can agree to adjust the measuring period. One adjustment would have the parties tie the measuring period to the date the tenant reopens, or is required to reopen, for business following the landlord's restoration of its premises.

As an example, if the original measuring period covers months 37 through 48 of the lease term, then the new measuring period would be the 37th through 48th months after the date the tenant reopens, or is required to reopen, the premises for business. Alternatively, the parties can agree to adjust the measuring period only if the casualty occurs during the measuring period or within some short period of time (eg, 18 months) prior to the start of the measuring period. Both the landlord and tenant should recognize that the tenant will need a meaningful period of time to re-establish its business following a casualty-related closure. If the parties believe that a 12-month ramping up period is sufficient, then the measuring period can be months 13 through 24 following the date the tenant reopens, or is required to reopen, the premises for business. Conversely, if following a casualty event, the landlord can restore the premises and the tenant can reopen at least 12 months prior to the measuring period, then the measuring period would not be adjusted. While such an alternative is less favorable for the landlord, it does preserve the integrity of the sales volume termination clause and avoids the unintended consequences in the event of a casualty. Note that the same principles apply to a closure occasioned by a condemnation or taking that affects the premises, and the condemnation clause or the sales volume termination clause should be similarly adjusted.

3) The tenant should not be permitted to terminate the lease if its sales exceed the sales volume threshold during any 12-month period prior to the measuring period. The purpose of the sales volume termination clause is to provide the tenant with an exit strategy in the event the store performs poorly. The landlord is willing to accommodate the tenant's request for a sales volume termination clause because the landlord is confident that it can provide a shopping center that will generate sufficient traffic to enable the tenant to satisfy the sales volume threshold. The sales volume termination clause, however, should not be used to shift the operational risks of the tenant's business to the landlord. Accordingly, if the tenant's sales during any 12-month period prior to the measuring period exceed the sales volume threshold, then the landlord has fulfilled its responsibility to provide an active and vital project, and should not then be faced with a tenant terminating its lease because a poor merchandising plan or incompetent store management drives the tenant's sales lower in subsequent years. This is often a particularly contentious point with many tenants and, as with the two points addressed above, should be discussed during the letter of intent stage.

4) The landlord should have the right to audit, inspect or otherwise independently verify the tenant's claim that its sales for the measuring period did not equal or exceed the threshold. If the tenant is otherwise required to pay percentage rent, then the landlord is likely obtaining monthly sales statements and may already have the requisite audit rights. If, however, the tenant is not obligated to pay percentage rent, then the lease may not obligate the tenant to provide sales reports on a regular basis. In such event, the landlord must have the right to review the tenant's sales records to verify the tenant's claimed sales volume.

5) If a tenant has a percentage rent obligation, the parties likely spent some time negotiating carve-outs from and qualifications to the definition of “gross sales” in the lease, all in an effort by the tenant to minimize gross sales for purposes of reporting percentage rent. If the sales volume termination clause is tied to the negotiated definition of gross sales, then not all revenue generated from the premises would be included in determining whether the tenant's sales have satisfied the sales volume threshold, thereby increasing the possibility that the tenant will be permitted to exercise its sales volume termination right. If possible, the sales volume termination clause should avoid the negotiated “gross sales” definition and employ a broader and more generic phrase, such as “all sales of merchandise and revenue derived from the business conducted at the demised premises.”

6) To prevent the tenant from engineering its exercise of the sales volume termination right, the sales volume termination clause should expressly prohibit the tenant from exercising the sales volume termination right if the tenant has opened a competing store within a specified radius of the shopping center. Naturally, if the tenant, or any affiliate, opens a competing business across the street, such business will likely negatively impact sales from the tenant's existing store, and, as a result, increase the likelihood that the tenant would be able to exercise its sales volume termination right. If the tenant wants to terminate its lease to move to a new project across the street, then, to the extent cash flow permits, the tenant can simply open the competing store, cannibalize sales from its existing location and terminate the lease pursuant to the sales volume termination clause. If the tenant is obligated to pay percentage rent, then the landlord may have already included a radius clause within the lease. In such instance, the same parameters can be incorporated into the sales volume termination clause. Otherwise, the sales volume termination clause will need to include a radius restriction.

7) The sales volume termination clause should be personal to the tenant, such that if the tenant were to assign its lease or to sublet its space, the sales volume termination right would lapse. The landlord granted the sales volume termination right to the named tenant in an effort to attract the named tenant to the development. Such tenant's successor may not have warranted a sales volume termination clause, and the landlord should not be required to extend such a concession to such successor. Finally, the tenant should not be able to exercise its sales volume termination right if the tenant is otherwise in default under the lease.

Conclusion

If a landlord provides a sales volume termination right to induce a tenant to its development, then the parties should negotiate more than just the sales volume threshold and the measuring period. Carefully considering the mechanics and including the additional considerations discussed above will produce a sales volume termination clause appropriately tailored specifically to address the tenant's needs and concerns while simultaneously protecting the landlord's interests.

As the popularity of lifestyle center developments continues to grow, the national and regional small-shop tenants forming the leasing backbone of these projects persist in their efforts to negotiate lease rights traditionally granted only to anchor tenants just a few years ago. One such right is the sales volume termination right. Generally, the sales volume termination clause allows a tenant to terminate its lease in the event sales from the tenant's premises do not exceed a predetermined sales volume during a specific period of time. The primary purpose of this clause is to provide a tenant with an exit strategy for an underperforming store. Although the cause of such underperformance may be attributable to a struggling shopping center, alternate causes include poor store management and misguided merchandising decisions, among others. Certainly, landlords would prefer to avoid granting tenants any termination rights; however, the relative bargaining position of the parties may require that the landlord concede to the tenant's insistence for a sales volume termination right. If a landlord finds itself providing a sales volume termination right, then the sales volume termination clause should be structured to address the tenant's specific concerns rather than serve as an open-ended termination right, and it should include a number of landlord protections.

Key Elements

The sales volume termination clause, when stripped bare, has two essential elements: the sales volume threshold and the measuring period. First, the parties must agree upon the sales volume threshold that will trigger the tenant's termination right. The tenant is motivated to set the threshold as high as possible in an effort to maximize its ability to utilize the termination right. If the sales volume threshold is set too high, the tenant will effectively guarantee itself the right to terminate the lease early, thereby reducing the value of the lease to prospective lenders and purchasers of the project. Accordingly, the landlord should negotiate as low of a threshold as possible to minimize the tenant's ability to utilize the termination right. To arrive at a meaningful sales volume threshold, the landlord and the tenant may establish the threshold as a percentage of the average sales volume at the tenant's other stores.

Second, the parties need to agree upon the appropriate period during which the tenant's sales must not exceed the sales volume threshold to permit the tenant to exercise its sales volume termination right. Generally, this measuring period is a 12-month period and is often the third or fourth lease year in the case of a lease with a 5-year term, and may be during the fifth or sixth lease year for a lease with a 10-year term. The landlord will not want the measuring period to occur too soon during the lease term because the tenant should have sufficient time to develop its customer base and brand identity at the project to generate optimal sales at the store. Similarly, the landlord will want to have sufficient time to fully lease and open the shopping center and implement appropriate marketing strategies in an effort to develop strong sales for all project retailers. On occasion, the tenant may seek to have the measuring period be more open-ended ' perhaps any 12-month period after the third year of the lease term ' thereby shifting the risk of poor store operations to the landlord. While the landlord should not agree to such a nebulous measuring period, if the tenant's initial lease term is of a sufficient duration, two discrete measuring periods 3 years apart could be offered.

Mechanics

Once the parties have agreed upon an appropriate sales volume threshold and measuring period, a number of mechanics will need to be established. Such mechanics are often not considered during the initial discussions concerning the sales volume termination clause, but should be carefully considered and included in the final letter of intent.

The sales volume termination clause should be drafted to require the tenant to notify the landlord in writing of its election to exercise the sales volume termination right within a short window of time ' perhaps 30 to 60 days ' after the end of the measuring period. This will focus the tenant's attention on determining whether the store is economically viable, notwithstanding that the store's sales were below the threshold. Having a window will also reduce the tenant's ability to leverage the threat of the exercise of termination at any time during the remainder of the lease term to gain a concession from the landlord with respect to some other matter in the lease.

The sales volume termination clause should provide that the tenant's failure to exercise the termination right prior to the expiration of the window is deemed a waiver of the termination right.

If the tenant values the sales volume termination clause, then the tenant should bear the responsibility to determine whether and when to exercise its termination right; it should not be the landlord's responsibility.

The sales volume termination clause should prescribe an effective date for any such termination. Ideally, the effective date should be tied to the end of the measuring period, rather than being tied to the date on which the tenant notifies the landlord of any exercise of the termination right. By establishing the effective date of the termination with certainty, the parties avoid any confusion as to the actual date on which the lease terminates. Additionally, the landlord can engage in meaningful re-leasing efforts because it will know the date on which it will regain possession of the space if the tenant exercises its termination right. On the other hand, if the effective date of the termination were 30 days after the date tenant notifies the landlord of its exercise of the termination right and the tenant has an extended period during which it may elect whether to exercise its termination right, then the tenant controls the effective date of the termination by coordinating delivery of the termination notice, leaving the landlord to guess as to the actual date of termination until such time as the tenant delivers its termination notice.

Additional Considerations

With the mechanics in place, the landlord should then turn its attention to a number of frequently overlooked items that can lessen the potential impact of the sales volume termination clause for the landlord.

1) The landlord should consider negotiating a termination fee. Presumably the calculus employed to establish the tenant's minimum rent rate included the landlord's transaction costs for the lease, including improvement allowances, brokerage commissions and attorneys' fees, with the expectation that such costs would be recovered over the entire term through the tenant's payment of minimum rent. If the tenant terminates the lease early, then a portion of such transaction costs would not be realized. Requiring the tenant to reimburse the landlord for the unamortized portion of such transaction costs, however, allows the landlord to recoup such costs. To avoid disputes as to the unamortized amount of such costs, the landlord should establish a termination fee in the sales volume termination clause based on the anticipated improvement allowance, brokerage commissions and attorneys' fees to be expended in connection with the lease and based on the negotiated effective date of any termination pursuant to the sales volume termination clause. Any such termination fee should be included in the final letter of intent. Tenants will often resist the payment of a termination fee equal to the unamortized amount of such transaction costs, in which event the landlord can agree to accept a percentage of such amortized costs. Alternatively, the parties can agree to the payment of minimum rent and additional rent for a period of time, thereby allowing the landlord to generate income from the space during the re-tenanting process.

If the tenant agrees to the payment of a termination fee, the landlord should require that fee to be paid concurrently with the tenant's delivery of the exercise notice. If the tenant objects, the landlord should require that the fee be paid no later than the effective date of the termination as a condition to the effectiveness of the termination. Moreover, the lease should provide that if the tenant fails to pay the termination fee in a timely fashion, then, at the landlord's election, the tenant's exercise of the termination right is voided and the lease remains in full force and effect.

2) If the tenant is not open in the entire premises during the entire time prior to and during the measuring period, the tenant should not be permitted to exercise the sales volume termination right. Inasmuch as the tenant's core concern in negotiating a sales volume termination clause is to secure the right to terminate the lease if the tenant fails to generate sufficient sales at the store, the tenant should have the responsibility of undertaking the necessary effort to develop such sales. If the tenant operates in less than all of the premises, or if the tenant is closed for any meaningful period of time, then it is not fulfilling its responsibility to maximize its sales from the store. Absent a provision to the contrary, such reduced occupancy or such closure increases the likelihood that the tenant will be able to take advantage of the sales volume termination right, and the tenant should not be permitted to take advantage of a situation it helped to create by having the ability to exercise its termination option. Of course, the landlord can make exceptions for limited closures for holidays and inventory/merchandising purposes.

However, an elite cadre of national tenants often rejects such a view, requiring that the landlord look simply to the amount of sales generated during the measuring period, without reference to whether the tenant has been open during or prior to the measuring period. In such cases, the landlord should require that the sales volume threshold be adjusted downward to account for any time during the measuring period that the tenant is not open for business. Recognizing that any meaningful closure will likely have a disproportionately adverse effect on average daily sales, and to discourage closures during the measuring period, any such downward adjustment should be at an accelerated rate – perhaps on a double straight-line basis. For example, a sales volume threshold of $3.65 million equates to $10,000 in sales per day. If the tenant is closed for a period of 30 days during the measuring period, the sales volume threshold would be reduced by $600,000, which is twice the product of the number of days of closure during the measuring period and the per diem sales volume threshold amount.

An additional concern arises in the event the tenant is not open prior to or during the measuring period because of a casualty on the premises. The casualty clause will likely require the landlord to rebuild the premises for the tenant following the occurrence of certain casualty events. The occurrence of such a casualty event during or just prior to the measuring period greatly diminishes the tenant's prospect of generating sufficient sales to satisfy the sales volume threshold and greatly increases the potential for the tenant to terminate the lease shortly after (or during) the landlord's reconstruction of the premises. To address this issue, the casualty clause should be revised to condition the landlord's reconstruction obligation upon the tenant's waiver of its sales volume termination right. For tenants objecting to a requirement to waive the benefit of the sales volume termination clause altogether, the landlord can agree to adjust the measuring period. One adjustment would have the parties tie the measuring period to the date the tenant reopens, or is required to reopen, for business following the landlord's restoration of its premises.

As an example, if the original measuring period covers months 37 through 48 of the lease term, then the new measuring period would be the 37th through 48th months after the date the tenant reopens, or is required to reopen, the premises for business. Alternatively, the parties can agree to adjust the measuring period only if the casualty occurs during the measuring period or within some short period of time (eg, 18 months) prior to the start of the measuring period. Both the landlord and tenant should recognize that the tenant will need a meaningful period of time to re-establish its business following a casualty-related closure. If the parties believe that a 12-month ramping up period is sufficient, then the measuring period can be months 13 through 24 following the date the tenant reopens, or is required to reopen, the premises for business. Conversely, if following a casualty event, the landlord can restore the premises and the tenant can reopen at least 12 months prior to the measuring period, then the measuring period would not be adjusted. While such an alternative is less favorable for the landlord, it does preserve the integrity of the sales volume termination clause and avoids the unintended consequences in the event of a casualty. Note that the same principles apply to a closure occasioned by a condemnation or taking that affects the premises, and the condemnation clause or the sales volume termination clause should be similarly adjusted.

3) The tenant should not be permitted to terminate the lease if its sales exceed the sales volume threshold during any 12-month period prior to the measuring period. The purpose of the sales volume termination clause is to provide the tenant with an exit strategy in the event the store performs poorly. The landlord is willing to accommodate the tenant's request for a sales volume termination clause because the landlord is confident that it can provide a shopping center that will generate sufficient traffic to enable the tenant to satisfy the sales volume threshold. The sales volume termination clause, however, should not be used to shift the operational risks of the tenant's business to the landlord. Accordingly, if the tenant's sales during any 12-month period prior to the measuring period exceed the sales volume threshold, then the landlord has fulfilled its responsibility to provide an active and vital project, and should not then be faced with a tenant terminating its lease because a poor merchandising plan or incompetent store management drives the tenant's sales lower in subsequent years. This is often a particularly contentious point with many tenants and, as with the two points addressed above, should be discussed during the letter of intent stage.

4) The landlord should have the right to audit, inspect or otherwise independently verify the tenant's claim that its sales for the measuring period did not equal or exceed the threshold. If the tenant is otherwise required to pay percentage rent, then the landlord is likely obtaining monthly sales statements and may already have the requisite audit rights. If, however, the tenant is not obligated to pay percentage rent, then the lease may not obligate the tenant to provide sales reports on a regular basis. In such event, the landlord must have the right to review the tenant's sales records to verify the tenant's claimed sales volume.

5) If a tenant has a percentage rent obligation, the parties likely spent some time negotiating carve-outs from and qualifications to the definition of “gross sales” in the lease, all in an effort by the tenant to minimize gross sales for purposes of reporting percentage rent. If the sales volume termination clause is tied to the negotiated definition of gross sales, then not all revenue generated from the premises would be included in determining whether the tenant's sales have satisfied the sales volume threshold, thereby increasing the possibility that the tenant will be permitted to exercise its sales volume termination right. If possible, the sales volume termination clause should avoid the negotiated “gross sales” definition and employ a broader and more generic phrase, such as “all sales of merchandise and revenue derived from the business conducted at the demised premises.”

6) To prevent the tenant from engineering its exercise of the sales volume termination right, the sales volume termination clause should expressly prohibit the tenant from exercising the sales volume termination right if the tenant has opened a competing store within a specified radius of the shopping center. Naturally, if the tenant, or any affiliate, opens a competing business across the street, such business will likely negatively impact sales from the tenant's existing store, and, as a result, increase the likelihood that the tenant would be able to exercise its sales volume termination right. If the tenant wants to terminate its lease to move to a new project across the street, then, to the extent cash flow permits, the tenant can simply open the competing store, cannibalize sales from its existing location and terminate the lease pursuant to the sales volume termination clause. If the tenant is obligated to pay percentage rent, then the landlord may have already included a radius clause within the lease. In such instance, the same parameters can be incorporated into the sales volume termination clause. Otherwise, the sales volume termination clause will need to include a radius restriction.

7) The sales volume termination clause should be personal to the tenant, such that if the tenant were to assign its lease or to sublet its space, the sales volume termination right would lapse. The landlord granted the sales volume termination right to the named tenant in an effort to attract the named tenant to the development. Such tenant's successor may not have warranted a sales volume termination clause, and the landlord should not be required to extend such a concession to such successor. Finally, the tenant should not be able to exercise its sales volume termination right if the tenant is otherwise in default under the lease.

Conclusion

If a landlord provides a sales volume termination right to induce a tenant to its development, then the parties should negotiate more than just the sales volume threshold and the measuring period. Carefully considering the mechanics and including the additional considerations discussed above will produce a sales volume termination clause appropriately tailored specifically to address the tenant's needs and concerns while simultaneously protecting the landlord's interests.