Leasing Covenant Loopholes

1) Statement Regarding the Exclusive-Less Center: Only give up the exclusive use protection if the center is truly a 'give none, get none' center. A 'give none, get none' center is one where no tenant is being granted an exclusive; the landlord will give no exclusives and tenants will get no exclusives. To ensure that the tenant is not giving up a right being granted to other retailers, include a representation and warranty by the landlord that no other tenant in the center has or will be granted exclusive use protection.

2) Leasing Covenant Is Binding on Successor Owners of the Property: As a covenant is an agreement between two parties, a potential loophole occurs when the center is sold or assigned to a new owner. Make sure the leasing covenant binds all future owners and/or affiliates of the landlord.

3) Protect Your Product: As noted above, leasing covenants often are limited to 'direct competitors.' This does not protect a tenant from a retailer not identified as a direct competitor but selling a product or service that is that tenant's specialty. Be clear as to what is a 'direct competitor.' Consider including a definition of primary sales; for example, a 'direct competitor' is any tenant or occupant at the center selling X merchandise in more than __% of its sales floor area.

4) Protect Second-Generation Uses: The leasing covenant will limit the landlord from leasing space to a direct competitor, but gives the tenant no protection for a change in use by another retailer at the shopping center. Protect the future change in use by:

a) Limiting the landlord's right to grant open use clauses: An open use clause is a right granted to tenants to operate any use in their premises. Often a tenant's specific use will be listed and then followed by the right to change to any lawful retail use. Most big box tenants will demand this right, and the landlord will not agree to a request limiting the landlord's right to grant open use covenants to big box tenants; however, smaller retailers often will agree to a limited use, with a change in use requiring the landlord's consent. A tenant should try to include a limitation on open use clauses to big box retailers only.

b) Requiring the landlord's consent to a change in use. Be sure that the leasing covenant limits the landlord from approving a change in use that 'directly competes' with the tenant's use. Landlords may balk at this requirement since it appears to defeat the purpose of a 'give none, get none' center; however, most landlords do try and exercise some control over the uses in their centers to guarantee a proper tenant mix and to ensure that the center continues to operate as a first-class shopping center. Where the landlord has that right, the tenant should ensure that its use is taken into account, and the landlord will not approve a use that directly competes with the tenant's use. This does not require the landlord to limit assignment/sublease rights in leases, but to the extent the landlord has created such limitations and has reserved the right to approve such changes, the landlord should not approve a similar directly competitive use.

5) Memorandum of Lease ('MOL'): Put future tenants on notice that there are certain protections of use in the lease. In an exclusive center, a MOL would include the exclusive being granted as it is binding on third parties and not merely a covenant between landlord and tenant. In an exclusive-less center, in order to protect a tenant's use, a reference should be added to the MOL regarding the leasing covenant. Landlords will require that this be very carefully worded to ensure that it cannot be interpreted as an exclusive (e.g., a broad sentence such as 'Landlord has provided Tenant certain protections of Tenant's use in the Premises' could be added to the document).

6) Remedy: The remedy added should be the same as if tenant had an exclusive whether that is abatement or reduced rent and the right to terminate.

7) Springing Exclusive: Add a right that in the event landlord does grant exclusives at any time in the future, tenant will, as of that date, also be granted an exclusive ' commonly referred to as a 'springing exclusive.' The springing exclusive should include the following:

a) Clear instructions. The timing and operation of a springing exclusive needs to be clearly set forth including: a requirement that the landlord notify the tenant if an exclusive is granted; when the springing exclusive 'springs'; and what is the exclusive right.

b) Memorandum of Lease. If an exclusive 'springs,' require that the landlord execute and record a revised memorandum of lease at the landlord's cost to reflect the terms of the exclusive.

c) Recognition of Exclusive. If an exclusive is granted to a future tenant and the existing tenant's exclusive 'springs' into effect, that future tenant should recognize the existing tenant's exclusive rights. There should be no reciprocal recognition, since the existing tenant should be carved out of the new exclusive.

d) Remedy. Include a remedy for an exclusive use violation.

8) Estoppel Certificates: An estoppel certificate can be an effective tool to verify whether or not any exclusives have been granted in the center. If the landlord requests an estoppel certificate, as part of the tenant's due diligence to confirm that the landlord is not in default under the lease, a written certification from the landlord should be requested, stating that no exclusives have been granted. If the tenant has the right to request estoppels from the landlord, the tenant should include in the estoppel certificate a representation by the landlord that no exclusives have been granted in the center.

Conclusion

By taking the above concepts into consideration, the retailer will get the comfort that its business is protected in the market without an exclusive, and the landlord will be able to move forward in the development of an exclusive-less center.

Camilla Titterington is senior counsel at PetSmart, Inc. in Phoenix. She can be reached at 623-587-2833 or [email protected].

Protecting the success of its business is of prime concern to any retailer client in the course of shopping center lease negotiations. A protection commonly found in leases is an exclusive use right granting a tenant either the exclusive right to sell a particular product in a center or the exclusive right to operate a particular business. An exclusive right in a lease is violated any time an occupant of the shopping center fails to comply with its restrictive terms. As such, it places a burden on the landlord to administer and police a tenant's exclusive throughout the term of the lease. Landlords have, therefore, started to move away from granting exclusive rights to giving leasing covenants ' a provision intended to give a retailer the protection for its use while removing the administrative burden from the landlord in enforcing exclusives. However, is the retailer really getting the benefit of protecting its use from future tenants? Below are some considerations to keep in mind when drafting a leasing covenant for a tenant.

Before looking at some protections to be added to a leasing covenant, it is important to clearly understand the differences between an exclusive and a leasing covenant. In its most common form, a leasing covenant is a promise to the tenant by the landlord not to lease to a 'direct competitor.' The primary distinction between an exclusive use and a leasing covenant is that a covenant is made by the landlord only and is only binding on the landlord. An exclusive is binding on all future tenants and the burden is on the landlord to enforce it against future tenants. Unless a leasing covenant is carefully negotiated, a retailer does not have any of the following exclusive use protections in a leasing covenant scenario: 1) remedy in the event of a rogue tenant violation; 2) protection on second-generation space (i.e., assignments or subleases by tenants to a direct competitor); 3) protection for specific classes of use; and 4) obviously, a right to an exclusive if one is granted to another tenant in the future.

In order to afford the tenant as much protection as possible in an exclusive-less center, the following provisions should be added to a leasing covenant:

1) Statement Regarding the Exclusive-Less Center: Only give up the exclusive use protection if the center is truly a 'give none, get none' center. A 'give none, get none' center is one where no tenant is being granted an exclusive; the landlord will give no exclusives and tenants will get no exclusives. To ensure that the tenant is not giving up a right being granted to other retailers, include a representation and warranty by the landlord that no other tenant in the center has or will be granted exclusive use protection.

2) Leasing Covenant Is Binding on Successor Owners of the Property: As a covenant is an agreement between two parties, a potential loophole occurs when the center is sold or assigned to a new owner. Make sure the leasing covenant binds all future owners and/or affiliates of the landlord.

3) Protect Your Product: As noted above, leasing covenants often are limited to 'direct competitors.' This does not protect a tenant from a retailer not identified as a direct competitor but selling a product or service that is that tenant's specialty. Be clear as to what is a 'direct competitor.' Consider including a definition of primary sales; for example, a 'direct competitor' is any tenant or occupant at the center selling X merchandise in more than __% of its sales floor area.

4) Protect Second-Generation Uses: The leasing covenant will limit the landlord from leasing space to a direct competitor, but gives the tenant no protection for a change in use by another retailer at the shopping center. Protect the future change in use by:

a) Limiting the landlord's right to grant open use clauses: An open use clause is a right granted to tenants to operate any use in their premises. Often a tenant's specific use will be listed and then followed by the right to change to any lawful retail use. Most big box tenants will demand this right, and the landlord will not agree to a request limiting the landlord's right to grant open use covenants to big box tenants; however, smaller retailers often will agree to a limited use, with a change in use requiring the landlord's consent. A tenant should try to include a limitation on open use clauses to big box retailers only.

b) Requiring the landlord's consent to a change in use. Be sure that the leasing covenant limits the landlord from approving a change in use that 'directly competes' with the tenant's use. Landlords may balk at this requirement since it appears to defeat the purpose of a 'give none, get none' center; however, most landlords do try and exercise some control over the uses in their centers to guarantee a proper tenant mix and to ensure that the center continues to operate as a first-class shopping center. Where the landlord has that right, the tenant should ensure that its use is taken into account, and the landlord will not approve a use that directly competes with the tenant's use. This does not require the landlord to limit assignment/sublease rights in leases, but to the extent the landlord has created such limitations and has reserved the right to approve such changes, the landlord should not approve a similar directly competitive use.

5) Memorandum of Lease ('MOL'): Put future tenants on notice that there are certain protections of use in the lease. In an exclusive center, a MOL would include the exclusive being granted as it is binding on third parties and not merely a covenant between landlord and tenant. In an exclusive-less center, in order to protect a tenant's use, a reference should be added to the MOL regarding the leasing covenant. Landlords will require that this be very carefully worded to ensure that it cannot be interpreted as an exclusive (e.g., a broad sentence such as 'Landlord has provided Tenant certain protections of Tenant's use in the Premises' could be added to the document).

6) Remedy: The remedy added should be the same as if tenant had an exclusive whether that is abatement or reduced rent and the right to terminate.

7) Springing Exclusive: Add a right that in the event landlord does grant exclusives at any time in the future, tenant will, as of that date, also be granted an exclusive ' commonly referred to as a 'springing exclusive.' The springing exclusive should include the following:

a) Clear instructions. The timing and operation of a springing exclusive needs to be clearly set forth including: a requirement that the landlord notify the tenant if an exclusive is granted; when the springing exclusive 'springs'; and what is the exclusive right.

b) Memorandum of Lease. If an exclusive 'springs,' require that the landlord execute and record a revised memorandum of lease at the landlord's cost to reflect the terms of the exclusive.

c) Recognition of Exclusive. If an exclusive is granted to a future tenant and the existing tenant's exclusive 'springs' into effect, that future tenant should recognize the existing tenant's exclusive rights. There should be no reciprocal recognition, since the existing tenant should be carved out of the new exclusive.

d) Remedy. Include a remedy for an exclusive use violation.

8) Estoppel Certificates: An estoppel certificate can be an effective tool to verify whether or not any exclusives have been granted in the center. If the landlord requests an estoppel certificate, as part of the tenant's due diligence to confirm that the landlord is not in default under the lease, a written certification from the landlord should be requested, stating that no exclusives have been granted. If the tenant has the right to request estoppels from the landlord, the tenant should include in the estoppel certificate a representation by the landlord that no exclusives have been granted in the center.

Conclusion

By taking the above concepts into consideration, the retailer will get the comfort that its business is protected in the market without an exclusive, and the landlord will be able to move forward in the development of an exclusive-less center.

Camilla Titterington is senior counsel at PetSmart, Inc. in Phoenix. She can be reached at 623-587-2833 or [email protected].