Protecting and Attacking Exclusive Use Provisions in Retail Leases

Exclusive use provisions form the foundation of the economic relationships between tenants and landlords in shopping centers across the United States. Landlords make use of these provisions to obtain the right tenant mix in their shopping centers as well as to demand premium rents from the tenants that desire these economic protections. Tenants desire exclusive use provisions to gain the competitive advantages and protections that such provisions afford to their products and services. With the proliferation of so-called 'big box' retailers in shopping centers and the phenomena of over-retailing in communities throughout the United States, exclusive use provisions are increasingly coming under attack. In Tippecanoe Assocs. II, LLC v. Kimco Lafayette 671, Inc., 829 N.E.2d 512 (Ind. 2005), the Supreme Court of Indiana entered the fray on this issue with a decision that affects the way these provisions should be drafted. This article, through a discussion of the court's decision in Tippecanoe Assocs. II, LLC, describes how exclusive use provisions are coming under attack and practical ways to draft around these issues and to protect landlords and tenants with exclusive use provisions in retail leases.

The Decision in Tippecanoe

What occurred in Tippecanoe Assocs. II, LLC is that the validity of an exclusive use provision was contested on the basis that the provision constituted an unreasonable restraint on trade. An exclusive use provision may be invalidated if it can be shown that the provision prohibits an overbroad type of activity or if the provision is excessively burdensome to one of the parties to the lease or to the public. In Tippecanoe Assocs. II, LLC, Kroger Company ('Kroger') assigned three leases in Tippecanoe County, IN, to Pay-Less Super Markets ('PayLess'). One of the leases (the 'Kroger Lease'), located in the Sagamore Shopping Center (the 'Center'), contained an exclusive use provision that prevented the owner of the Center from leasing space to another grocery store. At the time that PayLess took the assignment of the Kroger Lease, PayLess already operated two other grocery stores within two miles of the Center. PayLess, as the Indiana Supreme Court put it, 'cheerfully conceded' that it had no intention of operating a grocery store in the Center and acquired the lease to exclude competitors from the location. While PayLess did not operate a grocery store in the space formerly occupied by Kroger, PayLess paid rent and subleased the space to an appliance store. In 2000, 18 years after PayLess took the assignment of the space from Kroger, the owner of the Center asked the Indiana courts to declare the restrictive covenant unenforceable because the space was not being operated as a grocery store. This was done to allow the owner of the Center to enter into a lease with another grocery store chain in a large space that had become available.

The Indiana Supreme Court found that the exclusive use in the Kroger Lease had an adverse impact on competition. The court came to this conclusion even though PayLess was operating two other grocery stores within two miles of the Center and even though no facts on the competitive impact to Tippecanoe County were discussed by the court. Tenants that find themselves in PayLess' position could take the approaches that follow to protect their exclusive use provisions from attack, and landlords can negotiate needed relief short of litigation.

1) Present Facts on the Availability of the Protected Products Or Services in the Area.

The Indiana Supreme Court was troubled by the fact that an entity that was not operating in the Center was using the exclusive use provision to completely exclude from the Center the use protected by the provision. Therefore, it appears the anticompetitive argument is unlikely to be successful against a tenant that bargained for the exclusive use, is present in the shopping center, and is operating its business under the protected use. To address a court's concerns about the competitive impacts of an exclusive use provision, a tenant or assignee in a similar situation might defend itself by presenting evidence on the availability to the public of particular products or services in the community. The anticompetitive argument should be more difficult to make in a large metropolitan area where, due to over-retailing, consumers within a few blocks can find similar products and services to the ones subject to restraint in a particular shopping center. In a smaller community where a significant duplication in products or services available to consumers may not exist, a court may likely conclude as the Indiana Supreme Court did.

2) Present Facts That the Lease Is Between Sophisticated Parties.

Parties that find themselves in the PayLess situation, regardless of whether they are the landlord, the tenant, or a subtenant, should make a court aware that in attempting to 'balance the equities,' the result often unfairly rewards one party to the detriment of the other. The parties to any such dispute should be certain to inform the court of the experience and sophistication of the parties, especially where national retailers are involved. As in Tippecanoe Assocs. II, LLC, disputes over the enforcement of exclusive use provisions usually arise because one of the affected parties has become dissatisfied with the terms of the original transaction. This dissatisfaction could have resulted from poor negotiation, lack of foresight on the part of one of the parties, a change in market conditions, or changed circumstances of the parties due to a merger or consolidation. Regardless of the circumstances, it is arguable that courts should be reluctant to intervene on the side of large entities fully capable of protecting themselves. It is interesting to note that the Indiana Supreme Court never discussed whether the owner of the Center had tried to purchase from PayLess the right to terminate the exclusive. While PayLess would have had no obligation to relinquish the protections of the exclusive use provision, the value of the right should be quantifiable. Courts may invite more litigation into courtrooms across their state with rulings such as the one in Tippecanoe Assocs. II, LLC. Rather, courts should encourage parties whose sophistication enables them to negotiate among themselves to find market solutions to market problems.

Drafting Techniques to Protect Exclusive Uses

Although the outcome in Tippecanoe Assocs. II, LLC, disappointed PayLess' contractual expectations, landlords and tenants can better protect themselves and their future ability to enforce the exclusive use provisions in their leases. The doctrine of the enforceability of contracts strongly argues for the enforcement of exclusive use provisions in most leases, especially where it appears that the parties have negotiated and agreed upon specific provisions. Commercial real estate leases must be read as a whole because there is significant interaction among exclusive use provisions and other provisions of a lease. Continuous operation provisions, radius restrictions, and assignment provisions all are part of most retail lease negotiations and significantly affect the value and effect of an exclusive use provision in a lease.

Continuous Use Provisions

If the parties agree that a tenant will continuously operate the leased premises for the use permitted in the lease, and there is an exclusive use provision in the lease, the failure of a tenant to so operate is a breach of the lease, entitling the landlord to terminate the lease and rid itself of the exclusive use provision. Most tenants reject continuous operation clauses and will want to negotiate broad permitted use provisions, while at the same time including an exclusive use provision that protects its core use. The tenant is seeking greater flexibility in the products and services that it is able to offer, as well as an easier ability to assign the lease later on. Landlords also can narrowly define the permitted use to cover only the exclusive uses that are protected, virtually ensuring that no offensive use of the exclusive is later made by the tenant.

Where the parties to a shopping center lease have concluded that a continuous operation provision will not be a part of the lease, it may now be prudent for a tenant, in the face of holdings such as Tippecanoe Assocs. II, LLC, to include a provision in a lease addressing this point. For example:

Landlord and Tenant hereby expressly agree that Tenant shall not be required to use the Premises for any use, including for the exclusive use granted to Tenant pursuant to Section __ during the Term of this Lease.

Rather than requiring that the exclusive use be used for the entire term of the lease, the parties could specify that an exclusive use granted in a lease could expire if the leased premises is not used for a set period of time. For example:

In the event that the Premises shall not be used during the Term of this Lease for any of the uses set forth in Section __ ('Exclusive Uses') for a period of ___ years, the rights granted to Tenant thereunder with respect to such Exclusive Uses shall lapse and shall thereafter be of no further force or effect.

While tenants are likely to be wary of such a provision, Landlords might also protect themselves by negotiating a provision that allows them to purchase the exclusive use back from the tenant at a later date. For example:

Landlord may at any time during the Term of this Lease terminate the right to exclusively operate in the Shopping Center for the uses set forth in Section __ ('Exclusive Uses') upon ninety (90) days written notice thereof by paying Tenant the sum of $______________.

Radius Clauses

Landlords and tenants often also disagree about the inclusion of radius restrictions in a lease. These clauses restrict a tenant from operating another of its locations within a specified radius of the shopping center in order to significantly enhance the value of the shopping center. By drafting a radius clause that restricts the exclusive use rather than whatever operations the tenant may have, the landlord can pair the benefits that the tenant seeks with the protection that the landlord desires. If this pairing had been present in Tippecanoe Assocs. II, LLC, PayLess would have been in default of the lease if it operated other grocery stores within the restricted radius. Some tenants refuse to agree to such a provision or may agree only if the provision is narrowly tailored to apply to specified business units of the tenant. For example, a big-box retailer might agree to a radius clause restricting only its right to sell grocery items within a three-mile radius surrounding the shopping center. This would leave the retailer free to offer its other goods and services within the radius area. The more congruent the exclusive use provision and radius restrictions are to each other, the greater the value to the landlord and tenant.

Assignment Clauses

Assignment clauses also significantly impact the effectiveness of exclusive use provisions in leases. Landlords often will want to negotiate assignment clauses that allow them to withhold their consent unreasonably (if permitted by law). Tenants will want to state that a landlord's consent to an assignment of the lease may not be unreasonably withheld, conditioned, or delayed, as well as specify certain instances where a landlord's consent is not required. A landlord that allows for an assignment of the lease to occur in the event that a tenant merges with another entity, experiences a change of control, or sells all or substantially all of its assets to another entity may find itself in a similar situation to the owner of the Center in Tippecanoe Assocs. II, LLC. Large retailers and service providers with numerous locations in any market will carefully consider the benefits and consequences that each lease in their portfolio affords them in formulating their strategic plan for a particular market. Landlords that fail to consider the effects of merger and acquisition activity on their shopping centers may find themselves in a courtroom rather than with a clearly enforceable lease that protects their rights and their profits in the shopping center.

Other Protective Clauses

Courts should be wary of striking down exclusive use provisions in leases because such an action might have unintended consequences. A lease without an exclusive use provision does not command the rental that a lease with an exclusive use provision commands, and decisions such as the one in Tippecanoe Assocs. II, LLC, significantly impact the economics of the lease. Prudent parties can anticipate such events in the initial drafting of the lease by inserting anti-severability clauses. While a typical lease would have a severability clause, it may be advisable to exclude from its effect the unenforceability of exclusive use, continuous operation, and radius provisions. With such an anti-severability clause in place, the parties would have the right to terminate the lease if one of these provisions were later stricken from the lease by a court.

Another approach that parties may find helpful is to quantify the value to the leasehold estate of the exclusive use provision in the event that this provision is later held to be invalid. For example:

In the event that the provisions of Section __ shall be held to be invalid, the Base Rent shall be reduced by __% for the remainder of the Term of this Lease.

Parties to a commercial shopping center lease may also want to consider having other provisions such as radius clauses nullified in the event that an exclusive use provision is held to be invalid during the term of the lease. For example:

In the event that the provisions of Section __ shall be held to be invalid, the provisions of Section __ and Section __ shall be of no further force or effect.

Conclusion

The lesson to be learned from rulings like the one in Tippecanoe Assocs. II, LLC is that the parties to shopping center leases should be more proactive in anticipating the effects of changes in market conditions and the law during the term of a lease. A well-crafted lease that anticipates these changes will undoubtedly increase the value of both the shopping center and the leasehold, thereby benefiting all parties involved.

Jane Snoddy Smith is a partner in the Austin, TX, office of Fulbright & Jaworski, LLP, concentrating in the areas of real estate; commercial real estate; construction law; and structured finance. Bryan Wesley Patrick is an associate at Fulbright's Austin, TX, office, where he is a member of the firm's real estate group and practices in the areas of commercial real estate development and leasing.

Exclusive use provisions form the foundation of the economic relationships between tenants and landlords in shopping centers across the United States. Landlords make use of these provisions to obtain the right tenant mix in their shopping centers as well as to demand premium rents from the tenants that desire these economic protections. Tenants desire exclusive use provisions to gain the competitive advantages and protections that such provisions afford to their products and services. With the proliferation of so-called 'big box' retailers in shopping centers and the phenomena of over-retailing in communities throughout the United States, exclusive use provisions are increasingly coming under attack. In Tippecanoe Assocs. II, LLC v. Kimco Lafayette 671, Inc., 829 N.E.2d 512 (Ind. 2005), the Supreme Court of Indiana entered the fray on this issue with a decision that affects the way these provisions should be drafted. This article, through a discussion of the court's decision in Tippecanoe Assocs. II, LLC, describes how exclusive use provisions are coming under attack and practical ways to draft around these issues and to protect landlords and tenants with exclusive use provisions in retail leases.

The Decision in Tippecanoe

What occurred in Tippecanoe Assocs. II, LLC is that the validity of an exclusive use provision was contested on the basis that the provision constituted an unreasonable restraint on trade. An exclusive use provision may be invalidated if it can be shown that the provision prohibits an overbroad type of activity or if the provision is excessively burdensome to one of the parties to the lease or to the public. In Tippecanoe Assocs. II, LLC, Kroger Company ('Kroger') assigned three leases in Tippecanoe County, IN, to Pay-Less Super Markets ('PayLess'). One of the leases (the 'Kroger Lease'), located in the Sagamore Shopping Center (the 'Center'), contained an exclusive use provision that prevented the owner of the Center from leasing space to another grocery store. At the time that PayLess took the assignment of the Kroger Lease, PayLess already operated two other grocery stores within two miles of the Center. PayLess, as the Indiana Supreme Court put it, 'cheerfully conceded' that it had no intention of operating a grocery store in the Center and acquired the lease to exclude competitors from the location. While PayLess did not operate a grocery store in the space formerly occupied by Kroger, PayLess paid rent and subleased the space to an appliance store. In 2000, 18 years after PayLess took the assignment of the space from Kroger, the owner of the Center asked the Indiana courts to declare the restrictive covenant unenforceable because the space was not being operated as a grocery store. This was done to allow the owner of the Center to enter into a lease with another grocery store chain in a large space that had become available.

The Indiana Supreme Court found that the exclusive use in the Kroger Lease had an adverse impact on competition. The court came to this conclusion even though PayLess was operating two other grocery stores within two miles of the Center and even though no facts on the competitive impact to Tippecanoe County were discussed by the court. Tenants that find themselves in PayLess' position could take the approaches that follow to protect their exclusive use provisions from attack, and landlords can negotiate needed relief short of litigation.

1) Present Facts on the Availability of the Protected Products Or Services in the Area.

The Indiana Supreme Court was troubled by the fact that an entity that was not operating in the Center was using the exclusive use provision to completely exclude from the Center the use protected by the provision. Therefore, it appears the anticompetitive argument is unlikely to be successful against a tenant that bargained for the exclusive use, is present in the shopping center, and is operating its business under the protected use. To address a court's concerns about the competitive impacts of an exclusive use provision, a tenant or assignee in a similar situation might defend itself by presenting evidence on the availability to the public of particular products or services in the community. The anticompetitive argument should be more difficult to make in a large metropolitan area where, due to over-retailing, consumers within a few blocks can find similar products and services to the ones subject to restraint in a particular shopping center. In a smaller community where a significant duplication in products or services available to consumers may not exist, a court may likely conclude as the Indiana Supreme Court did.

2) Present Facts That the Lease Is Between Sophisticated Parties.

Parties that find themselves in the PayLess situation, regardless of whether they are the landlord, the tenant, or a subtenant, should make a court aware that in attempting to 'balance the equities,' the result often unfairly rewards one party to the detriment of the other. The parties to any such dispute should be certain to inform the court of the experience and sophistication of the parties, especially where national retailers are involved. As in Tippecanoe Assocs. II, LLC, disputes over the enforcement of exclusive use provisions usually arise because one of the affected parties has become dissatisfied with the terms of the original transaction. This dissatisfaction could have resulted from poor negotiation, lack of foresight on the part of one of the parties, a change in market conditions, or changed circumstances of the parties due to a merger or consolidation. Regardless of the circumstances, it is arguable that courts should be reluctant to intervene on the side of large entities fully capable of protecting themselves. It is interesting to note that the Indiana Supreme Court never discussed whether the owner of the Center had tried to purchase from PayLess the right to terminate the exclusive. While PayLess would have had no obligation to relinquish the protections of the exclusive use provision, the value of the right should be quantifiable. Courts may invite more litigation into courtrooms across their state with rulings such as the one in Tippecanoe Assocs. II, LLC. Rather, courts should encourage parties whose sophistication enables them to negotiate among themselves to find market solutions to market problems.

Drafting Techniques to Protect Exclusive Uses

Although the outcome in Tippecanoe Assocs. II, LLC, disappointed PayLess' contractual expectations, landlords and tenants can better protect themselves and their future ability to enforce the exclusive use provisions in their leases. The doctrine of the enforceability of contracts strongly argues for the enforcement of exclusive use provisions in most leases, especially where it appears that the parties have negotiated and agreed upon specific provisions. Commercial real estate leases must be read as a whole because there is significant interaction among exclusive use provisions and other provisions of a lease. Continuous operation provisions, radius restrictions, and assignment provisions all are part of most retail lease negotiations and significantly affect the value and effect of an exclusive use provision in a lease.

Continuous Use Provisions

If the parties agree that a tenant will continuously operate the leased premises for the use permitted in the lease, and there is an exclusive use provision in the lease, the failure of a tenant to so operate is a breach of the lease, entitling the landlord to terminate the lease and rid itself of the exclusive use provision. Most tenants reject continuous operation clauses and will want to negotiate broad permitted use provisions, while at the same time including an exclusive use provision that protects its core use. The tenant is seeking greater flexibility in the products and services that it is able to offer, as well as an easier ability to assign the lease later on. Landlords also can narrowly define the permitted use to cover only the exclusive uses that are protected, virtually ensuring that no offensive use of the exclusive is later made by the tenant.

Where the parties to a shopping center lease have concluded that a continuous operation provision will not be a part of the lease, it may now be prudent for a tenant, in the face of holdings such as Tippecanoe Assocs. II, LLC, to include a provision in a lease addressing this point. For example:

Landlord and Tenant hereby expressly agree that Tenant shall not be required to use the Premises for any use, including for the exclusive use granted to Tenant pursuant to Section __ during the Term of this Lease.

Rather than requiring that the exclusive use be used for the entire term of the lease, the parties could specify that an exclusive use granted in a lease could expire if the leased premises is not used for a set period of time. For example:

In the event that the Premises shall not be used during the Term of this Lease for any of the uses set forth in Section __ ('Exclusive Uses') for a period of ___ years, the rights granted to Tenant thereunder with respect to such Exclusive Uses shall lapse and shall thereafter be of no further force or effect.

While tenants are likely to be wary of such a provision, Landlords might also protect themselves by negotiating a provision that allows them to purchase the exclusive use back from the tenant at a later date. For example:

Landlord may at any time during the Term of this Lease terminate the right to exclusively operate in the Shopping Center for the uses set forth in Section __ ('Exclusive Uses') upon ninety (90) days written notice thereof by paying Tenant the sum of $______________.

Radius Clauses

Landlords and tenants often also disagree about the inclusion of radius restrictions in a lease. These clauses restrict a tenant from operating another of its locations within a specified radius of the shopping center in order to significantly enhance the value of the shopping center. By drafting a radius clause that restricts the exclusive use rather than whatever operations the tenant may have, the landlord can pair the benefits that the tenant seeks with the protection that the landlord desires. If this pairing had been present in Tippecanoe Assocs. II, LLC, PayLess would have been in default of the lease if it operated other grocery stores within the restricted radius. Some tenants refuse to agree to such a provision or may agree only if the provision is narrowly tailored to apply to specified business units of the tenant. For example, a big-box retailer might agree to a radius clause restricting only its right to sell grocery items within a three-mile radius surrounding the shopping center. This would leave the retailer free to offer its other goods and services within the radius area. The more congruent the exclusive use provision and radius restrictions are to each other, the greater the value to the landlord and tenant.

Assignment Clauses

Assignment clauses also significantly impact the effectiveness of exclusive use provisions in leases. Landlords often will want to negotiate assignment clauses that allow them to withhold their consent unreasonably (if permitted by law). Tenants will want to state that a landlord's consent to an assignment of the lease may not be unreasonably withheld, conditioned, or delayed, as well as specify certain instances where a landlord's consent is not required. A landlord that allows for an assignment of the lease to occur in the event that a tenant merges with another entity, experiences a change of control, or sells all or substantially all of its assets to another entity may find itself in a similar situation to the owner of the Center in Tippecanoe Assocs. II, LLC. Large retailers and service providers with numerous locations in any market will carefully consider the benefits and consequences that each lease in their portfolio affords them in formulating their strategic plan for a particular market. Landlords that fail to consider the effects of merger and acquisition activity on their shopping centers may find themselves in a courtroom rather than with a clearly enforceable lease that protects their rights and their profits in the shopping center.

Other Protective Clauses

Courts should be wary of striking down exclusive use provisions in leases because such an action might have unintended consequences. A lease without an exclusive use provision does not command the rental that a lease with an exclusive use provision commands, and decisions such as the one in Tippecanoe Assocs. II, LLC, significantly impact the economics of the lease. Prudent parties can anticipate such events in the initial drafting of the lease by inserting anti-severability clauses. While a typical lease would have a severability clause, it may be advisable to exclude from its effect the unenforceability of exclusive use, continuous operation, and radius provisions. With such an anti-severability clause in place, the parties would have the right to terminate the lease if one of these provisions were later stricken from the lease by a court.

Another approach that parties may find helpful is to quantify the value to the leasehold estate of the exclusive use provision in the event that this provision is later held to be invalid. For example:

In the event that the provisions of Section __ shall be held to be invalid, the Base Rent shall be reduced by __% for the remainder of the Term of this Lease.

Parties to a commercial shopping center lease may also want to consider having other provisions such as radius clauses nullified in the event that an exclusive use provision is held to be invalid during the term of the lease. For example:

In the event that the provisions of Section __ shall be held to be invalid, the provisions of Section __ and Section __ shall be of no further force or effect.

Conclusion

The lesson to be learned from rulings like the one in Tippecanoe Assocs. II, LLC is that the parties to shopping center leases should be more proactive in anticipating the effects of changes in market conditions and the law during the term of a lease. A well-crafted lease that anticipates these changes will undoubtedly increase the value of both the shopping center and the leasehold, thereby benefiting all parties involved.

Jane Snoddy Smith is a partner in the Austin, TX, office of Fulbright & Jaworski, LLP, concentrating in the areas of real estate; commercial real estate; construction law; and structured finance. Bryan Wesley Patrick is an associate at Fulbright's Austin, TX, office, where he is a member of the firm's real estate group and practices in the areas of commercial real estate development and leasing.