The Use of 'Use' Clauses in Restaurant Leases

For as long as merchants have clustered together to peddle wares, landlords and tenants have understood that consumers are attracted to destinations that present an appealing mix of shopping and dining alternatives from which to choose. If a consumer can satisfy her shopping needs and desires at one destination instead of having to travel to several, she will likely spend more time shopping at that one location (instead of traveling between shopping venues), and the project's merchants and landlord all benefit. If attractive dining options are available to her at the same destination, she will not have to leave to find food when hunger strikes and, again, the merchants and landlord all benefit.

While the clustering of merchants and eating establishments is almost always desirable, clustering also creates problems for landlords and tenants due to their sometimes conflicting objectives. For instance, to bolster profits, landlords typically want to lease projects to a desirable (as determined by the landlord) mix of tenants selling a range of products. To the landlord, competition between tenants is not necessarily bad. If a project is fully leased and tenants are paying their rents, the landlord is rarely unhappy. By contrast, a tenant's sales and profits may suffer if a landlord leases nearby space to the “wrong” competing merchants. Accordingly, tenants remain concerned about limiting their competition while still conducting business at desirable, high-traffic locations.

An 'Exclusive' Right

A tenant's desire to limit competition at a particular location is typically addressed by the tenant demanding an “exclusive” right in its lease to conduct a certain type of business at the project. For example, if the tenant is a Mexican restaurant franchise, an exclusive clause might grant the tenant the right to be the sole purveyor of Mexican food within the project. Landlords must be careful in granting exclusives, however, as a landlord's ability to lease space to other tenants, including sometimes highly desirable larger ones, can be adversely affected by an overly broad exclusive given to a tenant. To maintain leasing flexibility, the landlord must grant exclusives with great care and must seek through the lease's use clause to limit the tenant's merchandise mix and minimize the impact of any exclusive rights given the tenant.

Knowledgeable tenants' lawyers typically seek to secure broad and flexible use clauses for the tenant under the lease. Accordingly, tenant-oriented use clauses are usually permissive in nature: “The Demised Premises may be used for any lawful purposes.” Or “the Premises may be used for the sale of food items and related activities.”

By contrast, landlord-oriented use clauses are commonly structured to be much more restrictive in nature: “The Demised Premises shall be used and occupied only by the tenant named herein for the Permitted Use set forth in Subsection 2.1(a) above and under the trade name set forth in Subsection 2.1(b) above only and for no other use, purpose or trade name whatsoever without the prior written consent of Landlord.”

To be sure, some balancing of interests between landlord and tenant must occur if both parties are to achieve their critical objectives. An understanding of common landlord and tenant use objectives may therefore be helpful.

Common Landlord and Tenant Objectives

Although limiting or preventing competition at a desired location is an obviously desirable objective for most tenants, the enlightened tenant should also strive to build flexibility into its lease in case problems occur with the tenant's original intended use of the premises. If our Mexican restaurant franchise operator determines that Mexican food does not sell well at its leased location, the franchisee might not have a viable business, and it will need to work with its franchisor and landlord to address the dilemma. The franchisor might have a different brand that it would wish to test at that site, or the franchisee might wish to reduce its financial exposure under the lease by subletting the space or assigning its leasehold interest to another type of restaurant. Furthermore, the tenant may wish to incorporate ancillary or related uses into its operation, especially if new opportunities are provided by its franchisor. A highly restrictive use clause imposed by the landlord may greatly reduce the tenant's flexibility in such instance, thus increasing the tenant's overall operating risk at that location.

Most likely, the franchisor is not under a financial obligation on the franchisee's lease. However, any restrictions that reduce the ability of the franchisee to compete also could negatively affect the franchisor.

Other concerns a tenant may have can arise from changing neighborhood or area demographics, changing consumer tastes, changes in tenant mix at the location where tenant is operating, and increases in off-site and nearby competition from other merchants. A more broadly crafted, tenant-oriented use provision can help mitigate tenant concerns over these issues.

Landlords deal with a host of leasing issues when attempting to attract the “perfect” mix of tenants to a location. Filling the project to capacity is only one important objective. Leasing success often comes through putting important complementary users together in a project. Landlords need the flexibility to change the merchant mix and the restaurant mix, as conditions and consumer desires change.

If landlords allow overly broad use and exclusive clauses to find their way into smaller (and earlier) tenants' leases, they may find that problems arise in later lease transactions due to potential violations of the existing tenants' exclusives. By narrowly drafting these provisions in early leases, conflicts can be more easily avoided between existing tenants, and flexibility can be preserved in leasing to future tenants that have not yet been identified.

Landlords often enhance a project's income prospects by incorporating percentage rent (that is, rent based on a tenant's sales) provisions into certain tenants' leases. In so doing, the landlord becomes more vested in tenants' success and must focus on helping tenants maximize their own sales. Accordingly, tenant use clauses must be carefully limited so tenants do not directly compete with each other. Instead, with proper drafting, uses can be complementary, and tenants can engage in businesses that actually enhance each other's sales.

Ultimately, landlords and tenants both benefit from crafting leases that enhance prospects for tenant and overall project success. Shopping centers need diverse and appealing food courts. Industrial and office parks need quick and easy lunch facilities. Fast-food operations are important at locations where lunch hours are short. Hotels want restaurants with a character and quality consistent with that of the hotels themselves.

One question often asked about restaurant lease use clauses is whether language stating that the premises “shall be used” or “are to be used” for a specific purpose is tantamount to a requirement that the operator must continuously operate its business at the premises. While courts have generally been reluctant to force merchants to conduct business, there have been instances when an implied covenant to conduct business has been found to exist within a use clause. In such instances, courts have been influenced by the exact wording of the use clause, the effect of a closed restaurant on the balance of a shopping center, the existence of an exclusive that prohibits other tenants from competing with the tenant, and the existence of percentage rent provisions within the tenant's lease.

In the commercial leasing world, the careful lease scrivener must artfully anticipate the needs of both a project's landlord and prospective tenants, including restaurant tenants, before the first lease is signed. Special consideration should be given first to the likely needs of prospective anchors and larger box tenants (including theaters with food concessions) before smaller tenants' use and exclusive clauses are finalized. Additionally, to maximize the landlord's leasing flexibility, food service users (e.g., restaurants where food is prepared and served for on-premises consumption) should be distinguished by category (full-service tablecloth restaurants, fast-casual restaurants, drive-ins, fast-food restaurants, etc.), ethnicity (Mexican, American, etc.), and characteristics (seating patrons, take-out service, drive-up windows, liquor license, etc.) so their respective use clauses can be appropriately limited.

Conclusion

Use and exclusive clauses play a critical role in the success of restaurant tenants, landlords and commercial real estate projects. Restaurant franchisees are encouraged to engage knowledgeable counsel before signing premises leases. And before approving those leases, the franchisor should take care to ensure that the leases contain use and exclusive clauses crafted to enhance prospects for success of the franchisees and the brand.

William V. McRae, III is an attorney in the Atlanta offices of national law firm Chamberlain Hrdlicka, where his practice focuses on commercial real estate and securities. Having practiced law in Atlanta for more than 25 years, he specializes in handling the diverse transactional needs of franchisors, franchisees, developers, lenders, landlords, tenants, syndicators, and investors. He can be contacted at 404-658-5471.

As an aspiring restaurateur franchisee, a client might walk through a law firm's doors for the first time with a decent grasp of how to successfully operate a restaurant, but with no knowledge of real estate matters and absolutely no clue how to address the complexities associated with a restaurant premises lease. Although this article will not attempt to unravel all the mysteries of the world of commercial leases, it will address one important issue that can be problematic for both landlord and restaurant tenant if not thoughtfully addressed within the lease: the “use” clause.

Use clauses are lease provisions that confirm a tenant's rights to conduct specific activities at its leased premises while prescribing limits on such activities. Absent limitations on the tenant's activities, a tenant can do just about anything it wants within its premises, provided the activity is legal. (Hey, legal is good, right?) But can “legal” activity also be harmful to the landlord and other tenants? Unfortunately, it can.

An Appealing Mix

For as long as merchants have clustered together to peddle wares, landlords and tenants have understood that consumers are attracted to destinations that present an appealing mix of shopping and dining alternatives from which to choose. If a consumer can satisfy her shopping needs and desires at one destination instead of having to travel to several, she will likely spend more time shopping at that one location (instead of traveling between shopping venues), and the project's merchants and landlord all benefit. If attractive dining options are available to her at the same destination, she will not have to leave to find food when hunger strikes and, again, the merchants and landlord all benefit.

While the clustering of merchants and eating establishments is almost always desirable, clustering also creates problems for landlords and tenants due to their sometimes conflicting objectives. For instance, to bolster profits, landlords typically want to lease projects to a desirable (as determined by the landlord) mix of tenants selling a range of products. To the landlord, competition between tenants is not necessarily bad. If a project is fully leased and tenants are paying their rents, the landlord is rarely unhappy. By contrast, a tenant's sales and profits may suffer if a landlord leases nearby space to the “wrong” competing merchants. Accordingly, tenants remain concerned about limiting their competition while still conducting business at desirable, high-traffic locations.

An 'Exclusive' Right

A tenant's desire to limit competition at a particular location is typically addressed by the tenant demanding an “exclusive” right in its lease to conduct a certain type of business at the project. For example, if the tenant is a Mexican restaurant franchise, an exclusive clause might grant the tenant the right to be the sole purveyor of Mexican food within the project. Landlords must be careful in granting exclusives, however, as a landlord's ability to lease space to other tenants, including sometimes highly desirable larger ones, can be adversely affected by an overly broad exclusive given to a tenant. To maintain leasing flexibility, the landlord must grant exclusives with great care and must seek through the lease's use clause to limit the tenant's merchandise mix and minimize the impact of any exclusive rights given the tenant.

Knowledgeable tenants' lawyers typically seek to secure broad and flexible use clauses for the tenant under the lease. Accordingly, tenant-oriented use clauses are usually permissive in nature: “The Demised Premises may be used for any lawful purposes.” Or “the Premises may be used for the sale of food items and related activities.”

By contrast, landlord-oriented use clauses are commonly structured to be much more restrictive in nature: “The Demised Premises shall be used and occupied only by the tenant named herein for the Permitted Use set forth in Subsection 2.1(a) above and under the trade name set forth in Subsection 2.1(b) above only and for no other use, purpose or trade name whatsoever without the prior written consent of Landlord.”

To be sure, some balancing of interests between landlord and tenant must occur if both parties are to achieve their critical objectives. An understanding of common landlord and tenant use objectives may therefore be helpful.

Common Landlord and Tenant Objectives

Although limiting or preventing competition at a desired location is an obviously desirable objective for most tenants, the enlightened tenant should also strive to build flexibility into its lease in case problems occur with the tenant's original intended use of the premises. If our Mexican restaurant franchise operator determines that Mexican food does not sell well at its leased location, the franchisee might not have a viable business, and it will need to work with its franchisor and landlord to address the dilemma. The franchisor might have a different brand that it would wish to test at that site, or the franchisee might wish to reduce its financial exposure under the lease by subletting the space or assigning its leasehold interest to another type of restaurant. Furthermore, the tenant may wish to incorporate ancillary or related uses into its operation, especially if new opportunities are provided by its franchisor. A highly restrictive use clause imposed by the landlord may greatly reduce the tenant's flexibility in such instance, thus increasing the tenant's overall operating risk at that location.

Most likely, the franchisor is not under a financial obligation on the franchisee's lease. However, any restrictions that reduce the ability of the franchisee to compete also could negatively affect the franchisor.

Other concerns a tenant may have can arise from changing neighborhood or area demographics, changing consumer tastes, changes in tenant mix at the location where tenant is operating, and increases in off-site and nearby competition from other merchants. A more broadly crafted, tenant-oriented use provision can help mitigate tenant concerns over these issues.

Landlords deal with a host of leasing issues when attempting to attract the “perfect” mix of tenants to a location. Filling the project to capacity is only one important objective. Leasing success often comes through putting important complementary users together in a project. Landlords need the flexibility to change the merchant mix and the restaurant mix, as conditions and consumer desires change.

If landlords allow overly broad use and exclusive clauses to find their way into smaller (and earlier) tenants' leases, they may find that problems arise in later lease transactions due to potential violations of the existing tenants' exclusives. By narrowly drafting these provisions in early leases, conflicts can be more easily avoided between existing tenants, and flexibility can be preserved in leasing to future tenants that have not yet been identified.

Landlords often enhance a project's income prospects by incorporating percentage rent (that is, rent based on a tenant's sales) provisions into certain tenants' leases. In so doing, the landlord becomes more vested in tenants' success and must focus on helping tenants maximize their own sales. Accordingly, tenant use clauses must be carefully limited so tenants do not directly compete with each other. Instead, with proper drafting, uses can be complementary, and tenants can engage in businesses that actually enhance each other's sales.

Ultimately, landlords and tenants both benefit from crafting leases that enhance prospects for tenant and overall project success. Shopping centers need diverse and appealing food courts. Industrial and office parks need quick and easy lunch facilities. Fast-food operations are important at locations where lunch hours are short. Hotels want restaurants with a character and quality consistent with that of the hotels themselves.

One question often asked about restaurant lease use clauses is whether language stating that the premises “shall be used” or “are to be used” for a specific purpose is tantamount to a requirement that the operator must continuously operate its business at the premises. While courts have generally been reluctant to force merchants to conduct business, there have been instances when an implied covenant to conduct business has been found to exist within a use clause. In such instances, courts have been influenced by the exact wording of the use clause, the effect of a closed restaurant on the balance of a shopping center, the existence of an exclusive that prohibits other tenants from competing with the tenant, and the existence of percentage rent provisions within the tenant's lease.

In the commercial leasing world, the careful lease scrivener must artfully anticipate the needs of both a project's landlord and prospective tenants, including restaurant tenants, before the first lease is signed. Special consideration should be given first to the likely needs of prospective anchors and larger box tenants (including theaters with food concessions) before smaller tenants' use and exclusive clauses are finalized. Additionally, to maximize the landlord's leasing flexibility, food service users (e.g., restaurants where food is prepared and served for on-premises consumption) should be distinguished by category (full-service tablecloth restaurants, fast-casual restaurants, drive-ins, fast-food restaurants, etc.), ethnicity (Mexican, American, etc.), and characteristics (seating patrons, take-out service, drive-up windows, liquor license, etc.) so their respective use clauses can be appropriately limited.

Conclusion

Use and exclusive clauses play a critical role in the success of restaurant tenants, landlords and commercial real estate projects. Restaurant franchisees are encouraged to engage knowledgeable counsel before signing premises leases. And before approving those leases, the franchisor should take care to ensure that the leases contain use and exclusive clauses crafted to enhance prospects for success of the franchisees and the brand.

William V. McRae, III is an attorney in the Atlanta offices of national law firm Chamberlain Hrdlicka, where his practice focuses on commercial real estate and securities. Having practiced law in Atlanta for more than 25 years, he specializes in handling the diverse transactional needs of franchisors, franchisees, developers, lenders, landlords, tenants, syndicators, and investors. He can be contacted at 404-658-5471.