Lease Due Diligence

1. Use Restrictions

It is imperative that a tenant make itself aware of anything that can restrict its intended use of property it desires to lease. REAs can impose limits on the types of businesses that can operate on a particular parcel. It is important to read the REA to determine if it contains any restrictions that a tenant thinks can be problematic. For example, REA use restrictions may: 1) curb certain “service” uses such as financial institutions, brokerage offices, restaurants, health clubs, theaters, nightclubs, travel agencies and similar service establishments; and 2) provide that a developer “shall not permit more than [10%] of the floor area of the developer's mall stores to be occupied by such service establishments” without the prior approval of a major retailer. This could be a deal-breaker for your client! An REA can exclude a use completely (as in the case where “outdoor sales” and “drive-through service” activities are prohibited) or it can exclude a use from occurring within a certain distance from a major retailer, i.e., REAs excluding any pet shops within 150 feet from the entrance of the building of a major retailer (also known as an “anchor”).

2. Operating Restrictions

As important as use restrictions are, operating restrictions can be just as vital to a tenant. If certain operating restrictions in an REA are not compatible with a tenant's operating requirements, a tenant must be aware of this early on, before lease negotiations go too far. For example, an REA may require that stores within the mall be open for business to the general public during certain hours. Depending upon the business that is being run at a particular location, compliance with this provision could end up being an issue. In one case, a party to an REA was obligated to conduct its operations for 10 years using a particular trade name, and was required to operate in a manner similar to a majority of other stores operated by it under the same trade name or place a comparable substitute “department store” in the same location. If the REA's specific language defining a comparable “department store” is not precise enough, this opens the door for later disputes if a developer believes that the replacement tenant does not measure up to its mall standards and it can point to the REA to back up its position. For example, in 2005, when a Lord & Taylor store closed its operations at the Cherry Creek Shopping Center in Denver, the landlord protested when a Foley's Men's and Home store was chosen to replace the tenant. The landlord claimed the definition of “department store” in the REA prohibited such a move. Being aware of what the REA says before you enter into a lease could help a new tenant avoid getting in the middle of such situations. In another instance, an REA provided that each anchor could elect to extend its hours of operation (for five days in any particular year upon prior notice to the developer), to no later than midnight, and could require the developer to operate the exterior portion of the common area adjacent to such store during such extended hours of operation. Such a provision can be viewed as a benefit for many prospective tenants that anticipate the need to extend their hours of operation at certain times of the year.

3. Building Restrictions

It is hard enough for a tenant to negotiate the terms of a proposed build-out of space with a landlord. Add in the requirement for municipal approvals and it becomes even more difficult. If an REA causes the proposed building plans to be subject to the review and approval of additional parties, with interests that are potentially adverse to a tenant, this would certainly be another due diligence consideration.

Many REAs restrict the areas in which a building can be located. For example, REAs often refer to a “Permissible Building Area.” Such an area refers to the sites within the shopping center tract (or any component tract thereof) where a future store may construct its building. The Permissible Building Area may also have height or other restrictions. If the proposed redevelopment or expansion is not within the “Permissible Building Area” or violates any other restriction pertaining to construction contained in the REA (such as a requirement that all buildings be architecturally compatible with the other buildings in the project), this could lead to unintended problems. Even the installation of utilities serving the premises can be an issue when an REA states that all sewers, drains, mains and utility lines shall be underground and the lease's construction plans provide otherwise.

Also note that many REAs state that any building plan revision (for example, in the location, number of levels, height, and exterior configuration of any buildings and structures hereafter constructed) that differs from that shown in the REA are subject to the written approval of the other parties to the REA, which approval shall be at such parties' sole and absolute discretion. If a developer or major retailer has such broad approval rights, a tenant will have a tough time if it later complains that its building plans were arbitrarily denied.

Alteration restrictions in REAs can cause headaches because they often impose requirements that may be different from what is stated in the lease. For example, one REA states that all “staging areas shall be surrounded by an exterior grade plywood or woven wire or chain link fence, at least six feet in height, and painted a color approved by developer.” If the tenant did not read the REA, it may not be aware it violated this provision until it is too late. Also note that insurance requirements set forth in a lease must be at least as stringent as what is set forth in the REA and may require additional parties to be listed as additional insureds on applicable policies.

4. Access/Parking Restrictions

If a tenant does not have adequate space for its customers to park their cars, the customers will go elsewhere. If a retailer's employees must park too far from the entrance of its store, the employees will not be happy. That is why it is important to make sure that an REA provides for: 1) sufficient parking capacity for customers (usually five parking spaces for each 1000 square feet of floor area in the shopping center for normal retail uses); and 2) parking that is close enough for employees (to prevent them from complaining too loudly). Also be aware that some REAs provide that certain valet parking spaces can be reserved on a portion of the parking lot. This could be an issue if the reserved space is too close to a store entrance and makes parking less accessible to the tenant's customers.

5. Sign Restrictions

Sign restrictions in an REA may designate that signs must be a certain color, size or shape. Exhibits to an REA may contain additional signage criteria. Further, most REAs provide that no signs shall be erected if they fail to conform in any respect with the signage criteria. Those companies with strict signage requirements may seek approval to erect a nonconforming sign but such consent, often times, may be withheld for any or no reason.

6. Rules and Regulations

Just as there are rules and regulations attached to many leases, there are those that can be attached to an REA that can apply to an entire project. Do not assume that the rules and regulations of an REA are the same as those contained in your lease. Read the rules and regulations set forth in an REA with the same care that you would if they were stated in your lease. It is important to read them to be sure there are no terms and conditions set forth therein that a tenant would find to be objectionable.

7. Site Plan Layout

If a Site Plan states that it cannot be amended without the prior written consent of particular parties to the REA, and their consent may be withheld for any or no reason, those parties can make it virtually impossible for another tenant to modify the Site Plan subsequently. Thus, the layout of the buildings and other improvements, such as signs, loading docks, etc., can be set in such a way as to give the controlling retailers (usually anchor tenants) favorable: 1) store and signage visibility; and 2) parking and loading access that your client's store cannot attain. Depending upon a new retailer's size, if a REA has such a “frozen site plan,” this could be a factor causing a tenant to avoid choosing a particular leasing location.

8. Ambiguous or Sloppily Written Language

Not all REAs are equal. Some are written better than others. For example, in some REAs, there is language that has more than one meaning, i.e., a provision that a business be a “first-class enclosed mall-type tenant.” Moreover, if the REA was drafted a long time ago and the demographics have changed, the standard for determining who is a “first-class enclosed mall-type tenant” may also have changed. Such a term, without further refinement, can be viewed as a subjective description that can, in turn, lead to litigation seeking judicial determination as to what the term means. In any instance where the wording of a REA is not clear, one party or another may use such language to its advantage. In a leasing context, a prospective tenant may want to be aware of, and in some instances avoid, getting involved in deals where an REA could potentially be interpreted to its detriment.

Conclusion

Although REAs may serve a useful purpose by reducing conflicts that can arise when multiple parties control a shared property, for leasing practitioners it is important to realize that an REA can have a substantial impact on tenants that are leasing space within a project. Therefore, it is critically important that a leasing practitioner be well-versed in these potential issues.

Mark Morfopoulos, a member of this newsletter's Board of Editors, is an attorney in Hartsdale, NY. His practice is focused on all aspects of office and retail leasing. He can be reached at [email protected].

When several parties ' usually a developer and one or more retailers who own land adjacent to the developer ' desire to make integrated use of their respective properties, they can enter into a Reciprocal Easement Agreement (REA, which may also be called a Construction, Operation and Reciprocal Easement Agreement, COREA). Both REA and COREA are terms that describe a type of agreement that can be used to control the development, use, and maintenance of several parcels of land. They impose obligations that “run with the land.” Thus, the respective owner-landlords will be subject to the restrictions of, and benefit from, the rights contained in a REA. This also means that prospective tenants may benefit from, and be subject to, a REA's rights and restrictions. Therefore, it is not only the lease itself that can affect the rights and obligations of a landlord and tenant; REAs, and other agreements made by third parties (who have interests that may or may not coincide with those of a tenant), can change the whole dynamic of a leasing transaction.

Note, however, that quite often it may not be obvious that several owners control a particular project. Because the construction, operation, and use of the property are governed by a single agreement, it may seem that it is owned by one entity. To determine if property is affected by an REA, carefully review a title report to see what covenants and restrictions apply. Only then will you know if an REA could impose unwanted restrictions on leased property.

When negotiating a lease of a parcel that is subject to an REA, a practitioner must be aware that there are many ways that an REA can adversely impact a tenant. Eight factors to consider when reviewing an REA follow below.

1. Use Restrictions

It is imperative that a tenant make itself aware of anything that can restrict its intended use of property it desires to lease. REAs can impose limits on the types of businesses that can operate on a particular parcel. It is important to read the REA to determine if it contains any restrictions that a tenant thinks can be problematic. For example, REA use restrictions may: 1) curb certain “service” uses such as financial institutions, brokerage offices, restaurants, health clubs, theaters, nightclubs, travel agencies and similar service establishments; and 2) provide that a developer “shall not permit more than [10%] of the floor area of the developer's mall stores to be occupied by such service establishments” without the prior approval of a major retailer. This could be a deal-breaker for your client! An REA can exclude a use completely (as in the case where “outdoor sales” and “drive-through service” activities are prohibited) or it can exclude a use from occurring within a certain distance from a major retailer, i.e., REAs excluding any pet shops within 150 feet from the entrance of the building of a major retailer (also known as an “anchor”).

2. Operating Restrictions

As important as use restrictions are, operating restrictions can be just as vital to a tenant. If certain operating restrictions in an REA are not compatible with a tenant's operating requirements, a tenant must be aware of this early on, before lease negotiations go too far. For example, an REA may require that stores within the mall be open for business to the general public during certain hours. Depending upon the business that is being run at a particular location, compliance with this provision could end up being an issue. In one case, a party to an REA was obligated to conduct its operations for 10 years using a particular trade name, and was required to operate in a manner similar to a majority of other stores operated by it under the same trade name or place a comparable substitute “department store” in the same location. If the REA's specific language defining a comparable “department store” is not precise enough, this opens the door for later disputes if a developer believes that the replacement tenant does not measure up to its mall standards and it can point to the REA to back up its position. For example, in 2005, when a Lord & Taylor store closed its operations at the Cherry Creek Shopping Center in Denver, the landlord protested when a Foley's Men's and Home store was chosen to replace the tenant. The landlord claimed the definition of “department store” in the REA prohibited such a move. Being aware of what the REA says before you enter into a lease could help a new tenant avoid getting in the middle of such situations. In another instance, an REA provided that each anchor could elect to extend its hours of operation (for five days in any particular year upon prior notice to the developer), to no later than midnight, and could require the developer to operate the exterior portion of the common area adjacent to such store during such extended hours of operation. Such a provision can be viewed as a benefit for many prospective tenants that anticipate the need to extend their hours of operation at certain times of the year.

3. Building Restrictions

It is hard enough for a tenant to negotiate the terms of a proposed build-out of space with a landlord. Add in the requirement for municipal approvals and it becomes even more difficult. If an REA causes the proposed building plans to be subject to the review and approval of additional parties, with interests that are potentially adverse to a tenant, this would certainly be another due diligence consideration.

Many REAs restrict the areas in which a building can be located. For example, REAs often refer to a “Permissible Building Area.” Such an area refers to the sites within the shopping center tract (or any component tract thereof) where a future store may construct its building. The Permissible Building Area may also have height or other restrictions. If the proposed redevelopment or expansion is not within the “Permissible Building Area” or violates any other restriction pertaining to construction contained in the REA (such as a requirement that all buildings be architecturally compatible with the other buildings in the project), this could lead to unintended problems. Even the installation of utilities serving the premises can be an issue when an REA states that all sewers, drains, mains and utility lines shall be underground and the lease's construction plans provide otherwise.

Also note that many REAs state that any building plan revision (for example, in the location, number of levels, height, and exterior configuration of any buildings and structures hereafter constructed) that differs from that shown in the REA are subject to the written approval of the other parties to the REA, which approval shall be at such parties' sole and absolute discretion. If a developer or major retailer has such broad approval rights, a tenant will have a tough time if it later complains that its building plans were arbitrarily denied.

Alteration restrictions in REAs can cause headaches because they often impose requirements that may be different from what is stated in the lease. For example, one REA states that all “staging areas shall be surrounded by an exterior grade plywood or woven wire or chain link fence, at least six feet in height, and painted a color approved by developer.” If the tenant did not read the REA, it may not be aware it violated this provision until it is too late. Also note that insurance requirements set forth in a lease must be at least as stringent as what is set forth in the REA and may require additional parties to be listed as additional insureds on applicable policies.

4. Access/Parking Restrictions

If a tenant does not have adequate space for its customers to park their cars, the customers will go elsewhere. If a retailer's employees must park too far from the entrance of its store, the employees will not be happy. That is why it is important to make sure that an REA provides for: 1) sufficient parking capacity for customers (usually five parking spaces for each 1000 square feet of floor area in the shopping center for normal retail uses); and 2) parking that is close enough for employees (to prevent them from complaining too loudly). Also be aware that some REAs provide that certain valet parking spaces can be reserved on a portion of the parking lot. This could be an issue if the reserved space is too close to a store entrance and makes parking less accessible to the tenant's customers.

5. Sign Restrictions

Sign restrictions in an REA may designate that signs must be a certain color, size or shape. Exhibits to an REA may contain additional signage criteria. Further, most REAs provide that no signs shall be erected if they fail to conform in any respect with the signage criteria. Those companies with strict signage requirements may seek approval to erect a nonconforming sign but such consent, often times, may be withheld for any or no reason.

6. Rules and Regulations

Just as there are rules and regulations attached to many leases, there are those that can be attached to an REA that can apply to an entire project. Do not assume that the rules and regulations of an REA are the same as those contained in your lease. Read the rules and regulations set forth in an REA with the same care that you would if they were stated in your lease. It is important to read them to be sure there are no terms and conditions set forth therein that a tenant would find to be objectionable.

7. Site Plan Layout

If a Site Plan states that it cannot be amended without the prior written consent of particular parties to the REA, and their consent may be withheld for any or no reason, those parties can make it virtually impossible for another tenant to modify the Site Plan subsequently. Thus, the layout of the buildings and other improvements, such as signs, loading docks, etc., can be set in such a way as to give the controlling retailers (usually anchor tenants) favorable: 1) store and signage visibility; and 2) parking and loading access that your client's store cannot attain. Depending upon a new retailer's size, if a REA has such a “frozen site plan,” this could be a factor causing a tenant to avoid choosing a particular leasing location.

8. Ambiguous or Sloppily Written Language

Not all REAs are equal. Some are written better than others. For example, in some REAs, there is language that has more than one meaning, i.e., a provision that a business be a “first-class enclosed mall-type tenant.” Moreover, if the REA was drafted a long time ago and the demographics have changed, the standard for determining who is a “first-class enclosed mall-type tenant” may also have changed. Such a term, without further refinement, can be viewed as a subjective description that can, in turn, lead to litigation seeking judicial determination as to what the term means. In any instance where the wording of a REA is not clear, one party or another may use such language to its advantage. In a leasing context, a prospective tenant may want to be aware of, and in some instances avoid, getting involved in deals where an REA could potentially be interpreted to its detriment.

Conclusion

Although REAs may serve a useful purpose by reducing conflicts that can arise when multiple parties control a shared property, for leasing practitioners it is important to realize that an REA can have a substantial impact on tenants that are leasing space within a project. Therefore, it is critically important that a leasing practitioner be well-versed in these potential issues.

Mark Morfopoulos, a member of this newsletter's Board of Editors, is an attorney in Hartsdale, NY. His practice is focused on all aspects of office and retail leasing. He can be reached at [email protected].