Restaurant Leasing

In most instances, a restaurant's success is dependent on the talent in its kitchen. In this era of online reviews and cable networks dedicated to programming on eating out, consumers have unprecedented familiarity with individual chefs and restaurateurs. Hence, especially with respect to higher-end restaurant leases, a landlord should be keen to require that the people who have fostered (or will foster) the reputation of the restaurant be required to remain an integral part of the business. This “key-man” concept, borrowed from the private equity context, provides the landlord with remedies ' which may be as severe as termination of the lease ' if specific individuals sever ties with the restaurant.

Improvements and Alterations

In addition to ' and perhaps more important than ' key staff, a restaurant will thrive only when it offers its customers an enjoyable experience, outside of the mere act of dining. Physical elements such as access, layout, sound quality and decoration all factor profoundly into this experience, and hence the scope and expense of improvements in the space are critical considerations for the landlord. Nearly every restaurant lease will require the landlord's prior approval of the initial work in the space. While the lease parties may be anxious to create a unique space, the landlord is advised to remain conservative with its approval, particularly if it is paying or granting an allowance for the improvements. Alterations that are appropriate for one restaurant may not be palatable for another in the future, and a far-sighted landlord will be better positioned if it ever has to market space to a replacement tenant who is prepared to operate immediately.

Liquor License Contingencies

Many restaurants cannot survive without serving alcoholic beverages. Hence, tenants intending to serve liquor will frequently require that the procurement of the applicable license and zoning approval be preconditions to the effectiveness of the lease, or at least to the tenant's payment of rent. On its face, there may be no clear rationale for the landlord to object to this condition; however, the landlord should ensure that the timing of the contingency is compact and that the costs associated with the approvals are incurred by the tenant alone. Many municipalities, particularly in large urban areas, have intensive and expensive liquor licensure requirements, so the lease should compel the tenant to proceed through those processes with diligence and good faith. In any event, the lease should provide for a date certain by which the tenant must obtain its license and approvals, and for the ability of the landlord to terminate the lease if the tenant has not satisfied or waived its contingency.

Permitted Use

Issues may arise in a restaurant lease if the permitted and prohibited uses are not specifically enumerated. Unlike most other commercial leases, where the use may be stated simply as “general office use” or “warehouse,” restaurants vary greatly in terms of the food and beverage offered and the manner in which those items are delivered to customers. A landlord seeking to lease restaurant space to maximize exposure or drive traffic at its property (a shopping center, for example) should be especially cognizant of the permitted use in the lease, to restrict a conversion to a less desirable brand or concept by either the tenant or a transferee (discussed in greater detail below) and to preserve the landlord's favored tenant mix at its property. Moreover, applicable zoning often restricts the uses allowed without a variance or special use permit. For example, a property zoned to allow for a dine-in restaurant may not allow for drive-through or carry-out facilities.

Exclusives

Exclusive use provisions are also common in restaurant leasing, and offer valuable protection to tenants in multi-tenant properties. A larger, national restaurant tenant will often negotiate for an exclusive in this context, to enhance its position at the property and to prevent direct competition in the vicinity of the premises. From a landlord's perspective, however, an exclusive limits the variety of tenants to whom the landlord may lease other space at the property. Hence, a landlord will want to limit the provision as much as possible. For example, where a larger fast-food tenant may negotiate for a restriction on other fast-food restaurants at the property, the landlord will negotiate for a more limited restriction, perhaps against other “Mexican-themed” fast-food, or even against other “quick-serve, on-the-bone fried chicken.” Stronger tenants bearing the protection of exclusives will require that all subsequent leases at the property specifically describe the restriction and contain a covenant by the tenant to abide by it. This is another area where, in light of the economic fragility of restaurants, landlords should position themselves for flexibility in the event the tenant does not succeed and has to vacate prior to the expiration of the term.

If a landlord agrees to an exclusive use restriction, then it should also be careful to negotiate limitations on the tenant's relief in the event of a violation of that exclusive. The tenant will argue that any breach of its exclusive will result in an immediate and disastrous economic effect on its restaurant, and therefore should entitle the tenant to a variety of legal remedies, including injunctive relief, abatement of rent, termination of the lease and monetary damages. However, not every violation of this type is a result of the landlord's conduct. An existing tenant may cause a violation on its own, without the landlord's consent. Therefore, the landlord's lease obligation should be limited to a covenant to enforce exclusive provisions in other leases at the property, and should provide ample time for the landlord to cure any such violation before any remedies are available to the tenant.

Continuous Operation

In shopping centers and other multi-tenant environments, continuous operation covenants enable property owners to ensure that restaurant tenants with significant visibility, or who generate substantial traffic to or within the property, remain open for business during critical periods. These covenants are customarily stated in terms of minimum daily hours throughout the term, which hours may vary seasonally in retail environments with an emphasis on holiday sales. A landlord will be especially desirous of a continuous operation covenant from a restaurant tenant whose rent is payable in some fraction based upon its sales. As a remedy for a violation of this covenant (notwithstanding its payment of rent), the landlord should negotiate for the right to terminate the lease after the tenant has gone dark for a stated period of time, and to recapture the premises without further compensation or reimbursement to the tenant.

Assignment and Subletting

Due to the relative instability of their industry, restaurant tenants often negotiate for liberal rights to transfer their interest in a lease, whether by assignment, sublease or otherwise. A conventional transfer provision grants to the landlord the right to approve any assignment or sublease, but also prohibits the landlord from unreasonably withholding such approval. Landlords will often negotiate for some sharper corners on this subjective standard, such that approval will not be unreasonably withheld as long as the proposed transferee meets or exceeds an economic threshold. For instance, the landlord would reserve the right to withhold consent in its sole discretion if the proposed assignment is to an entity with a net worth below a stated amount, or below that of the existing tenant on a particular date. In any event, the lease should always provide that the assigning tenant remains primarily liable under the lease notwithstanding any transfer.

Conclusion

As a business, a restaurant is a unique proposition, often subject to extraordinarily thin margins and the whim of a fickle consumer base. As a result, restaurant leases present equally unique legal issues which should be addressed with the utmost care.

David P. Resnick is a member of this newsletter's Board of Editors and a Partner at Robbins, Salomon & Patt, Ltd. in Chicago.

Restaurant lease agreements represent a highly unique subcategory in commercial leasing. Whether a free-standing bistro, an in-line coffee shop or a fast-food drive-thru on a shopping center outlot, restaurants present characteristics and challenges that merit careful consideration by landlords. Conditions to occupancy, use restrictions and transfer of interests are all topics that are commonly negotiated in these types of leases. This article highlights a variety of lease provisions that are particularly germane to restaurant tenants.

Guaranties and Key-man Clauses

From a landlord's perspective, the importance of understanding the underlying business identity of a restaurant tenant cannot be understated. Like many other businesses, restaurants are often operated by limited liability entities that possess few, if any, assets. If the liability under the lease is to lie with a limited liability company or other similar entity, then the landlord should also receive a guaranty of all lease obligations from the parent entity or other affiliate of the tenant, or from a member or principal of the LLC who is determined to have requisite assets. Given the economic uncertainty that is common throughout the restaurant industry, a landlord is wise to seek this kind of credit enhancement from the tenant.

In most instances, a restaurant's success is dependent on the talent in its kitchen. In this era of online reviews and cable networks dedicated to programming on eating out, consumers have unprecedented familiarity with individual chefs and restaurateurs. Hence, especially with respect to higher-end restaurant leases, a landlord should be keen to require that the people who have fostered (or will foster) the reputation of the restaurant be required to remain an integral part of the business. This “key-man” concept, borrowed from the private equity context, provides the landlord with remedies ' which may be as severe as termination of the lease ' if specific individuals sever ties with the restaurant.

Improvements and Alterations

In addition to ' and perhaps more important than ' key staff, a restaurant will thrive only when it offers its customers an enjoyable experience, outside of the mere act of dining. Physical elements such as access, layout, sound quality and decoration all factor profoundly into this experience, and hence the scope and expense of improvements in the space are critical considerations for the landlord. Nearly every restaurant lease will require the landlord's prior approval of the initial work in the space. While the lease parties may be anxious to create a unique space, the landlord is advised to remain conservative with its approval, particularly if it is paying or granting an allowance for the improvements. Alterations that are appropriate for one restaurant may not be palatable for another in the future, and a far-sighted landlord will be better positioned if it ever has to market space to a replacement tenant who is prepared to operate immediately.

Liquor License Contingencies

Many restaurants cannot survive without serving alcoholic beverages. Hence, tenants intending to serve liquor will frequently require that the procurement of the applicable license and zoning approval be preconditions to the effectiveness of the lease, or at least to the tenant's payment of rent. On its face, there may be no clear rationale for the landlord to object to this condition; however, the landlord should ensure that the timing of the contingency is compact and that the costs associated with the approvals are incurred by the tenant alone. Many municipalities, particularly in large urban areas, have intensive and expensive liquor licensure requirements, so the lease should compel the tenant to proceed through those processes with diligence and good faith. In any event, the lease should provide for a date certain by which the tenant must obtain its license and approvals, and for the ability of the landlord to terminate the lease if the tenant has not satisfied or waived its contingency.

Permitted Use

Issues may arise in a restaurant lease if the permitted and prohibited uses are not specifically enumerated. Unlike most other commercial leases, where the use may be stated simply as “general office use” or “warehouse,” restaurants vary greatly in terms of the food and beverage offered and the manner in which those items are delivered to customers. A landlord seeking to lease restaurant space to maximize exposure or drive traffic at its property (a shopping center, for example) should be especially cognizant of the permitted use in the lease, to restrict a conversion to a less desirable brand or concept by either the tenant or a transferee (discussed in greater detail below) and to preserve the landlord's favored tenant mix at its property. Moreover, applicable zoning often restricts the uses allowed without a variance or special use permit. For example, a property zoned to allow for a dine-in restaurant may not allow for drive-through or carry-out facilities.

Exclusives

Exclusive use provisions are also common in restaurant leasing, and offer valuable protection to tenants in multi-tenant properties. A larger, national restaurant tenant will often negotiate for an exclusive in this context, to enhance its position at the property and to prevent direct competition in the vicinity of the premises. From a landlord's perspective, however, an exclusive limits the variety of tenants to whom the landlord may lease other space at the property. Hence, a landlord will want to limit the provision as much as possible. For example, where a larger fast-food tenant may negotiate for a restriction on other fast-food restaurants at the property, the landlord will negotiate for a more limited restriction, perhaps against other “Mexican-themed” fast-food, or even against other “quick-serve, on-the-bone fried chicken.” Stronger tenants bearing the protection of exclusives will require that all subsequent leases at the property specifically describe the restriction and contain a covenant by the tenant to abide by it. This is another area where, in light of the economic fragility of restaurants, landlords should position themselves for flexibility in the event the tenant does not succeed and has to vacate prior to the expiration of the term.

If a landlord agrees to an exclusive use restriction, then it should also be careful to negotiate limitations on the tenant's relief in the event of a violation of that exclusive. The tenant will argue that any breach of its exclusive will result in an immediate and disastrous economic effect on its restaurant, and therefore should entitle the tenant to a variety of legal remedies, including injunctive relief, abatement of rent, termination of the lease and monetary damages. However, not every violation of this type is a result of the landlord's conduct. An existing tenant may cause a violation on its own, without the landlord's consent. Therefore, the landlord's lease obligation should be limited to a covenant to enforce exclusive provisions in other leases at the property, and should provide ample time for the landlord to cure any such violation before any remedies are available to the tenant.

Continuous Operation

In shopping centers and other multi-tenant environments, continuous operation covenants enable property owners to ensure that restaurant tenants with significant visibility, or who generate substantial traffic to or within the property, remain open for business during critical periods. These covenants are customarily stated in terms of minimum daily hours throughout the term, which hours may vary seasonally in retail environments with an emphasis on holiday sales. A landlord will be especially desirous of a continuous operation covenant from a restaurant tenant whose rent is payable in some fraction based upon its sales. As a remedy for a violation of this covenant (notwithstanding its payment of rent), the landlord should negotiate for the right to terminate the lease after the tenant has gone dark for a stated period of time, and to recapture the premises without further compensation or reimbursement to the tenant.

Assignment and Subletting

Due to the relative instability of their industry, restaurant tenants often negotiate for liberal rights to transfer their interest in a lease, whether by assignment, sublease or otherwise. A conventional transfer provision grants to the landlord the right to approve any assignment or sublease, but also prohibits the landlord from unreasonably withholding such approval. Landlords will often negotiate for some sharper corners on this subjective standard, such that approval will not be unreasonably withheld as long as the proposed transferee meets or exceeds an economic threshold. For instance, the landlord would reserve the right to withhold consent in its sole discretion if the proposed assignment is to an entity with a net worth below a stated amount, or below that of the existing tenant on a particular date. In any event, the lease should always provide that the assigning tenant remains primarily liable under the lease notwithstanding any transfer.

Conclusion

As a business, a restaurant is a unique proposition, often subject to extraordinarily thin margins and the whim of a fickle consumer base. As a result, restaurant leases present equally unique legal issues which should be addressed with the utmost care.

David P. Resnick is a member of this newsletter's Board of Editors and a Partner at Robbins, Salomon & Patt, Ltd. in Chicago.