Negotiating a retail lease is one of the most critical stages in the life of a quick service restaurant. Each lease presents is own distinct issues and challenges; failing to have significant attention to detail can inadvertently result in an unsuccessful business or impede your growth; one oversight can destroy your succession plan or exit strategy.
Franchisees, often faced with immense market competition and the franchisor’s demanding development requirements, are prone to concede important issues and make careless mistakes in lease negotiations. What follows is a list of some critical lease provisions, which if not identified and properly negotiated, could have a material impact on the viability of your business:
Exclusive Use Protection
An exclusive use clause allows you to maintain an edge against competitors by restricting your landlord’s ability to lease space in your shopping center (and sometimes even within a larger area beyond the perimeter of your shopping center) to another tenant who is your competitor. When it comes to exclusive use protections, the interests of landlords and tenants are diametrically opposed; landlords want narrow exclusive use language so as to have the most freedom when choosing the tenant mix in their centers; whereas tenants want broad language to ensure that they won’t face competition in their own center. Franchisee tenants need to carefully consider exactly what part(s) of their business need protection so that the lease is as precise as possible. When negotiating this provision, tenants must be sure that the lease not only expressly requires the landlord to enforce the tenant’s exclusive, but also addresses the tenant’s remedies if the exclusive use is violated. Failure to addresses these points renders the protection granted by the provision essentially meaningless.
Landlord’s Consent to Assignment and Continuing Liability
As a tenant, your ability to assign your lease to a third-party has a direct impact on your ability to sell your business and ultimately realize a return on your investment. Like exclusive use protection language, assignment provisions are another instance where the landlord and tenant have conflicting needs. Landlords seek to exert extreme control over the transfer of their leases so as to ensure the qualifications and viability of the assignee tenant. Contrarily, tenants look for the ability to freely assign the lease, so as to minimize any delays or road blocks to the exit of their businesses. Landlords will often seek to maintain the right to approve or reject the proposed assignee, in their sole discretion. Franchisee tenants should, at minimum, seek to tie the landlord’s ability to approve an assignment to a standard of reasonableness, thus curtailing the landlord’s ability to reject a proposed assignment. Ideally, if possible, the franchisee tenant should negotiate the ability to assign the lease as of right (i.e., without landlord consent), to their franchisor, to other approved franchisees within the same system, or to any other party who purchases all or substantially all of their assets.
Related to the need to address landlord’s consent to assignment is the need to address whether or not the assigning tenant and any then existing guarantor have continued liability for tenant obligations which accrue after the assignment. Landlords will always seek to collect as many potential obligors as possible and typically require that, even if they consent to an assignment of the lease, the tenant and guarantor will remain liable under the lease. From the landlord’s perspective, multiple obligors ensures that the landlord has a long list of parties to sue in the event of a tenant default, thereby increasing their chances of actual collection. It is critical for a tenant to negotiate, up front, the tenant’s release as well as the release of any-then existing guarantor upon an assignment of the lease. As a compromise, again, franchisee tenants should, at a minimum, seek to tie their release to certain minimum thresholds (such as the net worth of the assignee tenant and its principals, in the aggregate).
Right to Participate in the Sale
Landlords often seek to retain the right to share in the sales proceeds when their tenants sell their businesses, stating that it is only because of the landlord’s property that the tenant has a store to sell in the first place. We have seen leases where the landlord is entitled to up to 50 percent of the sales proceeds. Failing to address this properly can result in the tenant not being able to afford to sell its business because it won’t be able to keep enough of the sales proceeds. Given that it is the tenant, and not the landlord, who uses blood, sweat and tears to grows its business and make it saleable, at a minimum, the lease should provide that the landlord is not entitled to any portion of any monies received by the tenant in connection with an assignment of the lease to the tenant’s franchisor or another approved franchisee. Ideally, this provision should be deleted completely and the lease should expressly state that the landlord is not entitled to any portion of sales proceeds under any circumstances, period.
These are some of the most important steps franchisees must consider in any lease, but there are more. Among other things, we will examine non-compete clauses and what happens when your landlord tries to terminate your lease and recapture your premises in an upcoming issue of Independent Joe. •
Karen Abrams is Senior Counsel at Paris Ackerman & Schmierer, LLP. She represents tenants in the full range of their business matters including leases, financing, sales, acquisitions and business operating documents.