By: Edward B. Woodall

Welcome to the conclusion of our blog post series on common commercial lease pitfalls. In the first installment, we discussed some of the most common, but often overlooked, issues that can arise when parties sign a commercial lease without reading the fine print or thinking about definitions, future changes, and the like. Today, we’ll be discussing terms that are often included to protect the landlord’s interest and how they can be negotiated.

Guarantees

With smaller or newer tenants, particularly those without long track records of timely rent payments, most landlords will demand a guaranty from the tenant’s owner. If the owner signs a guaranty, then he or she will be on the hook for all money owed by the tenant to the landlord, including rent payments, TICAM, and maybe even attorneys’ fees incurred in suing for late rent or ejectment. This should make tenants wary—their assets are normally protected from their business’s creditors. Unfortunately for uneasy tenants, there is typically not much wiggle room in whether a guaranty is required or not. But the contents of the guaranty can sometimes be negotiated. In businesses with multiple owners, landlords may sometimes be satisfied with receiving guarantees from some, but not all of the owners. For example, if the active members of a business venture and those with the greatest wealth are willing to guarantee a lease, sometimes smaller silent partners can avoid signing the guarantee. Tenants can also get concessions with respect to notice and cure. Landlords are often willing to give guarantors notice of any breaches of the lease by the tenant, and to give them the same amount of time the tenant receives to cure the breach before landlord sues the tenant, charges late fees, etc. Silent partners, or even minority owners without the power to act on behalf of the tenant entity, should rightly be concerned about this—the ability to intervene and pay rent or perform other tenant obligations before a default occurs can save them a massive headache and a massive liability under the guarantee.

Default, Termination, and Other Remedies

Breaches of contract, defaults, remedies, and notice and cure can be enormously complicated. When the lease is signed, the sections of the lease that deal with these issues usually feel needlessly long and complicated—after all, they address events that everyone signing the lease hopes won’t happen. But wise landlords and tenants should always review these sections carefully before signing the lease. When ordinary lease events like a late rent payment, a TICAM dispute, or an alleged breach of another tenant’s exclusive happen, these sections can be the difference between a fixable problem and a messy legal dispute ending in ejectment from the leased premises and significant damages. Some of the points that landlords and tenants should review and negotiate are:

  • Notice and cure periods: These periods should be carefully reviewed and tailored to the situation. It’s not uncommon to have a shorter cure period for monetary defaults, like not paying rent, than for non-monetary defaults, which by their nature may take longer to cure.
  • What remedies are available, and in what situation? May the landlord terminate in any situation, or only in certain situations? If termination isn’t available, what other remedies are?
  • What, if any, limitations does the lease place on damages? Landlords usually want to demand the entire outstanding balance of the rent—the amount which the tenant would have paid over the remainder of the lease term, had it not been terminated. But tenants can often negotiate this down and limit their damages to a certain number of months or years of rent or reduce the total due by the fair market rent of the property.

Continuous Operation, Co-tenancy, and Competition

Landlords often want to insert covenants of continuous operation into leases. As the name suggests, these covenants require the tenant to keep the business open and operating continuously. They are most commonly used with anchor tenants like grocery stores or department stores, but landlords whose operations rely on generating traffic, like the owners of malls or shopping centers, will impose covenants of continuous operations on all tenants if they can. While covenants of continuous operation can be drafted very simply, landlords and tenants should consider the following issues:

  • How long does the covenant of continuous operation last? The entire lease term, or a certain number of years?
  • How detailed is the covenant of continuous operation? Some prescribe the hours and days that the tenant must be open, while others are less specific.
  • What is the penalty for failing to be open? It’s common for leases to require that the tenant pay a daily fee to the landlord if they’re not open.
  • Is there a notice and cure process for tenants who breach the covenant of continuous operation? If so, it needs to be carefully drafted so that the tenant cannot close up shop, receive notice, open for a day or two, and close back up.
  • As an alternative to covenants of continuous operation, some landlords—particularly those with less bargaining power—opt for requirements that the tenant open for business (for at least one day) by a certain date.
  • If the lease doesn’t have a covenant of continuous operation, the lease should be clear that a tenant who has “gone dark” (ceased business operations) must continue paying rent, maintaining and cleaning the leased premises, and performing all other obligations under the lease.

The other side of this particular coin is the co-tenancy clause. These clauses are disfavored by landlords, but some tenants have the bargaining power to get them in the lease. A co-tenancy clause allows a tenant to delay opening, reduce hours, cease operations, reduce rent paid, or even terminate the lease if a certain other tenant (usually an anchor tenant or a complimentary use) leaves the shopping center or fails to open, or if a certain percentage of the shops in a shopping center are vacant. Landlords should avoid these whenever possible and should make sure that they have ample time and opportunity to cure the violation of the co-tenancy clause before the tenant’s rights under the clause are triggered.

Covenants not to compete and exclusives are also two sides of the same coin. In both cases, and especially for covenants not to compete, counsel should be consulted to ensure efficacy and legal validity. Covenants not to compete are imposed on tenants, and prevent them from operating another store, location, or business within a certain distance of the leased premises. In North Carolina, these are subject to strict limits with respect to duration and distance. The drafting of covenants not to compete is fraught with complexity. In addition to deciding on reasonable, legally enforceable time and distance restrictions, landlords should plan to answer the following questions:

  • What, exactly, is prohibited? Is the tenant prohibited from operating the only same business or brand? May the tenant operate a location in the same line of business, but under a different legal entity or brand? Is the tenant prohibited from operating any business in the field?
  • Does the covenant not to compete apply only to the legal entity of the tenant? What about affiliates, like parents, subsidiaries, or companies with most or all of the same owners and managers?
  • What happens if the covenant not to compete is violated? Does the landlord want to be able to terminate the lease, sue for lost profits, receive a daily fee, or even obtain an injunction (court order) shutting down the competing business?

The tenant should ask itself these same questions when it negotiates for an exclusive, which prohibits the landlord from leasing to a direct competitor, or a list of prohibited uses, which prohibits the landlord from leasing space for a purpose that the tenant finds objectionable or inconsistent with their business. How broadly will the exclusive be defined? Does it apply only to the shopping center in question, or to all property owned by the landlord within a certain distance? What happens if the landlord sells some or all of its other property to another party? The commercial real estate attorneys at Venn Law Group have extensive experience negotiating these issues from both sides and can help a landlord or tenant figure out what is most important for its business and negotiate the best deal.

Conclusion

In this two-part series, you’ve seen only a small portion of the endlessly complex, and endlessly fascinating, world of commercial leasing. Hopefully you now see that leases are deceptively simple and are in many respects even more complicated and important to your business’s success than buying or selling land. If you want to learn more, or if you want help negotiating a lease or resolving a leasing dispute, contact us here.

Edward Woodall: Corporate and Commercial Real Estate attorneyEdward B. Woodall is an attorney at Venn Law Group who works incorporate law and commercial real estate, including leasing, financing, taxation, business structures, and dispute resolution. He is passionate about helping business owners solve a variety of complex legal problems and has performed more than 100 hours of pro bono work. In addition to his law degree, he also has a background in history and Spanish.