OPERATIONS COVENANT
By Joel R. Hall
The Gap, Inc.
San Bruno, California
©
Copyright 1999
4.01
Covenant to Operate/Express v. Implied.
Shopping center lease forms, as they first developed, generally did not contain an
express covenant of the tenant to operate from his premises. While many of these leases
did include percentage rent clauses, few contained an express covenant of the tenant to
operate so as to ensure that the tenant would be generating sales. There is a substantial
body of case law wherein the covenant of a tenant to operate has been implied by the
courts from a variety of factors including the presence of other operating requirements in
the leasei1 or the adequacy of the minimum rent being paid as compared to the
percentage rent provisions.
This last factor of the adequacy of rent has been the most influential in determining
whether a continuous operations covenant will be implied. If the court found that the
minimum rent was nominal, it often concluded that the parties intended that the landlord
also rely on the percentage rent generated from tenant's sales to ensure an adequate rental
return from the premises. Conversely, if the minimum rent was found to have been
adequate -- when viewed at the time of lease execution, not at the time of the lawsuit -then no covenant would be implied, the court refusing to protect the landlord from its
own imprudence in failing to include an express covenant or providing for rent increases
over the term.
In modern shopping center leasing practice landlords rely principally upon the express
covenant to support the tenant's obligation to operate the store and produce percentage
rent.
4.02
The Obligation: General Obligation v. Specific Hours Requirement.
As shopping center leases evolved, they began to include a general covenant of the
tenant to operate from the premises such as the following:
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Figure 4-1
General Covenant to Operate
Tenant agrees to continuously and uninterruptedly occupy and use
during the term the entire Premises for the Permitted Use and to
conduct Tenant's business therein in a reputable manner.
A slightly more specific clause, like the one which follows, was also found in early leases
(including the ancestral version of the International Council of Shopping Centers'
standard form) and referred to hours of operation in a general way:
Figure 4-2
General Reference to Hours of Operation
Tenant agrees to remain open for business during the usual days and hours
for such business as are customary in the vicinity of the Shopping Center.
Today, most shopping center leases include rather specific requirements, with the right of
the landlord to change hours from time to time such as the following clause:
Figure 4-3
Specific Reference to Hours of Operation
Tenant will operate Monday through Saturday from 10:00 A.M. until 9:00
P.M., on Sundays from 12:00 Noon until 6:00 P.M. or during such other days
and hours as are designated by Landlord.
As a general rule, as each form of the covenant evolved in leasing practice it did not
replace the former one but rather was merely added to it. Now one can find all three
versions in one lease, recited one right after another.
The reason for this, aside from the pull of tradition, was the theory that if for some reason
the other stores were not operating in a uniform fashion - e.g., if the department stores or
satellite stores operated every day but closed early or at different times - then the
Landlord could still rely on clauses like Figure 4-2 to retain some residual, general (and
vague) obligation to operate for at least some period of time (for example, until 3:00 P.M.
when most of the tenants were still open). Thus, those landlords willing to include a
cotenancy requirement in their lease would write them in the following form:
Figure 4-4
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Reference to Operation of Other Tenants
Tenant will operate during such days and hours that the ABC Department
Store plus tenants occupying at least seventy-five percent (75%) of the GLA
of the Shopping Center are open and operating. (Emphasis added)
4.03
The Covenant to Operate from a Landlord's Perspective.ii2
A fundamental, philosophical issue regarding sharing of risks emerges in every
cotenancy clause negotiation. Has a tenant entered into a lease for space in the shopping
center with an iron-clad guarantee of full operation of all major department stores and all
other tenants as a condition to such tenant's obligation to operate, or, has the tenant
entered into a lease for the right to operate within a shopping center market created by the
landlord but with the attendant risks of discontinued operation of major department stores
and/or certain other retail tenants? It is important to note that the success or failure of
major department stores and other retailers within the shopping center is often not a
function of the operation of the specific shopping center, but rather of the marketplace
generally, and the ability of the department stores and satellite stores to operate within the
marketplace.
From a landlord's perspective the risk of department stores or other
retailers closing is, therefore, a marketplace risk, and not necessarily a developer risk
which should be borne exclusively by the owner of the shopping center. From a
landlord's perspective, the chain retailers most capable of negotiating strong cotenancy
clauses are also those retailers who are often financially stronger than the owner of the
shopping center itself and are capable of analyzing the demographics of any retail market
and the trends within that market. Therefore, their obligation to operate should not be
dependent (or co-dependant) upon the continued operation of their neighbors.
Tenants often highlight the hundreds of thousands of dollars invested by them in
improvements and merchandise. The landlord, in response, may point to tens and
hundreds of millions of dollars expended in development of the shopping center. Both
the landlord and the tenant share the desire to see the shopping center become a
successful development. From where a landlord sits, however, to ask a tenant to risk ten
or a hundred thousand dollars in a shared risk with the landlord's ten or hundred million
dollar risk does not appear unreasonable.
4.04
Modifying the Covenant to Operate from a Tenant's Perspective.
The argument that the closure of a department store is a "marketplace risk" rather than a
developer risk is based upon a rather feeble theory. When the landlord induces a tenant
into a center, it is the retail environment created by the center and the department stores
that the tenant has responded to, with the demographics of the marketplace being an
extremely important but secondary influence. If all a tenant were concerned about was
the marketplace, it would not need to go into the landlord's shopping center. It could find
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a street location in that marketplace with only the minimum rent and taxes to worry about
-- no percentage rent, no CAM charges, no central HVAC, no merchant's association, no
kiosks, no relocation clause, no intrusion by columns or conduits, no use clause, no
tradename restriction, a free right to assign and no operating covenant. It is the retail
environment created by the shopping center that a tenant bargains for (and that the
Landlord held out to the Tenant), not merely the marketplace in which it is located.
For the satellite tenant in an enclosed regional mall, an operating covenant for the entire
term of the lease is a fact of life. Nonetheless, in order to increase his flexibility and
reduce his downside risk, it is essential for the tenant to modify the operating clause with
a cotenancy provision. After all, the Landlord enticed the tenant into his mall by
projecting an image of a community of quality named retailers iii3
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4.05 Negotiating for a Cotenancy Requirement
Negotiating For A Cotenancy Requirement. Assume that the business representatives
of the landlord and tenant have agreed that the tenant's operating requirement is to be tied
to a department store and a certain percentage of mall tenants. A landlord will sometimes
submit a clause like the following:
Figure 4-5
Tenant's Requirement to Operate - Cotenancy
Tenant shall be required to operate during designated days or hours
provided that the ABC department store (or its successor) is required to
operate and 75% of the tenants (including Tenant) are required by their
leases to be open during such days and hours. (Emphasis added)
To the tenant, such a clause is a travesty of the agreement between the business people
and a mockery of the tenant.iv4 From a tenant's perspective, such a provision should be
modified in accordance with the following principles.
Elements of The Cotenancy Clause - Discussion
4.05-1. The Department Stores and Their Successors. The tenant should not permit
the anchors to be designated merely as "ABC or its successors or replacement" or "the
occupant of the space initially intended to be occupied by ABC"; this is totally
unacceptable from a tenant's point of view. The principal and procuring cause in
inducing the tenant into the center is who the anchors are and where he is in relation to
them. Thus if ABC is a department store of known and desired quality -- exuding a high
drawing power -- then, replacing ABC with a lower-end operator lacking the same
drawing power for the same type of customer frustrates the tenant's legitimate business
expectations.
To make matters worse, most landlords have departed from the use of the word
"department stores" in their lease forms and now attempt to create classes of "Major
Tenants" or "Anchor Stores" who are merely large space users and may not even be
department stores at all. Such "Anchor Stores" are simply defined in terms of square
footage without any name recognition tied to the definition but they are nevertheless
intended by the landlords to satisfy the operating cotenancy requirements. Some leases
define such stores as small as 15,000 or 20,000 square feet; they may even presume to
call them "department stores"!v5 In such a case, a satellite tenant may find that his
operating covenant is tied to the sporting goods store, the toy store or the furniture store
rather than to a Penney's or Macy's. In order to protect himself the tenant must insist that
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the concept of "anchor store" be specified to mean a "department store" and that the term
"department store" in turn be carefully defined to encompass only those retail operations
commonly accepted as "true" department stores.
The definition of a "true" department store is comprehensively discussed in
Appendix - I of these materials.
"I Can't Control The Department Stores". Many landlords have resisted even
including the department stores as part of a cotenancy requirement on the grounds that
department stores often have only a limited operating covenant in terms of years or
sometimes none at all; therefore, they cannot control them. This is particularly true
where the department store owns its own parcel, having purchased it from the landlord.
However, when the tenant approved the deal, he was buying into the concept of a
synergistic retail environment, anchored by department stores. In fact, the presence of
specifically named department stores was one of the key selling points the landlord used
to induce the tenant into the center. The landlord cannot now turn around and completely
discount those considerations as unimportant to the tenant. If the landlord chooses to
parcel out portions of the tract to the department stores, fine, but he cannot then pretend
or ask the tenant to pretend that they no longer exist for purposes of the lease. The issue
is not whether the landlord is at "fault" or whether he can control the department stores;
the only thing that matters to the tenant is whether the named department store is open or
not.
4.05-2. "Actually Open" vs. "Required to be Open". Predicating a tenant's
requirement to be open on the majors being "required to be open" rather than "actually
being open" is still a position taken by many landlords. However, to state the condition
in terms of being "required to be open" is discounting the tenant's prime motivation.
The presence or absence of an operating covenant in the department store's lease or REA
is not the controlling factor for the tenant. Again, the only thing that matters to him is:
"Is the department store open or not?"
When applied to the satellite stores, the "required to be open" test is especially
problematic. It is unlikely that the condition could ever fail because every satellite lease
contains an operations covenant, even if it is coupled with a cotenancy provision. Indeed,
if these tenants went dark in violation of their leases, the landlord would still have met
the test simply because there was a clause in their leases requiring them (in some form or
another) to be open, whether or not they were actually open.
The only thing that matters to the tenant is how many other retailers are actually open,
regardless of what their leases say. That is what the tenant bargained for when he signed
the lease. Landlords frequently offer the tenant a covenant that the landlord will use all
reasonable efforts to enforce the operating clauses of those other leases while insisting
that the tenant accept the "required to be open" language. From a tenant's perspective
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such efforts are not especially helpful because specific performance is difficult to obtain
and termination of the other fellow's lease does not increase the number of other stores
that are open.
4.05-3. Percentage of the Satellite Cotenancy. The phrase "75% of the tenants
(including Tenant) are open . . ." in Figure 4-5 is a problem for the tenant because if the
shopping center is only 80% leased then the landlord's requirement is diluted to merely
75% of 80% or 60%. This provision would allow the landlord not to require an operating
covenant in 40% of his leases while still requiring the tenant to operate. The cotenancy
requirements must be tied to a percentage of the gross leasable area of the center being
open, not just a percentage of the tenants the landlord happens to have.
Is The Premises Included In The Count?. Another point sometimes injected by
the landlord's counsel is whether the tenant or the premises should be included in the
count. For example, if the total satellite store gross leasable area ("GLA") was 100,000
square feet and the tenant occupied 5,000 square feet, the landlord would argue that the
75,000 square feet (75% of 100,000) includes the tenant's store itself as being counted
towards meeting that total. This means that the landlord only has to have 70,000 square
feet of other space open - 70% of the 100,000 square foot total GLA - in order to require
the tenant to open.
From a tenant's perspective, he is interested in what the other stores are doing before he
himself can be required to be open; his own store should not be included. Often the
tenant will write the clause as follows: "75% of the gross leasable area of the
Shopping Center (other than [or excluding] the Premises)". What the tenant intends
is that 75,000 square feet of other stores be open before tenant is required to be open.
And that 75,000 square feet is calculated as 75% of the total GLA of the center, even if
that total includes the area of the Premises.
However, the landlord complains that such an interpretation raises the cotenancy
requirement to 80% (75,000 plus the 5,000 square foot Premises = 80,000 square feet),
although the logic of adding in the area of the Premises is difficult to follow since we are
supposed to be talking about what the other stores are doing. The landlord would
interpret that phrase to mean that (1) first, you subtract the tenant's 5,000 square feet from
100,000 = 95,000 square feet, and then (2) you take 75% of 95,000 = 71,250 square feet
of "other" GLA. Thus, 71,250 of other satellite GLA must be open to require tenant to be
open. This is almost the same result as the Landlord's original position of simply
including the tenant's premises in the count (70,000 vs. 71,250).
Admittedly, the phrase is open to two interpretations despite the flaw in the landlord's
logic. To make the tenant's intention perfectly clear, the following phrase should be
used:
Figure 4-6
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"... provided that the ABC Department Store plus stores other than the
Premises and representing seventy-five percent (75%) of the total GLA of the
Shopping Center (which calculation of total GLA includes the GLA of the
Premises but excludes the GLA of the Department Stores) are operating
during such designated days and hours."
4.05-4. Closing Completely or Maintaining Limited Hours?
above, provides as follows:
Figure 4-4, discussed
Tenant's Obligation Fluctuating
With The Level of Open Stores
(Figure 4-4 Revisited)
Tenant will operate during such days and hours that the ABC Department
Store plus tenants occupying at least seventy-five percent (75%) of the GLA of the
Shopping Center are open and operating. (Emphasis added)
Clearly, a tenant does not bargain for an obligation to be open simply because most of the
other tenants are open during some days and hours, if those days and hours don't make
any sense for the tenant - e.g. 11:00 a.m. to 3:00 p.m. Nor does the tenant bargain for the
privilege of being allowed to close early (e.g. 3:00 PM) simply because the landlord
could only maintain the cotenancy requirement up until that time. From a tenant's
perspective, his obligation to open for business at all, as well as his obligation to operate
during specified days and hours, should be treated as one, directly tied to the cotenancy
requirements. Thus, a tenant seeking to modify the covenant to operate might draft the
opening lines in the following manner:
Figure 4-7
Tenant's Obligation to Open Excused
Tenant shall not be required to open the Premises for business at all nor to
operate during designated days and hours unless the ABC Department Store
plus stores other than the Premises and representing seventy-five percent
(75%) of the total GLA of the Shopping Center (which total GLA includes
the GLA of the Premises but excludes the GLA of the Department Stores)
are operating during such designated days and hours."
In this way the tenant has protected himself against having to operate during days or
hours that are not right for him simply because the cotenancy requirements are being
maintained during those times.
But there is one more factor to consider. The landlord has the right to redefine the
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"designated days and hours" to suit his purposes. Suppose, for example, that because
many stores were closing early the landlord redefined store hours to be "10:00 a.m. to
3:00 p.m. because that is the period that the landlord managed to meet the operating
cotenancy requirements. Or he simply redefined the "designated days and hours" as
those days and hours that the department stores and a majority of the satellite stores were
open.
These may not be hours that the tenant would want to maintain. Any sales that he might
experience during this short day would be outweighed by the expense of hiring staff,
allocating inventory and running utilities; it may be cheaper simply to not open at all.
Alternatively, the landlord may want to designate later hours during the Holiday season
or to hold occasional "Midnight Madness" sales. It must be solely at the tenant's option
to operate during these additional hours which exceed his accepted core hours.
To deal with this possibility, the following clause must be added to Figure 4-7:
Figure 4-8
Limiting Changes of Specific Hours
Notwithstanding the foregoing and regardless of the days and hours of
operation that the Landlord may designate or whether the Operating
Requirements are being met, the Tenant shall not be required to:
(i)
open earlier than 10:00 a.m. or later than 11:00 a.m. Monday
through Saturday, or to open earlier than 12:00 noon on
Sunday;
(ii)remain open later than 9:30 p.m. Monday through Saturday or 6:00
p.m. on Sunday;
(iii)to be open at all if tenant would thus be required to be open for
business less than eight hours per day Mondays through
Saturdays or less than five hours on Sunday.
Right of Tenant to Stay Open During Additional Hours. Now that the tenant has
made the point that he is not required to be open during additional hours, he will want to
provide for the right to open during extra hours if other tenants in the mall are open.
In negotiating this point the landlord may wish to exclude tenants such as theaters or
restaurants and permit tenant to open only if other regular retailers are open after hours.
He may also want the tenant to pay its share of the costs of operating the shopping center
during those additional hours, allocated among the square footage of those tenants that
are actually participating. This compromise is perfectly OK.
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4.05-5. Exemption For Inventory and Remodeling. There should also be provision for
temporary closings due to inventory and remodeling or restoration in the case of casualty
or condemnation. Although this exception would seem to be obvious, there have been
eyebrows raised in a few malls when the tenant did close; so it is now prudent to provide
for this in the lease.
The landlord will want limits put on these permitted closures; this is appropriate provided
the tenant has given himself sufficient time to accomplish these objectives.
4.05-6. Requirement to Open On National Holidays. Most retailers close on certain
special national holidays like Easter, Thanksgiving and Christmas. This is rarely a
problem. However, what has become an increasing problem for some tenants is the
growing tendency of malls to require New Year's Day openings because the anchor
chooses to be open on that day. Many retailers guarantee this day off to their employees.
The tenant should specify his needs in the lease to avoid any doubt. A provision like the
following would work:
Figure 4-9
Ability to Close on Holidays
Notwithstanding the foregoing and whether or not the foregoing
requirements are being met, in no event may the "designated days and
hours" of the Shopping Center as determined by Landlord require Tenant:
(a)
[see Figure 4-8 above]
(b)
to be open Easter Sunday, Thanksgiving Day, Christmas Day
or New Years Day; . . .
4.05-7. Requirement to Open on Sunday. There are still a few local jurisdictions that
limit Sunday openings. Even in such jurisdictions, however, some landlord lease forms
may require the tenant to open on Sundays (i) while the statute is being contested or (ii) if
only a small penalty is involved. This is not acceptable as the landlord may not make this
decision for the tenant. Further, the fact that a fine may be small is of no consolation to a
tenant (or its store manager) who may end up with a misdemeanor conviction on his
record.
If presented with such a clause, a tenant should add the following:
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Figure 4-10
Operating Requirement Not to Violate Laws
Notwithstanding the foregoing and whether or not the foregoing
requirements are being met, in no event may the "designated days and
hours" of the Shopping Center as determined by Landlord require Tenant:
(a)
[see Figure 4-8 above]
(b)
[see Figure 4-9 above]
(c)
to be open when to do so would violate any law, criminal or
civil, or subject Tenant or its employees to a fine or penalty,
whether
criminal
or
civil
in
nature.
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§4.06 FAILURE OF THE COTENANCY REQUIREMENT
4.06 Failure of the Cotenancy Requirement.
Tenant may not invoke its remedies (see §4.07 infra) until the cotenancy requirements
have failed. But it is not always clear when this occurs. What if the department stores or
satellite stores open late or close early? What if they are closed for force majeure reasons
or for remodeling or taking inventory? What if a department store has gone dark but has
been replaced by someone else who does not occupy all of the space that was formerly
occupied by the department store?
These are all legitimate concerns and should be addressed by the parties. Following is a
sample clause:
Figure 4-11
A store shall not be considered open for business if such store is open and
operating less than (X) the designated days and hours, or (y) is operating in
less than all of its space as set forth herein. Notwithstanding the foregoing, if
the Operating Requirements are not being met because a store is closed by
reason of casualty, condemnation or the making of repairs or alterations or
the taking of inventory, such closure shall not give rise to any right of Tenant
to pursue any of Tenant's Remedies unless such closure continues beyond a
period of sixty (60) days following the occurrence.
The landlord may want to provide for different grace period times for different situations.
For example, a renovation or restoration of a department store will take longer than that
of a satellite store. These differences ought to be recognized provided the tenant puts an
ultimate limit on them. Although the real time it may take to complete these operations
may often exceed those limits, the question the tenant must face is how long must he
endure the cotenancy failure by reason of such occurrences, regardless of whether the
closures are anyone's "fault". A provision such as the following would work:
Figure 4-12
Notwithstanding the foregoing, the closure of any Department Store or
Satellite Store by reason of the following causes shall not be deemed a
cotenancy failure nor give rise to any right of Tenant to pursue any of
Tenant's Remedies unless such closure continues beyond the periods
hereinafter set forth:
A.
Fire or other casualty: Department Stores - 180 days; Satellite Stores 60 days;
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B.
Remodeling: Department Stores - 90 days; Satellite Stores - 60 days;
C.
Taking inventory: Department Stores - 10 days; Satellite Stores - 5
days;
D.
Unavoidable delay other than fire or other casualty:
Stores
30
days;
Satellite
Stores
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Department
30
days.
4.07 Tenant's Remedies If Cotenancy Requirements Fail
Once the cotenancy requirements have failed, there must be method of relief
available to the tenant to minimize his exposure to potential losses. Three remedies are
generally employed: the right to go dark, the right to pay an alternate rent and the right to
terminate the lease. Each is discussed below.
4.07-1. The Right To Go Dark. From a tenant's perspective, he did not bargain for the
right to operate in the middle of a deserted project nor in one that is 50% empty. Rather,
he bargained for, and his minimum rent is based upon, an environment of a collective of
retailers who together create a synergism for their collective benefit. If the retail climate
around him has decayed to a point such that his sales have fallen below profitable levels,
he no longer enjoys that healthy environment originally bargained for. He must, of
necessity, close.
The following provision is an example of a clause which permits the tenant to close his
store upon a failure of the operating requirements.
Figure 4-13
Tenant Permitted to Close Store
Tenant shall not be required to open the Premises for business at all nor to
operate during designated days and hours unless the ABC department store
plus stores other than the Premises and representing seventy-five percent
(75%) of the total GLA of the Shopping Center (which total GLA includes
the GLA of the Premises but excludes the GLA of the Department Stores)
are operating during such designated days and hours. The aforementioned
minimum co-tenancy requirements operating during the designated days and
hours shall in combination be called the "Operating Requirements". If the
Operating Requirements are not met at any time, then Tenant shall have no
obligation to operate and may close the Premises during such period of time
that such Operating Requirements are not being met. (Emphasis added)
Landlord's Grace Period. The landlord will complain, with justification, that it will
take some time to replace the department stores or the satellite stores and that the tenant
should wait for a period of time before electing one of his remedies. Usually they ask the
tenant to wait at least one year. While it's true that it can take a year or longer to replace
a department store (and perhaps 6 months to replace a satellite store), the question that
the tenant must ask himself is whether he can afford to operate in the red for such a
period. Typically, he cannot. Upon a failure of the operating requirements (whether
because of a department store closure or a satellite store closure) he must be permitted to
immediately go dark.
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As a compromise, a tenant might agree to a grace period before he elects to go dark, e. g.
3 months for satellite stores, 6 months for department stores.
Sales Tests. Many landlords take the view despite the failure of the cotenancy
requirements, the tenant should not have the right to go dark (or exercise any other right
for that matter) unless the tenant's sales are impacted by the closure.
From the tenant's viewpoint, this argument is flawed. It is inappropriate for the landlord
to require the tenant to justify his decision once the landlord has failed to maintain the
cotenancy requirements.
The decision of whether to close will be made by the tenant in the exercise of its own
economic self-interest and common sense. If the sales levels he is experiencing are still
sufficient to operate profitably despite the cotenancy failure, he will stay open regardless
of what the lease says or who is open around him. If sales are below profitable levels, he
must close. His own profit motivation will decide that question for him, not some
provision in the landlord's lease form.
It must also be remembered that when the cotenancy requirements were being met, the
tenant was required to operate whether his store was profitable or not. However, once
there is a cotenancy failure he should have the right to close based on whether he can
continue to operate profitably, a decision only he can make. Or, he may be entitled to
receive rent relief (and ultimately the right to terminate) while he continues to operate in
a substantially vacant center.
Sales Drop Test. Some landlords insist that despite the failure of the cotenancy
requirements, the tenant should not have the right to go dark unless his sales are directly
and negatively affected by the closure of the other stores, as reflected in a certain amount
of decline which occurs within a proximate time thereafter.
This argument is also faulty. The tenant's sales may have been already bottomed
out at the time of the cotenancy failure because of a continuing decline of his business
resulting from a continuing decline of the center.
By the time the cotenancy
requirements finally fail he may not be able to demonstrate a further drop in sales. The
landlord would then point out that this is proof that the tenant's poor business was due to
other factors unrelated to the cotenancy failure and that there was no causal connection
between the two.
However, prior to the cotenancy failure, the tenant was required to be open despite the
level of his sales. After the cotenancy failure, he is entitled to make the choice that will
minimize his losses and not be sandbagged by his previous level of sales. Otherwise, the
tenant who needs the relief the most will be penalized the hardest while other tenants who
were operating at a higher level and can demonstrate a decline in sales would be entitled
to such relief. Tenants will operate if they can make money; they will close if they
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cannot. Its not appropriate for the landlord to determine whether tenant's losses are
sufficient to justify a closure.
It must be remembered that in the clause illustrated in Figure 4-13 above, the tenant is not
asking for the right to cease paying rent. He will continue to pay full rent and other
charges on the vacant space but he has cut his losses by eliminating the expenses of
salaries, utility consumption and investment in merchandise for that store. Indeed, while
the cotenancy requirements are being met but are at less than full operational levels -- for
example at 76% and minus one of the department stores -- the tenant is operating and
paying a 100% rental for a 76% center. In other words, the landlord has been given a
contingency margin of up to 25%; also, one or more of the other department stores may
have closed but the operating Requirements are still being met. If the cotenancies fall
below even those levels the tenant will still have to pay the 100% rent but at least he can
close the store and limit his expenses.
Simple Sales Test. Rather than require the tenant to demonstrate a sales drop
immediately following the cotenancy failure, the parties might agree to set a certain sales
threshold to determine the tenant's right to go dark. If the tenant's sales are above that
threshold despite the cotenancy failure, then the tenant may not go dark so long as his
sales remain above that threshold. If his sales are or eventually fall below the threshold
while a continuous cotenancy failure is in progress, then the tenant may close. The
threshold must be a reasonable one, but it is not necessary that it be set at the tenant's
profit/loss breakeven point. It must be a simple gross sales threshold (the tenant should
not have to disclose his profit and loss statement for the store) and should be sufficient to
allow the tenant to determine whether any profit he is making is worth the effort. The
tenant is in the best position to determine what that threshold should be.
Landlord's Right to Terminate if Tenant is Dark. Often a landlord will want the
right to terminate the lease if the store is closed for a period of time. While this may not
an be unwelcome result for the tenant, the tenant will want the landlord to reimburse him
for the remaining undepreciated costs of the tenant improvements installed by the tenant
at his expense (i.e., exclusive of any construction allowance received from the landlord).
At that point, the landlord may wish to reconsider his cancellation if the cost is too high;
he should be given the opportunity to do so.
Tenant's Right to Reinstate Lease. On the other hand, the tenant may wish to
preserve the lease if he is in the middle of negotiations for an assignment or sublease. Or,
he may be willing to give the store another try, especially if the formerly empty spaces
are being leased up but are not yet at the cotenancy threshold. Therefore, he will want
the right to nullify the landlord's termination and reinstate the lease provided the tenant
reopens within a specified period of time. The landlord may object to the reinstatement,
however, if he has already made a deal with someone else while the tenant was closed; he
should be permitted to pursue his other deal. The following clause embodies all of the
foregoing concerns:
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Figure 4-14
Landlord's Right to Terminate for Closure. In the event Tenant remains
closed for a continuous period of sixty (60) days, Landlord shall have the
right, during the time the Premises is closed, to terminate this Lease on thirty
(30) days notice to Tenant provided that Landlord pays to Tenant (the
"Reimbursement") the amount of Tenant's Remaining Improvement Costs,
calculated as of the effective date of termination. Within twenty (20) days
after receipt of Landlord's termination notice, Tenant shall furnish to
Landlord Tenant's statement, certified as correct by Tenant's Chief
Financial Officer or the Controller of Tenant who shall be a CPA, of the
amount of Tenant's Remaining Improvement Costs. The validity and
effectiveness of Landlord's cancellation shall be conditioned upon the
payment to Tenant of the Reimbursement within ten (10) days after
submission by Tenant of its statement of Tenant's Remaining Improvement
Costs. In the event, however, Tenant fails to furnish Landlord its statement
of Tenant's Remaining Improvement Costs within the twenty (20) day period
aforesaid, the requirement of Landlord to pay the reimbursement shall be
deemed waived by Tenant.
Landlord's Right to Rescind Cancellation. Within a period of ten (10) days
following receipt of Tenant's statement of the Remaining Improvement
Costs, Landlord shall have the right to withdraw its termination notice and
to reinstate this Lease.
Tenant's Right to Reinstate. Notwithstanding the foregoing, Tenant shall
have the right to nullify Landlord's termination and to reinstate this Lease
by notifying Landlord (the "Reinstatement Notice"), within ten (10) days
after receipt of Landlord's notice, that Tenant intends to reopen the Premises
for business within sixty (60) days thereafter and to resume payment of
either the Minimum Rent or the Alternate Rent, whichever was in effect at
the time Tenant elected the Right to Close Remedy. The validity and
effectiveness of Tenant's reinstatement shall be conditioned upon Tenant's
actual opening of the Premises and the resumption of the applicable rent
within the sixty (60) day period aforesaid.
Landlord's Right to Nullify Tenant's Reinstatement. If Tenant elects to
reinstate this Lease, Landlord shall have the right, for a period of ten (10)
days following receipt of the Reinstatement Notice, to notify Tenant that it
has signed a lease with another tenant for the Premises, as evidenced by a
fully executed copy thereof between Landlord and such other tenant. In such
event, Tenant's reinstatement of this Lease shall be ineffective and the term
hereof shall expire upon the original termination date specified in Landlord's
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cancellation notice.
Tenant's Rights After Reinstatement. Many landlords take the position that once
the tenant makes the decision to reinstate, he waives all cotenancy protection forever
after. This is too harsh and unfair. Tenant's decision to reinstate is based on a business
decision he is making predicated on how things are at that moment in time. If he does
reopen, it is most likely based upon the fact that he now feels he can operate profitably
and is willing to give it another try. He should not be penalized for this. It is appropriate
however, to limit his rights in some fashion for the immediate future to prevent an
endless cycle of closings, terminations and reinstatement.
An acceptable clause would be an obligation of tenant to operate and pay full minimum
rent for a year from the reinstatement regardless of any cotenancy failure, with the tenant
to have his full panoply of remedies thereafter for the then existing or any new cotenancy
failure. Further, if he closed again and the landlord again terminated the lease, the
tenant's right to reinstate would be eliminated. However, if the cotenancy failure is
cured and subsequently fails again later on, the tenant would once again have all of his
rights and remedies, including the right to reinstate the lease if it were terminated by the
landlord by reason of the tenant's closure.
4.07-2. Straight Percentage Rent In Lieu of Going Dark. Landlords frequently offer
to allow the tenant to simply convert to a straight percentage rent upon a cotenancy
failure but forbid the tenant the right to go dark. From a tenant's perspective such a
gesture may be of little value if he is having a $100 day. The fact that his rent expense
for that day has been reduced to $5 does not compensate for his high operating costs.
When the tenant is operating in the red, the savings in rent may just not be worth it.
It is better for the tenant to have the choice in this matter - i.e. either to go dark and pay
minimum rent or to stay open and pay straight percentage rent. Sometimes sales may be
adversely affected by the closure of the other stores but still have not reached an
unprofitable level. It may the behoove tenant to stay open and go on straight percentage
rent. This would protect him against further declines in sales until they reached the point
where he would want to go dark and simply pay minimum rent. Thus, the conversion to
straight percentage rent with no minimum guarantee, even where the tenant's sales are
still acceptable, is the price the landlord must pay to have the tenant stay open despite the
failure of the operating requirements.
Landlord's Argument. Other landlords take the view that if the tenant elects to remain
open and operate, he should continue to pay the minimum rent. This argument is also
untenable. If the tenant's sales had been below the percentage rent breakpoint or were
even below his profitability level while the cotenancies were being met, the tenant was
required to operate and pay the minimum rent. However, if the landlord has failed to
hold up his end of the bargain and the cotenancies have failed, then if the tenant elects to
remain open, the landlord must share the risks with him. If the tenant's sales were above
the breakpoint at the time of the cotenancy failure and continue above that level, the
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landlord continues to receive exactly the rent that he bargained for. However, if the
tenant's sales were below the breakpoint at the time of the failure or fall below the
breakpoint thereafter, then its only fair that the tenant pay a percentage of his sales rather
than a guaranteed minimum amount.
Sales Test. As in the case where the tenant seeks to close the store, landlords try to
impose a sales test upon the tenant as a precondition to its right to switch to the a straight
percentage rent. The discussion above regarding a sales test in the context of a decision
to go dark is equally applicable here.
Figure 4-15
Tenant May Close or Pay Percentage Rent
In the event that the Operating Requirements are not being met, then
effective immediately, Tenant shall have the following rights:
(a)
Right to Close. To immediately close the Premises for business and
during such period of closure Tenant shall continue to pay the
Minimum Rent plus additional rents under this Lease and Tenant will
perform all of such other obligations as are applicable to a vacant
premises. This remedy shall be referred to as the "Right to Close
Remedy."
(b)
Alternative Rent. To remain open for business but effective
immediately, to pay monthly, as alternative rent (the "Alternative
Rent"), during the period that there is a Cotenancy Failure, in lieu of
Minimum Rent and Percentage Rent (computed in the manner set
forth in this Lease) an amount equal to
percent ( %) of all Gross
Sales (as defined herein) made in the Premises for each month (or
portion thereof) during such period. All other additional rents and
charges shall continue to be paid as required by other provisions of
this Lease. Each such payment of the Alternative Rent shall be made
within thirty (30) days after the end of each month (except that the
utilities portion shall be paid when due, if other than monthly) and
shall be accompanied by Tenant's statement of Gross Sales made
during the previous month. This remedy shall be referred to as the
"Alternative Rent Remedy."
Landlord's Grace Period. As in the case of Tenant's right to go dark, the landlord will
complain, with equal justification, that it will take time to replace the department stores
or the satellite stores and that he should be given a grace period before the tenant can
elect one of its remedies. However, unlike the case of the right to go dark, the tenant
must be permitted to immediately convert to percentage rent.
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4.07-3. Tenant's Right to Terminate the Lease. At some point in time the tenant must
have the right to terminate the lease if the operating requirements have failed for an
extended period. Consistent with the paragraph immediately preceding, he can agree to a
grace period before he is entitled to terminate the lease.
Figure 4-16
Tenant's Right to Terminate
In the event the operating Requirement have not been met for a continuous
period of six (6) months, in the case of the Department Stores, or for three (3)
months in the case of the Satellite Stores, then in addition to the Right to
Close Remedy and the Alternative Rent Remedy, Tenant shall have the
continuing right thereafter and while such Cotenancy Failure continues, to
cancel and terminate this Lease upon thirty (30) days notice to Landlord.
The remedy described herein shall be referred to as the "Termination
Remedy." Once such Termination Remedy has been exercised by Tenant,
Tenant's cancellation shall not be affected or nullified by the fact that the
Operating Requirements have once again been met during the thirty (30) day
cancellation notice period unless Tenant, in its sole discretion, elects to
revoke its cancellation notice and reinstate this Lease.
Tenant Must Choose. Some landlords attempt to require the tenant to make the
decision to terminate within a limited period of time or otherwise waive his rights
altogether. If the tenant elects to remain, then, the landlord argues, the tenant must
operate, pay full minimum rent and waive all of his cotenancy protection forever after.
This is too harsh of a result. While the negative effect of the cotenancy failure
has been hurting the tenant's sales, they may still be at marginal profitable levels. He just
may not be ready to make such an irrevocable, draconian choice at that time. It may be
that later on the effect of the cotenancy failure will worsen and drive his sales below the
profitable level. The tenant must simply wait and see.
However, the landlord may have a legitimate concern in avoiding the uncertainty
of not knowing from one moment to the next whether he is going to have a lease or not.
In such a dilemma he is unable to make arrangements to find a replacement for the
tenant's space. As a compromise, the tenant might agree that if he decides to stay, he will
operate and pay full minimum rent for another year, regardless of the cotenancy failure.
If at the end of that year there has been a continuous cotenancy failure during the interim,
then the tenant gets to make the same election again. This process would be repeated
thereafter on an annual basis assuming that there has been a continuous cotenancy failure
all along.vi6
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4.08 Landlord's Remedies If Tenant Violates Covenant
Remedies for Violations of Operating Covenants. A breach of the operating
covenant contained in the lease constitutes a material breach of the terms of the lease,
entitling a landlord to exercise all of its rights under the lease and at law to terminate the
lease and regain possession. As noted below, injunctive relief for failure to operate may
also be available in certain states. Providing for an additional remedy, such as the
liquidated damages payment contained in Figure 4-18 below, may be important to
address situations where the termination of the lease for default is too drastic a remedy in
the case of a tenant who is otherwise a productive part of the shopping center but refuses
to operate during shopping center hours. The liquidated damages provision may be
preferable to injunctive relief because it can be invoked immediately, without significant
cost, and without the requirement of initiating a court proceeding.
4.08-1 When Has The Tenant Violated The Covenant?. As in other cases of a failure
of performance under the lease, there should be a cure period after notice before a tenant
is deemed to be in default. In other cases, a failure of performance by the tenant may be
so minor or impossible to cure that to unleash all of landlord's remedies upon him would
be disproportionate to the crime. For example, opening early or closing late or failing to
be open for a single day are incurable defaults. They have already been committed and
cannot be cured. In such a case, only a repetition of the offense should precipitate a
default. Following is an appropriate clause:
Figure 4-17
When Failure to Operate is a Default
A. Failure to Open. An Event of Default will be deemed to occur upon the
failure of the Tenant to be open for business at all - when otherwise required
by Section
or other provisions of this Lease to do so - on a fourth (4th)
occasion during any one Lease Year provided that on each of the previous
three (3) occasions during said Lease Year Tenant had received written
notice from Landlord of such failure and has been accorded on each such
occasion five (5) business days in which to correct such failure and reopen for
business.
B. Opening Early/Late. In the case of a failure of performance under Section
which is incurable by notice because such failure has already occurred - e.g.
where Tenant has failed to maintain the minimum number of hours required
by that Section on a particular occasion - an Event of Default will be deemed
to occur on the fourth (4th) such occasion during a Lease Year provided that
on each of the previous three (3) occasions of a failure of like nature during
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said Lease Year Tenant had received notice of such failure from Landlord.
A default under (a) is curable. A default under (b) is not curable - once the Tenant has
failed to open in time by opening late, the deed is already done. With respect to a failure
to open at all, the Tenant must have committed this breach on a 4th occasion during the
Lease Year provided that on the 3 previous occasions Tenant was given 5 days to reopen.
With respect to opening late or closing early, Tenant must have committed this breach on
a 4th occasion during the Lease Year provided that he received notice of the prior
breaches on all 3 of the previous occasions.
4.08-2. Lease Termination. As in any default situation, the lease or the tenant's right to
exclusive possession is subject to forfeiture in cases where the tenant violates the
operating covenant.vii7 While this may be what the tenant wants, he should be made to
realize that in such a case he also will be subject to the whole range of damages which are
provided for in the lease and at law consequent upon a default.
A.
Rent Damages - Monthly Accounting and Deficiencies. A landlord may
elect to collect the rent monthly from the tenant or hold him liable for the
difference between the lease rent and the rentals landlord may be able to
collect on a reletting.
As stated above, most tenants bargain for the right to go dark if the
cotenancy conditions fail and to pay the rent on the vacant space.
Therefore, to that extent the result to the tenant will be the same whether
he has legally or illegally closed the store - he will be liable for the rent (or
any deficiencies) each month. A tenant who has illegally gone dark will
also be liable for the landlord's expenses in retaking possession, preparing
the premises for reletting and broker's commissions.
A tenant who has legally closed will not be liable for percentage rent and
should not be liable for the "Failure to do Business" penalty discussed
below.
B.
Rent Damages (Accelerated). As an alternative to collecting monthly rent
(or any deficiencies thereof) for the rest of the term, the landlord may
accelerate the rent, i.e., declare as immediately due and payable the
difference between the rent reserved for the balance of the term less the
fair rental value of the premises for that period, discounted to present
worth. Thus, the tenant may be facing an enormous monetary obligation if
he goes dark to alleviate the current financial burden of operating every
day at a loss. In addition, he may be subject to substantial general
damages flowing from his default.
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4.08-3. Damages (Other Than Rent), With or Without Termination.
A.
General Damages. Aside from the rent damages discussed above, the
normal rules on damages apply in a case where a tenant violates his
covenant to operate. Depending on the tenant's relationship to the rest of
the center, the damages flowing from his breach may be enormous. In
Hornwood v. Smith's Food King No. 16, 772 P. 2d 1284 (Nev 1989), a
supermarket tenant breached his operating covenant and the landlord
sought consequential damages based on the diminution in value of the
shopping center. The court found that the tenant, as an anchor,(1) drew
the largest amount of customers, (2) attracted other satellite tenants, and
(3) was essential for long term financing. When the anchor tenant left, the
rental value of the shopping center immediately decreased by virtue of the
vacancy, discouraging replacement tenants and customers and thereby
decreasing the overall value of the center. The court awarded the landlord
"diminution in value damages" in excess of one million dollars stating:
"Smith's is a sophisticated business entity. Smith's knew that its
presence as the anchor tenant had a critical impact on the shopping
center's success. Without an anchor tenant, obtaining long term
financing and attracting satellite tenants is nearly impossible for a
shopping center. Perhaps more importantly, the anchor tenant
insures the financial viability of the center by providing the
necessary volume of customer traffic to the shopping center.
Therefore, we find that the district court clearly erred in
concluding, as a matter of law, that the diminution in value of the
Hornwoods' shopping center was unforeseeable."
While the withdrawal of a satellite tenant is not likely to have the same
impact as that of an anchor, the inclusion of a properly drafted liquidated
damages provision is important so as to eliminate any danger of excessive
damages.
B.
Liquidated Damages. Most shopping center leases today contain a
liquidated damages provision such as the following:
Figure 4-18
Failure to do Business
The parties covenant and agree that because of the difficulty or impossibility
of determining Landlord's damages by way of loss of the anticipated
percentage rent from tenant or other tenants or occupants in or adjoining the
shopping center, or by way of loss of value in the shopping center because of
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diminished salability or mortgagability or adverse publicity or appearance
by tenant's actions, should Tenant (a) fail to take possession of the Demised
Premises on the Delivery of Possession Date for the purposes of commencing
Tenant's Work or, (b) fail to open for business in the Demised Premises fully
fixtured, stocked and staffed on the commencement date, (c) vacate, abandon
or desert the Demised Premises, or (d) cease operating or conducting its
business therein, (except during any period the Demised Premises are
rendered untenantable by reason of fire, casualty, permitted repairs or
alterations) or (e) fail or refuse to maintain business hours on such days or
nights or any part thereof as provided in paragraph 17 hereof, then and in
any of such events (hereinafter collectively referred to as "failure to do
business"), Landlord shall have the right, at its option, and as liquidated and
agreed damages (and not as a penalty) due to the difficulty of ascertaining
actual damages, (i) to collect not only Fixed Minimum Rent and other rents,
charges and sums herein reserved, but also an amount payable as additional
rent equal to the Fixed Minimum Rent reserved for the period of Tenant's
failure to do business, computed at a daily rate for each and every day or
part thereof during such period; and Landlord and Tenant agree that such
additional rent shall be deemed to be their best estimate of the damages
which will be suffered by Landlord as a result of Tenant's defaults as set
forth in (a), (b), (c), (d) and (e) of this sentence and such amount shall be
payable as liquidated damages in lieu of any percentage rent that might have
been earned by Landlord during such period, and (ii) to treat such failure to
do business as an "Event of Default" within the meaning of Paragraph 22 of
this Lease. Landlord's claim that Tenant has vacated, abandoned or
deserted the Demised Premises shall not be defeated solely because Tenant
may have left all or any part of its trade fixtures or other personal property
in the Demised Premises." (Emphasis added)
Liquidated Damages - Compensation or Penalty?. When negotiating a liquidated
damage provision in the lease for a violation of the operating covenant, a tenant should
establish a figure which is a realistic estimate of what the landlord's probable loss of
percentage rent will be -- in other words the tenant will want to make the number
compensatory rather than punitive. A figure of 15% - 20% of the daily minimum rent
(for a brand new store which fails to open on the commencement date) and an average of
the most recent percentage rent (over an agreed upon period) for an existing store would
be acceptable to a tenant.
The importance to a tenant of a valid liquidated damages provision is underscored by the
Hornwood case described above.
Clause is Subject to Cotenancy Failure. If the tenant has "legally" gone dark
because the operating requirements have failed, then the tenant should not be required to
pay the "failure to do business" penalty. Therefore, the tenant must insert, where
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appropriate, into a clause like Figure 4-18 the following phrase: "except when such
closing or cessation of business is otherwise permitted by this Lease."
Liquidated Damages Provision - Security For Performance or Alternate
Performance As a Bar to Injunctive Relief? While one might speculate that a liquidated
damages provision precludes the ability of the landlord to obtain an injunction (see §4.084 below) because his remedy at law (the liquidated damages) was deemed adequate by
his own admission, this is not the case. A preponderance of courts have held that the
right to specific performance is not determined by whether the provision is one for a
penalty on the one hand or for liquidated damages on the other; rather, the question is
whether the provision was intended merely as security for performance of the obligation
or was intended as an alternative to the obligation, giving the tenant the option either to
perform the obligation (operate the store) or to pay or forfeit the penalty or liquidated
sum. If it appears that the parties intended that the covenant be performed and that the
provision for liquidated damages was merely security for such performance, then specific
performance generally will not be denied on the "adequacy" ground. It is only when the
lease stipulates for one of two things in the alternative -- the performance of the covenant
or the payment of a sum in lieu thereof -- that equity typically will not decree specific
performance. In a shopping center lease it is more likely that the liquidated damages
provision will be construed as security, not alternate performance, and will not in itself
serve as a bar to the landlord's suit for specific performance. But see Lippman v. Sears,
Roebuck & Co., 44 Cal.2d 136, 280 P.2d 775 (1955), where the court reached an
opposite result.
4.08-4 Specific Performance or Injunctive Relief. The landlord's most effective
remedy is, of course, specific performance of the covenant requiring the tenant to operate
(or reopen) or an injunction preventing the tenant from closing. While a violation of the
operating covenant will entitle the landlord to all of its usual legal rights and remedies -forfeiture of the lease, eviction and damages resulting from the breach -- the question of
whether a court will consider equitable relief to be more appropriate and force the tenant
to remain open is a crucial one. To a tenant, the compulsory continuance of a business
that is suffering losses each day may be more onerous than eviction and damages.
The two most important obstacles that the landlord will encounter in securing specific
performance of a continuous operations covenant are (1) establishing that the landlord's
remedy at law for damages is inadequate and (2) the judicial doctrine against burdening
the equity court with ongoing and continuous supervision of its decree. While several
courts recognize that the unique nature of a shopping center will support the conclusion
that damages are an inadequate remedy and would otherwise have normally been
disposed to grant specific performance, these courts nevertheless generally have declined
to do so because of a judicial policy against issuing a decree that will require continued
judicial supervision and special skills to ensure its enforcement. See Reicker, Specific
Performance of Shopping Center Leases in California, 21 Hastings Law Journal 532.
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A increasing number of jurisdictions (but still a minority of them) have granted specific
performance or injunctive relief to the landlord and have not been troubled by the
traditional reluctance of equity court to involve themselves in the supervision of its
decree. The prevailing majority view, however, would deny the landlord relief on this
ground.
4.08-5 Landlord's Express Reservation of the Right to Injunctive Relief. Typically,
the following clause appears in a landlord's lease form:
Figure 4-19
Landlord's Right to Injunction
In the event of any breach or threatened breach by Tenant of any of the
terms and provisions of this Lease to be performed and observed by Tenant,
Landlord shall have the right to injunctive relief and declaratory relief or
any other equitable relief as if no other remedies were provided for herein.
This language would appear to suggest that the tenant has stipulated that the landlord's
remedy at law was inadequate. However, regardless of whether the parties can
contractually confer equitable jurisdiction to a landlord (given the broad discretionary
power of an equity court) and relieve the landlord of the duty to plead and establish it, the
tenant should avoid any implication that the lease does so. The clause should be
modified as follows:
Figure 4-20
Landlord's Right to Injunction - Modified by Tenant
In the event of any breach or threatened breach by Tenant of any of the
terms and provisions of this Lease to be performed and observed by Tenant,
Landlord shall have the right to seek injunctive relief and declaratory relief
or any other equitable relief as if no other remedies were provided for herein.
Another way to achieve this result would be the following clause:
Figure 4-21
Landlord's Right to Injunction - Modified by Tenant [Alternate]
In the event of any breach or threatened breach by Tenant of any of the
terms and provisions of this Lease to be performed and observed by Tenant,
Landlord shall have the right to injunctive relief and declaratory relief or
any other equitable relief as if no other remedies were provided for herein
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provided however that the foregoing shall not be deemed to relive Landlord
of the obligation to establish his entitlement to injunctive relief, including,
without limitation, that his remedy at law is inadequate.
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Appendix I: Definition of Department Store
§4.09-1 Importance of Department Store in The Lease. The concept of a department
store in the Lease is relevant for the following reasons:
a.
b.
c.
d.
e.
f.
the opening requirements clause;
the continuous operations cotenancy provisions;
excluding the area occupied by the department store from the denominator
of Tenant's proportionate share formula ("Tenant's denominator") for
purposes of CAM and taxes, insurance and other additional rents.
increases in the minimum rent when an additional department store opens
in the center;
imposition of a special "grand re-opening" or promotion charge when a
department store is added to the center;
when there is a relocation clause in the Lease, the addition of a department
store is one of the triggering events which activates the clause.
§4.09-2 Why Is A Precise Definition Important?. Up until the last decade, the issue
wasn't important. A "department store" was never defined in leases. Everyone seemed to
know and agree on what that meant, even if the perception was extremely subjective and
not consistent between one store and the next. The parties focused their attention on the
number and identity of the department stores for the various provisions of the Lease.
When landlords switched from the use of the word "department store" to words
like "Anchor Store" or "Major Store" or simply began defining department stores as large
space users, the impact on the tenant was dramatic. Unless the concept of department
store was more carefully defined, the tenant would experience some very surprising and
unhappy results.
For example: Landlord A.viii8 Any store in excess of 15,000 sq. ft.
Landlord B. A "Major" is any store in excess of 25,000 sq. ft. A
"Junior Major" is any store in excess of 15,000 sq.
ft.ix9
Landlord C.
Any store designated by Landlord as an
"anchor".[!]
Therefore, if the Macys department store went dark and a furniture store replaced
it, the Landlord argued that the operating cotenancy clause was complied with. If the JC
Penney store closed and a superdrug store replaced it, the tenant would be stuck
subsidizing the drug store for CAM and taxes. All this, simply because the new tenant
occupied a large amount of GLA.
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§4.09-3 The Concept of Department Store Is Very Subjective. Before there was a
need to specifically define the term, the number of "departments" was not the deciding
factor in describing a "department store". Although a certain merchandise assortment
was necessary, the extent varied widely from one department store to the next. Indeed, in
the definition which follows later in these materials, where certain objective criteria are
set forth, many stores which are traditionally regarded as true "department stores" would
not even qualify while many other stores who were never regarded as department stores
would qualify.
This fact illustrates the subjective nature of the concept. The idea of a department store is
based on historical impressions and perceptions. It is extremely difficult define
objectively in such a way as to accurately include all of the "right' people and exclude all
of the "wrong" people. Consider the following types of retailers:
General Merchandiser. There are general merchandise retailers - one which is
well known in California - who would literally meet every objective criteria under our
definition for a department store: large, multi-departmented carrying apparel, electronics,
housewares, furniture, appliances, tools. But nobody thinks of them as a "department
store.
Catalog Store. These stores are also large and multi-departmented, carrying
electronics, housewares, furniture, appliances, tools (perhaps apparel). Again, nobody
thinks of them as a "department store". They are a "catalog" type of store.
Membership Warehouse Stores. Large, multi-departmented, carrying apparel,
electronics, housewares, furniture, appliances, tools. However, nobody thinks of them as
"department stores".
Why? I think the biggest influence in people's perception is the fashion level and service
level of the store coupled with its size. The large size also makes possible an extensive
assortment of merchandise (i.e. departments) but this varies widely among these retailers.
In the membership warehouse stores, they are very "industrial" in their layout and look,
with no special store design feature. Customers pick their own merchandise; there is no
real sales force, just cashiers.
These three types of stores would fall into the category of "Super Stores" which are
discussed under "CAM and Taxes" below.
The Large Apparel Store. In recent years some of these stores which started out
as small in-line shops have expanded their merchandise mix and have occupied a
lot of GLA - exceeding 75,000 sq. ft. in some malls. Nevertheless, as attractive
and successful as these retailers are, no one really thinks of them as "department
stores", probably because of their satellite store roots. However, landlords have
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been pressured to attempt to characterize them as department stores for cotenancy
purposes as well as special treatment for CAM and taxes.
Dictionary Definition.
If you try to define the term Webster's way:
"a large retail store carrying several lines of
merchandise and organized into various departments
for sales and administrative purposes."
Landlords would love this definition.
An Honest Definition.
After studying all of the stores who qualify and all who
don't, one arrives at the following definition:
"A Department Store is a retail operator who, in the
collective unconscious of developers and retailers, was
always thought of that way, whether they carried a full
line of merchandise including appliances, electronics
and hardgoods (Sears, Penneys, Montgomery Ward) or
simply an extensive apparel line (Nordstrom's, Saks,
Mervyn's or Bonwit's)."
§4.09-4 "True" Department Stores vs. "Super Stores" and Large Space Users.
Only "True" Department Stores Count - Not Large Space Users. For purposes of the
operating cotenancy clause, only "true" department stores count. A large user does not an
anchor make. The department store was the only true anchor - the party that constituted
the major draw of customers to the project. The satellite stores, while creating synergy of
their own, relied upon and fed off of this draw. It was always department stores that
provided this effect, not large users. Because of their known and desired quality of
operation and their perception in the minds of the consuming public, department stores
exude a high drawing power. As the key to any shopping center project, they were given
special status and attendant privileges such as preferential treatment for CAM and tax
purposes.
Landlords are now being pressured into diluting the definition of a department store
partly by reason of the present retail climate and partly (or mostly) by greed. With
traditional department stores going into bankruptcy it is getting harder for landlords to
find replacements in the form of true department stores. It is especially harder for them to
replace one department store with another of equal or better fashion level. In many cases,
particularly in centers that are going downhill, they will only be able to find a lower-end
department store, or worse, a single use large user, to occupy the former department store
space. It is at this point that the Landlord, having replaced the Macys with a furniture
store, will announce that the department store operating cotenancy requirement has been
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maintained.
The other dominant pressure upon the Landlord to cram the large user into the definition
of a department store has been where the landlord has been forced, because of that user's
size, to limit his contribution to CAM and taxes. In this situation landlords are merely
motivated by greed in their attempt to make the satellite tenants pick up the deficiency; it
has nothing to do with the fact that good replacement department stores are getting harder
to find. In fact, a center may have plenty of true department stores and in addition one or
two large users who have special deals on CAM and taxes.
To replace a true department store with a mere large user lacking the same drawing
power for the same type of customer frustrates the tenant's legitimate business
expectations. In such a case, a satellite tenant may find that his opening requirements,
operating cotenancy and his increased minimum rent is tied to the sporting goods store,
the toy store, the furniture store or a "Super Apparel" store rather than to a Penney's or
Macy's while his additional rent obligation includes subsidizing these operators for CAM
and taxes. The character of the center cannot be mongrelized to such a point that large
users are standing in place of true department stores while the landlord continues to
perpetuate the fiction that we still have an "anchor" here. In the enclosed mall context
"Anchors" were always understood to be true department stores, not large single users
such as a 75,000 square foot furniture store or home improvement center.
§4.09-5 Landlord's Arguments In Favor of Large Users and Against A Definition.
"But Large Users Generate Lots of Traffic". So does The Gap, The Limited, Ann
Taylor, Crate & Barrel etc., but that is not the single criterion to elevate them to an anchor
status. Department stores, by a combination of their size, fashion level, manner of
operation and perception in the mind of the public, generate far more traffic than the large
user.
In addition, the traffic these operators generate is often not the kind of consumer
upon whom traditional mall satellite tenants rely. A furniture store brings out customers
come once every three years to buy a sofa or other piece. Membership warehouse stores
attract shoppers who are buying groceries and sundries in bulk and very inexpensive
apparel. While the membership warehouse store can be regraded a Super Store for CAM
and taxes, they are not a department store for operating cotenancy purposes.
Mere large users can never be the kind of destination store for consumers that true
department stores are.
"How Do You Distinguish These Large, Multi-Departmented Stores From "True"
Department Stores?" What if Super Apparel Store "X" becomes a department store?
But the whole point of this discussion is who knows what that is or when that occurs?
Compare Nordstrom's and Mervyn's, on the one hand, and The Limited on the other; they
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are very similar (some would say they are the same) in that they are large apparel
retailers. The former have always (or for a long time) been regarded as true department
stores.
While Nordstrom's itself started out as a mere shoe store decades ago, at some
point in history they evolved, in the public's mind, into a department store. Many of the
established department stores for that matter started out in the 19th Century as little more
than dry goods stores in downtown business districts. But over the years as they
increased their merchandise lines, they established themselves in the minds of the
consuming public as department stores.
However, large space apparel retailers who have a long history of being
associated with satellite stores cannot now be regarded as department stores. Perhaps
such stores are being handicapped or prejudiced by their own history and origin as a
satellite stores. However, fair or not, perception is all that counts and such stores have
always been (and continue to be) perceived as satellite stores and not as department
stores. One simply does not think of a shopping center as being "anchored" by a large
apparel retailer, thereby bestowing upon them department store status.
"Its Too Subjective". Exactly - the concept of a department store, once you try to analyze
it, is all subjectivity. We are dealing with a concept that is to a large extent subjective
and based on historic impressions and perceptions. When you try to define it absolutely
with words, the risk of ambiguity falls on the Tenant with the result that his rights and his
rents will be determined by entities that he never imagined.
"The Clause is Too Long And Complex". Its also a very important clause and the
alternatives are unacceptable. Assignment clauses are often very much longer yet
everyone in the leasing community accepts that fact. The department store issue is far
more important as it affects the tenant's everyday operation whereas the assignment
clause may be invoked (if at all) only once during the term.
"Excluding Stores By Name Will Violate The Anti-Trust Laws". This argument is
epitome of bootstrapping. There is no anti-trust question. By merely naming stores
specifically that do not qualify as "department stores" for definitional purposes, we are
not preventing the Landlord in any way from signing leases with those retailers. We are
simply defining who is and who is not a department store for operating cotenancy and
CAM/tax purposes under our Lease.
If the Landlord takes the position that he will be discouraged from or lacks
incentive to sign deals with those large users because:
a.
he cannot then require the tenant to continue operating if those large users
replace department stores, or
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b.
he cannot force the tenant to pay for the caps those large users enjoy in
CAM and taxes,
then Landlord is making that decision voluntarily and purely on the basis of his own
avarice. But Landlord's greed cannot then be turned around and characterized as the
tenant's anti-trust problem. The "anti-trust issue" is a bogus one.x10
§4.09-6 Outline of The Definition.
Department Store. With the exceptions noted below, a department store is a store with
the following features:
(1)
(2)
(3)
(4)
Size - minimum of 75,000 square feet;
operates under a single tradename;
operates within a single set of demising walls;
is multi-departmented store carrying several different classes of
merchandise, which shall include the following classes ("merchandise
test"):
"Core" Merchandise
apparel;
apparel accessories;
cosmetics and perfume;
jewelry;
housewares;
plus one from the following list:
Additional Merchandise
domestics and linens;
electronics;
home furnishings;
appliances;
furniture;
floor coverings;
Even under this generic, objective definition, many stores traditionally regarded as
"department stores" would not qualify because of the merchandise test. On the other
hand, other stores that didn't belong in this category would qualify, e.g. General
Merchandise retailers, Catalog Stores, Membership Warehouse stores.
To resolve this dilemma, a list was created of pre-approved stores who are
universally accepted as "department stores", regardless of what merchandise they carry so
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long as they meet the size, single tradename and demising walls requirements. The
longer the list, the better for both Landlord and Tenant.
• Pre-Approved Department Stores. "Department Store" will include a specific list of
pre-approved named stores, whether or not they meet the merchandise test.xi11
[Add List of Pre-Approved Department Stores]
• Specifically Excluded Stores By Name. "Department Store" will exclude a specific list
of unacceptable stores by name, whether or not they meet the generic requirements
above. among these will be the large apparel specialty store.
[Add List of Specifically Excluded Stores]
The list of specifically excluded stores is necessary to keep out certain stores, whether or
not they meet the criteria set forth above.
• Additional Exclusions - Specific "Types" of Store. "Department Store" will exclude
the following types of stores, whether or not they meet the requirements of the basic
definition above:
(i)
(ii)
(iii)
(iv)
super drug stores;
home improvement centers;
an off-price or discount or clearance division of any of the stores
appearing on the pre-approved list;
a catalog store.
These stores must be excluded; otherwise, they would literally meet the test of the
basic definition - they are large, single-named, single stores and multi-departmented.
• Adding "New" Department Stores. If Landlord wants to qualify a store not on the
pre-approved list, he may do so provided such store meets the generic tests and is not
otherwise excluded by name or by type. If the parties cannot agree, the matter is decided
by arbitration.
• Replacing Stores - "Suitable Replacement".
The Named Department Store. For purposes of the operating cotenancy, a
suitable replacement of the named department store shall be a department store whose
merchandise, in terms of quality (and price) is equal to or better (higher) than that carried
by the named store which is being replaced. By naming the original store, the tenant has
set a certain quality or fashion level. Such store must be replaced by "like-kind" or
better.
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The Unnamed Department Store. A suitable replacement of the unnamed
department store is simply another department store. Since the tenant didn't name the
store, he did not tie into a certain fashion level for that store. Any true department store
will do.
SUPER STORE/LARGE USER DEFINITION DISTINGUISHED - CAM & TAXES
Super Stores. The category of "Super Stores" was created to embrace multidepartmented stores who didn't make it on to the pre-approved list, e.g. general
merchandise stores, membership warehouse stores and catalog stores. These are large
retailers with some variety of merchandise mix and whose name and reputation - i.e.
drawing power - may entitle them to quasi-department store status for CAM and tax
purposes, but never for operating cotenancy purposes. Their GLA may be excluded from
the denominator of the tenant's proportionate share fraction, but only under certain
limited circumstances. This category was created in an attempt to reach a compromise
with the Landlord's desire to have all large users subsidized. They are more than a Large
User but less than a department store.
Large Users are simply that - large boxes, often with only one category of
merchandise (e.g. a furniture store). Their GLA is almost never excluded from Tenant's
denominator, with only one or two narrow and very limited exceptions.
• Super Store A "Super Store" meets all of the objective criteria of the department store
definition as to size, single tradename, single set of demising walls and the merchandise
test.
However, unlike a department store, there is no list of specifically excluded stores.
Therefore, many stores on the "excluded" list for department store purposes could qualify
as Super Stores.
Also, unlike a department store, a Super Store may include:
•
•
•
home improvement centers;
an off-price or discount or clearance division of any of the stores
appearing on the pre- approved list;
a catalog store.
However, like a department store, a Super Store excludes:
•
•
super drug stores
an apparel specialty store
Large User. A Large User is a store that meets the size, single tradename and
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single set of demising walls test but there is no merchandise test. A Large User can be
merely a single purpose user such as a furniture store. However, Large Users will still
specifically exclude specialty apparel retailers. Note that for a Large User there are no
specifically excluded named stores, no excluded types of store other than an apparel
specialty store nor is there any merchandise test. All that is needed is:
(1)
(2)
(3)
Size - minimum of 75,000 square feet;
operates under a single tradename;
operates within a single set of demising walls;
Once a retailer qualifies as a Super Store, then whether and to what extent the GLA of
that store would be excluded from the denominator of the tenant's proportionate share
fraction will be determined by certain rules.
REPLACEMENT OF KEY STORES IN POWER CENTERS
"Key Stores" in Strip Centers. In strip or power centers the cotenancy requirements are
tied to certain identified "key stores" and the problems of identifying them and replacing
them become much more perplexing. Department stores do not typically appear in these
markets, with the exception of value priced stores such as Wal-Mart, Target, K-Mart,
Kohls, Bradlees and the like.
The non-department store key stores are usually category killers such as Toys R' Us,
Home Depot, Office Depot, Border's Books, Blockbuster Video, Bed Bath & Beyond,
Circuit City, Linens & Things, Michael's (Art Supplies), Sports Authority, SportsMart,
Petsmart as well as big box apparel users such as Ross, T.J. Maxx, Marshalls and Old
Navy. In some leases, they may also include smaller stores occupied by well established
retailers such as Pier One. Replacing these stores when they go dark for purposes of the
cotenancy clause becomes a very tricky exercise, both definitionally and practically.
A power center landlord will find it very difficult to deal with a key store cotenancy
clause for two reasons: (1) key stores do not typically have operating covenants;xii12 (2)
many key stores are retrenching or going out of business in today's retail climate.
Therefore, the likelihood of a cotenancy failure occurring is greater than in the context of
an enclosed mall where there are several department stores, not all of whom are
specifically named for cotenancy purposes. The problem of replacing key stores
becomes severe.
Nevertheless, a tenant can no more be expected to abandon that very synergistic appeal of
a power center with which the landlord courted him than he can in the enclosed mall
context. Cotenancy protection is as much a fact of life in power centers as in malls.
Who Can Replace The Key Stores?. From a landlord's perspective, any retailer of
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national or regional repute is sufficient. This will never appease any tenant. If a sporting
goods category killer or a big box apparel tenant goes dark, replacing them with a
nationally known auto parts store will hardy preserve the retail climate the tenant thought
he was getting. In such a case, the tenant is entitled to pursue his go-dark remedy as well
as his rent relief remedy and termination rights under the conditions discussed in §4.07
above.
A Solution. One solution is to provide that a replacement retailer, for purposes of
the cotenancy clause only, will be subject to tenant's approval,xiii13 which will not be
unreasonably withheld so long as:
(1)
(2)
(3)
(4)
the use is the same (or within certain pre-approved use classifications);
the merchandise is of similar quality and price points;
the replacement is of national or regional repute;
the replacement occupies substantially all of the vacating store's space.
This approach is the simplest to negotiate and implement and preserves the
essential character of the center that the tenant originally bargained for.
1
i
E.g., provisions requiring a tenant to keep the store continually stocked and staffed, a covenant to use his best efforts
to maximize sales and a requirement that the tenant staff the store with a sufficient number of employees.
2
ii
Portions of this §4.03, "From a Landlord's Perspective" reprinted with permission of Mark S. Hennigh,
Esq., Greene, Radowshy, Maloney & Share, San Francisco, CA and Elizabeth H. Belkin, Esq., Rudnick &
Wolfe, Chicago, ILL.
3
iii
Although the boilerplate of his lease (and the site plan at the back of the lease) will disclaim any inference of such
an inducement.
4
iv
"No poet ever interpreted nature as freely as a lawyer interprets truth." Jean Giradoux
5
v
One developer has created two classes of special retailer: any store in excess of 25,000 square feet is called a
"Major" and any store in excess of 15,000 square feet being labeled a "Junior Major"(!), presumably for purposes of
CAM and taxes.
6
vi
Of course, if the cotenancy requirements are once again met at any time during this period, the chain is broken and
the tenant must operate and pay full minimum rent. Upon a subsequent cotenancy failure, the whole process starts all
over again: (1) the tenant may pursue his three remedies, (2) after the requisite waiting period, he may elect to cancel or
to remain and is afforded the annual review cycles thereafter.
7
vii
For this discussion, we are ignoring the distinction between whether the landlord technically, under local law, has
permanently terminated the tenant's lease or right to possession on the one hand or has simply "borrowed" his right to
possession, for purposes of reletting, on the other. The important point here is that the tenant continues to be liable for
the rent for the balance (or what would have been the balance) of the term.
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viii
ix
8
The names of the developers have been omitted.
9
The GLA of "Junior Majors" are excluded from the denominator of tenant's proportionate share formula.
x
10
Landlords who complain about illusory anti-trust issues should examine their own behavior when they require a
tenant to sign a lease in shopping center "B" (which the tenant didn't want) in order for that tenant to obtain a lease in
shopping center "A" (which he did want). This is called a tie-in agreement and may be illegal per se. It is a much more
legitimate anti-trust issue.
xi
11
However, they still must meet the size, single tradename and single set of demising walls test of (1) - (3)
above.
xii
12
In malls, department stores may not have them either or may only have them for a relatively short period of
time. But the satellite stores will all be required to operate (subject to their own cotenancy clauses). Therefore, a much
grater percentage of tenants, by number, will be required to operate than not.
xiii
13
A disclaimer should appear in the lease that the tenant's approval right for this limited definitional purpose in
no way or manner precludes the landlord from entering into leases or agreements with anyone he chooses, in the
exercise of his sole and absolute discretion.
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