Lease Terms Restaurant Tenants Need to Understand
Standard commercial leases are generally 25-35 pages, and can be over 50 if a complex deal. As a restaurant tenant, you want to get into the center and start making money as soon as possible, but this is no reason to rush the negotiation process. Landlords want security in the deal, and the less negotiating power you have as a tenant the more likely it is a landlord will reserve extensive protections in the lease that could end up severely financially harming tenants who perform poorly. This blog highlights important lease terms in connection to commercial restaurant leases. Tenants should strongly consider hiring a lawyer and going over the entire lease with them, with specific attention paid to the below terms.
Delivery Date
Receiving the building from the landlord is obviously a critical component to being able to start operating your restaurant. The typical lease will present this as a specific date of time, but tenants need to be wary of things going wrong. Old tenants might not be out in time, the landlord might not finish their work in the building by the delivery date, construction might not be completed, permits not obtained, and so on. As a tenant, you should have the goal of negotiating termination rights if the building is not delivered on time, as well as commitments by the landlord to reimburse out-of-pocket expenses that may occur due to late delivery, including the return of any security deposit.
Permits
Opening a new restaurant requires several levels of government approvals, licenses and permits. What can really hurt a restaurant tenant is not having the necessary permits to start selling food on the first day of your lease term. To avoid this, tenants should focus on negotiating a right to terminate the lease if they are unable to obtain needed licenses or permits. This contingency will have a variety of factors, including the length of the contingency period, a list of necessary approvals, whether additional time can be granted to seek the license/permit, and any fees in the event of termination.
Gross Sales Termination Rights
If you’re opening a restaurant, you should already have an idea of what your annual sales need to be to make a profit, and you should negotiate around this number before signing a lease. Typically referred to as a “gross sales kick-out clause”, this provision allows a tenant to terminate the lease if sales do not reach a breakpoint number. This is an exit strategy that obviously benefits the tenant, but you should be able to convince a landlord of its benefit to them as well. A landlord doesn’t want a failing tenant, and is almost exclusively concerned with collecting rent. If sales aren’t on track to meet the annual breakpoint, both parties have benefits in ending the lease. Important pieces of this provision should include the breakpoint number itself, the measuring period, lead-time before termination, and any fees associated with termination. As a tenant, you want to be able to exercise this right as early as possible, so you can terminate with as little lost money as possible.
Assignments and Subleases
A tenant’s ability to assign (transfer the lease interest to a new tenant) and sublease (lease out a portion of your space to another tenant) are important provisions because it allows for greater control of a tenant’s ability to exit the lease. Tenants should try to negotiate in a way that limits to the furthest extent possible a landlord’s ability to deny or delay assignments/subleases. Moreover, Tenants should try to carve out requirements that would not require landlord consent to transfer. Often, landlords allow tenants to transfer to subsidiary or affiliate companies under tenant’s control. If a landlord demands that their consent is required, tenants should focus on negotiating more specific rules for when a landlord may or may not withhold consent. These clauses should revolve around the financial situation and management/operating experience of the prospective transferee,
Exclusive Uses
An exclusive use clause restricts the landlord from bringing in business that competes with the tenant. For a restaurant tenant, how much you’ll reasonably be able to restrict the landlord in this way will depend on how national of a brand the tenant’s business is, how big the center is, and the landlord’s reputation. However, it’s very unlikely that you’ll be able to prevent other restaurants from operating in the center. However, a tenant should strongly negotiate for the right to be the only restaurant of their type in the shopping center, and prevent similar restaurants from coming into the center for the duration of the tenant’s lease. Other things to consider include the scope of the landlord’s obligation to protect exclusive use rights, and any termination rights in connection to exclusive uses.
Sampling
If your restaurant is located in a mall, or if free samples is a critical component of your business, then it’s important to get rights to sample food in the lease. Tenants who adopt this business model should request the right to offer free samples, and define in the lease the areas where they can offer such samples.
Relocation
Landlord’s often will have provisions in the lease giving them the right to relocate you if they wish, and this is often a restaurant’s tenant’s worst nightmare, as we can assume a tenant wants a specific space for good reasons. Your first goal as a tenant should be to remove this clause altogether, but this isn’t always possible. If you cannot convince a landlord to eliminate a provision like this, then you should have the following goals: restrict how often landlord can do this to once during the term; require advance notice; require the landlord to pay for everything relating to the relocation to the fullest extent possible; require that the new site be as similar as possible; and obtain the right to terminate in the event of relocation.
Percentage Rent Exclusions
Sometimes a landlord will demand a tenant to pay, in addition to other rent under the lease, “percentage rent.” This is simply a percentage of gross sales or revenue generated at the restaurant. Tenants should try to avoid having to pay percentage rent, but if you’re dealing with a landlord who has a good bit more negotiating leverage, it might be unavoidable. If a tenant has to end up paying percentage rent, try to negotiate the following exclusions:
Common Area Charges
If a tenant is operating in a shopping center, there are going to be areas designated for common use, and a landlord will almost always charge the tenants to repair and maintain these common areas. In negotiations, a tenant’s goal should be to minimize such charges. A tenant can try to do so by limiting the following expenses:
Personal Guaranty
Landlords often require tenants to obtain a personal guaranty - someone who will perform the tenant's obligations (mostly its monetary obligations) if the tenant fails to do so. Depending on the bargaining strength of the respective parties, there are a few ways a tenant might be able to limit liability under a personal guaranty.
Implementing a burn-off clause terminates personal liability of the guarantor if the tenant does not default in a certain amount of time (e.g., the first two years of the lease).
Implementing a rollover clause that terminates the personal guarantor’s liability after a certain amount of time and only up to a certain amount of rent (e.g., up to two years of rent for the first four years).
Security Deposit
While security deposits are often the first month or two of rent, sometimes landlord’s will require large security deposits to feel safe entering into the deal. If a landlord is demanding a tenant to pay a particularly large amount, try to negotiate a provision that requires the landlord to refund the tenant if it does not default on the lease after a certain period of time (e.g., 50% of the security deposit will be refunded after one year of no uncured defaults, with the remaining 50% to be refunded after three years of the same).
Delivery Date
Receiving the building from the landlord is obviously a critical component to being able to start operating your restaurant. The typical lease will present this as a specific date of time, but tenants need to be wary of things going wrong. Old tenants might not be out in time, the landlord might not finish their work in the building by the delivery date, construction might not be completed, permits not obtained, and so on. As a tenant, you should have the goal of negotiating termination rights if the building is not delivered on time, as well as commitments by the landlord to reimburse out-of-pocket expenses that may occur due to late delivery, including the return of any security deposit.
Permits
Opening a new restaurant requires several levels of government approvals, licenses and permits. What can really hurt a restaurant tenant is not having the necessary permits to start selling food on the first day of your lease term. To avoid this, tenants should focus on negotiating a right to terminate the lease if they are unable to obtain needed licenses or permits. This contingency will have a variety of factors, including the length of the contingency period, a list of necessary approvals, whether additional time can be granted to seek the license/permit, and any fees in the event of termination.
Gross Sales Termination Rights
If you’re opening a restaurant, you should already have an idea of what your annual sales need to be to make a profit, and you should negotiate around this number before signing a lease. Typically referred to as a “gross sales kick-out clause”, this provision allows a tenant to terminate the lease if sales do not reach a breakpoint number. This is an exit strategy that obviously benefits the tenant, but you should be able to convince a landlord of its benefit to them as well. A landlord doesn’t want a failing tenant, and is almost exclusively concerned with collecting rent. If sales aren’t on track to meet the annual breakpoint, both parties have benefits in ending the lease. Important pieces of this provision should include the breakpoint number itself, the measuring period, lead-time before termination, and any fees associated with termination. As a tenant, you want to be able to exercise this right as early as possible, so you can terminate with as little lost money as possible.
Assignments and Subleases
A tenant’s ability to assign (transfer the lease interest to a new tenant) and sublease (lease out a portion of your space to another tenant) are important provisions because it allows for greater control of a tenant’s ability to exit the lease. Tenants should try to negotiate in a way that limits to the furthest extent possible a landlord’s ability to deny or delay assignments/subleases. Moreover, Tenants should try to carve out requirements that would not require landlord consent to transfer. Often, landlords allow tenants to transfer to subsidiary or affiliate companies under tenant’s control. If a landlord demands that their consent is required, tenants should focus on negotiating more specific rules for when a landlord may or may not withhold consent. These clauses should revolve around the financial situation and management/operating experience of the prospective transferee,
Exclusive Uses
An exclusive use clause restricts the landlord from bringing in business that competes with the tenant. For a restaurant tenant, how much you’ll reasonably be able to restrict the landlord in this way will depend on how national of a brand the tenant’s business is, how big the center is, and the landlord’s reputation. However, it’s very unlikely that you’ll be able to prevent other restaurants from operating in the center. However, a tenant should strongly negotiate for the right to be the only restaurant of their type in the shopping center, and prevent similar restaurants from coming into the center for the duration of the tenant’s lease. Other things to consider include the scope of the landlord’s obligation to protect exclusive use rights, and any termination rights in connection to exclusive uses.
Sampling
If your restaurant is located in a mall, or if free samples is a critical component of your business, then it’s important to get rights to sample food in the lease. Tenants who adopt this business model should request the right to offer free samples, and define in the lease the areas where they can offer such samples.
Relocation
Landlord’s often will have provisions in the lease giving them the right to relocate you if they wish, and this is often a restaurant’s tenant’s worst nightmare, as we can assume a tenant wants a specific space for good reasons. Your first goal as a tenant should be to remove this clause altogether, but this isn’t always possible. If you cannot convince a landlord to eliminate a provision like this, then you should have the following goals: restrict how often landlord can do this to once during the term; require advance notice; require the landlord to pay for everything relating to the relocation to the fullest extent possible; require that the new site be as similar as possible; and obtain the right to terminate in the event of relocation.
Percentage Rent Exclusions
Sometimes a landlord will demand a tenant to pay, in addition to other rent under the lease, “percentage rent.” This is simply a percentage of gross sales or revenue generated at the restaurant. Tenants should try to avoid having to pay percentage rent, but if you’re dealing with a landlord who has a good bit more negotiating leverage, it might be unavoidable. If a tenant has to end up paying percentage rent, try to negotiate the following exclusions:
- Excise taxes on sales or services where such taxes are paid by the tenant directly to the taxing authority.
- Any cash or credit refunds from sales that are later returned by the purchaser and accepted by the tenant.
- Transfers of merchandise between the tenant’s restaurants solely made for the convenient operation of the tenant's business.
- Any returns to shippers, distributors, or manufacturers.
- Sales of equipment, fixtures, or other property after they have exhausted their substantial use in the tenant's business, but this does not include any stock sales or transfers.
- Gift cards before they have been redeemed.
- Insurance proceeds or other sums/losses received or paid in connection to a settlement or legal claim.
- Contributions/donations to nonprofit or charitable organizations unless such contributions result in profit to the tenant.
- The value of any promotional sales.
- The value of automatic gratuities, tips, service fees and commissions, including any ATM service fees.
Common Area Charges
If a tenant is operating in a shopping center, there are going to be areas designated for common use, and a landlord will almost always charge the tenants to repair and maintain these common areas. In negotiations, a tenant’s goal should be to minimize such charges. A tenant can try to do so by limiting the following expenses:
- Exclude certain costs from the definition of common area charges.
- Reduce what is included in the definition of the common areas.
- Limit the landlord’s ability to exclude certain portions of the shopping center.
- Implement a cap that prevents a tenant’s share of common area charges from increasing on a year-to-year basis by more than a specific percentage.
- This might be a fixed percentage.
- Or, this might be a variable number, based on a consumer price index.
- Landlords will want to exclude from any cap uncontrollable costs such as taxes, insurance, and utilities.
- Landlords will also want to apply caps on a cumulative basis, and a tenant should try to avoid this because it allows the landlord to carryover costs from previous years.
Personal Guaranty
Landlords often require tenants to obtain a personal guaranty - someone who will perform the tenant's obligations (mostly its monetary obligations) if the tenant fails to do so. Depending on the bargaining strength of the respective parties, there are a few ways a tenant might be able to limit liability under a personal guaranty.
Implementing a burn-off clause terminates personal liability of the guarantor if the tenant does not default in a certain amount of time (e.g., the first two years of the lease).
Implementing a rollover clause that terminates the personal guarantor’s liability after a certain amount of time and only up to a certain amount of rent (e.g., up to two years of rent for the first four years).
Security Deposit
While security deposits are often the first month or two of rent, sometimes landlord’s will require large security deposits to feel safe entering into the deal. If a landlord is demanding a tenant to pay a particularly large amount, try to negotiate a provision that requires the landlord to refund the tenant if it does not default on the lease after a certain period of time (e.g., 50% of the security deposit will be refunded after one year of no uncured defaults, with the remaining 50% to be refunded after three years of the same).