Colorado Real Estate Journal - October 21, 2015
The retail mix in the development and ongoing management of strip malls, shopping centers, pad sites and other types of retail centers is critical for the continuing success of a retail project. Owners typically want use provisions that protect their vision of the project while tenants want exclusive use provisions to protect their use from similar competitive uses. The use provisions typically consist of permitted uses, required uses and restricted uses while the exclusive-use provisions grant the retailer an exclusive right to offer a certain product or service in the project. Both exclusive- and permitted-use provisions if not properly addressed on a project wide basis in the covenants and lease documents may create long-term unintended consequences for developers, owners, landlords and tenants in the project. Carefully drafted covenants, letters of intent, leases or purchase agreements will prevent future conflict among retailers, lessen defaults and keep occupancy higher. The importance of consistency of the use provisions with the exclusive-use provisions apply to retail projects whether the proposed transaction is a lease or the owner-occupant is purchasing a pad site or a portion of the project. In a lease transaction, the controlling documents are usually any recorded covenants and the lease; with an acquisition, the documents are recorded covenants and a recorded use restriction whether in a deed or in a restrictive use document. Use restrictions also may be found in easements, deeds, a memorandum of lease or other recorded documents, so a complete title review should be performed before granting any exclusive uses by a landlord and a tenant should confirm that its permitted use and any exclusive use granted may be granted by landlord/developer. Recorded covenants typically contain use restrictions that prohibit certain types of uses, for example, “no portion of the property will be used for an athletic or health club, studio or gym, game arcade or amusement center.” The covenants run with the land, so when pad sites or portions of the project are sold to parties other than the developer, the use restriction covenants continue to bind the entire project. In theory, this is to protect the original vision of the project and allow the developer to sell portions of the project and still have a cohesive retail center, without worry of the prohibited uses becoming uses. On the flip side, however, the developer/owner usually has to obtain the written consent in a recorded document of some or all owners and their lenders who have purchased portions of the project to amend the recorded covenants. An example of a problematic scenario stemming from the above prohibited use in the retail project: A developer has a difficult time leasing some of the larger retail spaces and is approached by a potential tenant who wants to create a space to rent for fancy kids’ birthday parties with an “amusement” component the developer has sold off several pad sites to owners who have issues with certain aspects of the development of the retail project, such as the number of available parking spaces, and as a result will not sign an amendment to the covenants to allow the amusement center as a use in the birthday party space lease without concessions from the developer in return and, in the meantime, the potential tenant finds another location and the developer loses the lease. Lease provisions often grant overly broad exclusive uses to tenants and simultaneously limit the tenant’s use to a required specific use. For example, “Tenant will use the premises only as a prototypical noodle restaurant. Tenant shall have the exclusive right to sell noodles and pasta for on- or off-premises consumption.” This exclusive is too broad for the landlord and the required use too limiting for the tenant. The exclusive prohibits the landlord from leasing other portions of the project to many types of restaurants (any restaurant that serves any type of pasta) and also limits what other restaurant tenants may serve without creating a landlord default under the noodle restaurant lease. For example, a sandwich shop would not be able to sell any soup with pasta in it (Italian wedding or chicken noodle). This exclusive also would eliminate the ability of a landlord to lease to convenience stores, specialty food stores, novelty stores, discount stores and sundries stores without creating a potential default if any product containing pasta were sold. This provision also is problematic for the tenant because it limits a tenant’s ability to sublease or assign its lease in the future to any other type of restaurant but it also makes assigning it to any type of tenant almost impossible because it could not comply with the “prototypical” requirement. The same issues arise in use restrictions/exclusive grants in deeds or other covenants. Conflict in the documents both internally and among documents may result if not carefully drafted. For example, a tenant may require a landlord to add the following language “and any other lawful use” to its permitted/required use to avoid the subleasing difficulty outlined above. Covenants also may contain the phrase “and any other lawful use” along with the list of permitted uses in a retail project. “And any other lawful use” creates a tension with the prohibited uses that are generally “lawful uses” and also with the exclusive uses granted in leases or covenants unless the document also includes a provision “and any other lawful use not otherwise prohibited (in the various documents).” To avoid issues, covenants and leases should narrowly tailor the use provisions, whether prohibited uses, permitted uses or exclusive uses, so that the intent is clear and the provisions are not overly broad so that uses and potential retailers are not inadvertently limited. Thoughtfully drafted exclusive-use provisions will specifically grant the exclusive use in the project, but in a limited manner. For example, the document should be clear that the exclusive use will not apply to other premises in the project that sells pasta or noodles in no more than 25 percent of floor space for retailers and no more than 25 percent of gross sales of restaurants. With this limitation however, a landlord will want to require in its leases with future tenants a requirement to provide landlord with itemized gross sales reports by product and floor area to avoid a default of the exclusive granted to the noodle restaurant and to be able to document the amount of pasta being sold by other tenants. The exclusive use should also only apply if the original tenant is in the premises and operating the business related to the exclusive use. The exclusive use also should carve out previously leased premises and any future uses of those already leased spaces so that the landlord does not have future issues with releasing or subleasing those premises. If the use of the premises changes, the exclusive should automatically terminate. A grant of use restrictions in a recorded document also should terminate if the original party to the document no longer operates the exclusive use on the property. The lease should also clearly state that the granted exclusive use provision does not prohibit the landlord from leasing to similar but not exactly the same use. For example, if the exclusive use is for a “full-service health and fitness studio,” does that exclusive prohibit a spa, a yoga or Pilates studio, or a retailer that sells vitamins? Related uses that the landlord wants to ensure are permitted without violating the exclusive use should be clearly stated as permitted uses under the exclusive use. Landlords also may want to have a provision in the lease that requires the tenant to reasonably approve related uses but do not violate the exclusive use in an estoppels or other document prior to leasing to the related-use tenant. Also tricky for the landlord in defining to which property the exclusive use applies. At a minimum, the landlord should be clear that the exclusive only applies to property owned by the landlord in the specific project and permits the landlord to sell portions of the project unencumbered by the exclusive use. The developer/ landlord may want to define limited areas that the exclusive use applies to that is less than the entire project to maximize flexibility. Prohibited uses also may only apply to certain limited areas that are defined in the lease or the recorded covenants. Tenants also must be clear on the portions of the project the exclusive covers. If the landlord is a pad site owner or only owns a portion of the project, the exclusive would not be binding on the developer or the project but only the portion owned by the landlord. The tenant may want to limit the developer’s ability to finesse the exclusive use by transferring the property to a separate entity owned by the landlord or its affiliates by including a provision that binds the affiliates of the landlord in the lease to the exclusive-use grant. Tenants should also consider that if the exclusives, permitted and prohibited uses that a tenant wants to protect are not in a recorded document, it would not bind a future landowner if part of the project is sold to a different owner unencumbered. The remedy provisions in the documents also require careful drafting. Whether in a lease or recorded covenants, the property owner must have notice and the opportunity to cure prior to the tenant having any available remedies. In some cases, a cure may not be available and, as a result, landlords will want to limit the remedies available to the tenant to the right to terminate the lease and avoiding injunctive relief, and all forms of damages. For example, if in the project with the “no pasta may be sold” lease the landlord failed to consider that a permitted use of “Middle Eastern restaurant and any other lawful use” includes the sale of pasta unless specifically prohibited or limited by that lease, then the landlord would be in a situation that if pasta were sold by the Middle Eastern restaurant the tenant of that lease would not be in default of its lease, despite creating a default for the landlord under the “no pasta may be sold” lease, thus prohibiting landlord from curing the exclusive-use default under the noodle lease. However, tenants may resist having a sole remedy to terminate the lease, as this may not be a practical remedy for a tenant, particularly if the tenant is a franchisee and that location is critical to its franchise agreement. The parties involved in the retail transaction should carefully consider the consequences of the use provisions in the documents for long-term planning in addition to the short-term consideration of closing the transaction.