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Common Issues in Negotiating Exclusive Use Restrictions in Shopping Center Leases

Making a long-term leasing commitment in a shopping center entails a substantial investment in space improvements (or even constructing a new building and related site improvements under an outlot ground lease), fixturing, staffing, and stocking of a store. Therefore, a retail tenant has a legitimate business interest in protecting its investment against lost sales from competitors in the same shopping center. Accordingly, retail tenants commonly negotiate for exclusive use provisions that preclude the landlord from leasing other space within the center for uses that would compete with the tenant’s intended business.

Several issues frequently arise in negotiation of exclusive use clauses in shopping center leases, the resolution of which (as with most negotiated lease provisions) is often a function of the size of the lease, the economic strength of the tenant, and the overall relative bargaining positions of the parties.

1. Scope of Exclusives. The scope of an exclusive sought by a tenant is usually a function of the breadth of the tenant’s business. Narrowly focused businesses can be served by narrowly defined exclusives (e.g., “sale of furniture”). However, businesses with a broader scope of products and services, or those with more generalized products, create more difficulties. The tenant, of course, has an interest in protecting the full range of its business, while the landlord has an interest in limiting restrictions on the scope of potential tenants to fill the remainder of the center. A retail pharmacy, for instance, may have an interest in protecting against another pharmacy use, but it also may derive substantial sales from other categories of products sold in its retail stores (health and beauty aids, greeting cards, etc.). Similarly, a bank tenant may have an interest not only in protecting against a competing bank branch, but in ensuring that no other tenant conduct ancillary banking services, such as ATM machines, commercial lending, or investment sales or services. The landlord will have a natural reluctance to restrict its other space from ancillary uses, in order to preserve the possibility of leasing to tenants who intend such uses but do not pose a threat to the tenant’s core business.

A common compromise between these competing interests (assuming relatively equal negotiating position) is an agreement on caps on the sales volume that another tenant may derive from, or the size of retail display areas that another tenant may devote to, the ancillary protected uses. Another common compromise is agreement on carve outs for specific prospective tenants with whom the landlord may be negotiating or for specific categories of tenants for which other space in the center may be particularly well suited.

2. Existing Tenant Carve Outs. Another common issue is whether, and possibly to what extent, the tenant’s requested exclusives will apply to other tenants who are already operating or already under lease for other space in the center. The tenant would have already evaluated the then-current operating businesses of the existing tenants to determine if they operate a competing use or present an unacceptable degree of competition. Even if the tenant has decided that neither is the case, it still may face the potential for unacceptable future competition from those same existing leases, depending upon how broad or narrow the existing tenant’s permitted use clause is drafted in its lease. If the existing tenant’s lease broadly permits “any use permitted by law,” then the new tenant faces the risk of the existing tenant’s changing its use in the future to one (or introducing a new product line or category) that competes with the tenant’s business, or, perhaps more commonly, sublets its space to a direct competitor of the tenant.

The landlord’s default position is that since those leases are already signed and in place, the landlord has no right to retroactively modify their use clauses or to otherwise compel existing tenants to restrict (or further restrict) their use of their space. Accordingly, attentive landlords usually demand that the exclusive granted to the new tenant contain a carve out for existing tenants. Inattentive landlords who do not include such a carve out leave themselves exposed to the untenable situation where an existing tenant commences a permitted use under its lease that is in conflict with an exclusive granted to a subsequent tenant. In such a situation, the landlord is in default under the subsequent tenant’s lease (due to violation of the exclusive), but it is powerless to force the existing tenant to cease the conflicting use.

Where the prospective new tenant is a key tenant or a potential anchor tenant to the shopping center, the landlord may have sufficient economic incentive to try to negotiate with existing tenants to amend their leases to include the new tenant’s exclusives (and to offer economic incentives, where appropriate). The landlord usually will be disinclined to undertake such measures for the new tenant, but new tenants with an otherwise reasonably strong bargaining position can negotiate provisions in their lease to mitigate the risks of an existing tenant’s changing use to one that violates the new tenant’s exclusives. For instance, if the landlord has the right to consent to the existing tenant’s assignment of its lease or sublease of its space, the new tenant might seek an agreement by the landlord that it will not consent to any assignment or sublease if the proposed assignee or subtenant is a competing business. Similarly, the tenant might ask the landlord to agree that it will condition any future amendment or extension of the existing tenant’s lease on the inclusion of the new tenant’s exclusive use restrictions.

3. Termination of Restrictions. Another common issue is whether the tenant’s exclusive use restrictions will terminate prior to the expiration or earlier termination of the lease. One such scenario that is often negotiated is whether the restrictions will remain in effect if the original tenant ceases operating the business for which the exclusive was created. Landlords will argue that if the tenant goes dark (and if the landlord does not otherwise have recapture rights, or chooses not to exercise them), there is no business to protect against competition and the landlord should be free to lease other space in the center to a competing business. A similar situation arises if the original tenant subleases its space to a subtenant whose business does not benefit from the exclusives granted to the original tenant. Again, the landlord will push to have the tenant’s exclusive terminate upon the tenant’s sublet and cessation of the original use.

The tenant, conversely, will argue that if it ceases operation of its business but is not otherwise in default, the exclusives should remain in effect. In this regard, the tenant has a compelling case that if it is continuing to pay the landlord full rent for the space (or the outlot), the landlord should not allow a competitor to set up shop in the center. Also, if the tenant has a long-term lease (particularly ground leases that often have terms of 25 years or more), the tenant has the further argument that even if it ceases operations (due to market conditions or operational needs), it may still resume operations later when market conditions or operational needs change. Thus, again, as long as the tenant is continuing to pay rent and perform its lease obligations, the exclusives should remain in effect.