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Using Contingencies and Termination Rights to Build Retail Leases


Ideally, every retail lease strikes a reasonable balance between the interests of the landlord and the tenant and lays the groundwork for a mutually beneficial relationship. However, things do not always go according to plan. Economic realities change, businesses evolve, and forces outside of the parties’ control can make a productive lease relationship impracticable or impossible. With that in mind, it is important for both parties to expect the unexpected by incorporating certain contingencies and termination rights into a retail lease.

Given the serious repercussions of these rights, it is essential that these provisions are drafted carefully and without ambiguity. When it comes to a contractual right of one party to sever the relationship and to terminate the lease agreement, there needs to be careful consideration of all factors and a clear triggering of the right.

These are a few of the provisions that require particular attention:

Opening and operating covenants

An opening covenant requires the retail tenant to open its store and operate for a specified minimum amount of time. The rationale is that if the tenant builds the space out, stocks goods and hires the employees needed to open the store, the retail landlord may be reasonably confident that the tenant will continue to operate for some time. Additionally, if the overall rent consideration includes a component of percentage rent, it is important for the landlord to have an operational tenant, so that such tenant can hit its minimum gross sales thresholds earlier and begin paying higher rents sooner.

An operating covenant, on the other hand, prohibits the tenant from closing its store for longer than a specified amount of time. These provisions protect the landlord should a tenant cease to operate, leaving a dark storefront in a shopping center that may deter shoppers.

Performance ‘kick-out’ rights

A performance termination, or “kick-out,” right is typically exercisable by the tenant, allowing termination of the lease if the store performs poorly. If the parties agree to incorporate a performance kick-out right, they must define what constitutes a “sale” and what level of sales will trigger the termination right. This type of provision helps protect a tenant that may either be relatively unsophisticated or who may not have had sufficient time or resources to properly conduct a full market analysis of the area it is moving into.

The parties must also determine the “target period” during which sales should be measured. Since sales may start out slow and ramp up as the lease term progresses, parties should avoid setting a premature target period. Parties will also want to determine the proper comparison time frames, especially if a particular tenant’s sales are seasonal in nature.

Permitting contingencies

Permitting contingencies give the parties a way out of the lease if they fail to obtain necessary approvals, such as building or operational permits. Failure to obtain such approvals could make it impossible for the parties to pursue or continue the operation they contemplated at the time of lease-signing.

If the parties agree to include permitting contingencies in a lease, they must clearly identify the party responsible for obtaining the permit in question, the timeframe for application, and the level of effort the party must expend in pursuing the permit.

Co-tenancy provisions

Under co-tenancy provisions, tenants are only required to open or operate if certain other tenants in the shopping center are also open and operating. This assures the tenant it will not be the only store operating in an otherwise empty center.

If a landlord cannot meet the requirements of a co-tenancy provision within a specified amount of time, the tenant may have the right to pay reduced rent until the requirements are satisfied, or even terminate the lease. The landlord may wish to make this termination right mutual, so a single tenant cannot linger in a mostly empty center while paying reduced rent, preventing the landlord from putting the property to different use.

The parties will need to clearly describe the triggers to such termination and if and how long a landlord may have to correct such violation. How long does the landlord have to replace the tenancy? Must the replacement tenant be open and operating? Will a signed term sheet be sufficient? Will the co-tenancy requirement be based upon square footage of other tenants? What are the types of uses of other tenants? Again, many factors will need to be carefully considered and drafted.

Recapture rights in connection with assignment or subletting

Assignment and subletting provisions are not explicit termination rights but are often used by tenants seeking a way out. Assigning or subletting can be a good solution from both parties’ perspectives if the leasing dynamic or the tenants’ needs or ability to perform change over time.

Landlords should consider adding a “recapture right” to the assignment and subletting provisions, giving them the right to terminate the lease and take the space back if a tenant notifies them that it intends to assign or sublet. This prevents the landlord from having to continue the lease term with an undesirable assignee or sublessee or wait until the lease term expires to use the space for another, more productive purpose. From a tenant’s perspective, it may be preferable to have the landlord recapture the undesired space, rather than have to find a replacement and remain jointly liable for premises that it is no longer using.

Casualty and eminent domain

Having a casualty or taking occur during the term of a lease can be a worst-case scenario and can fundamentally change the parties’ ability to complete their lease obligations. It is important to add termination rights, which allow the tenant to terminate if the space is not, or cannot be, repaired or restored within a specified amount of time, and which allow the landlord to terminate if repairing or restoring the space is economically impracticable.

All of these provisions are merely the tip of the iceberg. While these rights and contingencies can provide flexibility to landlords and tenants if things do not go as planned, they must also be considered in the context of the entire lease to make sure the necessary protections and clarifications are included, and to ensure they do not render other provisions in the lease ineffective or unfair.