There is an old saying: be careful of the short but deep hole. Because it is short, you should have no issue jumping over it. However, in the rare instance where you stumble and fail to cross the hole, you find yourself in a world of hurt due to its depth.
The Use and Exclusive Use provisions in a commercial lease are like the short but deep hole; while disputes are uncommon, when they do occur, the parties face significant damages and potentially, the loss of a tenant’s development. This article addresses a few strategies that landlords and tenants in a commercial lease can utilize to avoid stumbling into this deep hole.
Tenant’s Permitted Use
Both the landlord and tenant have an incentive to establish a clear and concise Permitted Use. From the landlord’s perspective, it can control the tenant mix in a development to avoid duplication of products and services. This increases traffic, leading to a more successful development. From the tenant’s perspective, a clear permitted use provides clarity regarding the use of the leased premises, thereby offering flexibility to meet current and future business needs.
A tenant will want to have as broad a Permitted Use as possible. Ideally, a Permitted Use for any “legal use” is the ultimate goal for a tenant. This allows a tenant the greatest flexibility for future planning, along with an enhanced ability to assign or sublet the leased premises. However, landlords are generally reluctant to agree to such a broad Permitted Use. In these cases, a tenant should try to include not only its specific use but also all “related and ancillary uses” in its Permitted Use. It is always advisable for a tenant to negotiate that any required landlord’s consent to alter the Permitted Use should specifically state that such consent shall not be unreasonably withheld, conditioned, or delayed.
A landlord will want to establish a specific and limited Permitted Use for each tenant. This enables the landlord to control the tenant composition, preventing duplication of products and services within the development. With such diverse composition, not only does the landlord enhance all tenants’ chances of success, but it also helps minimize the number of vacant sites in a development. This, in turn, increases the value of the development for any future financing or sale. In this context, it also allows the landlord to oversee any modifications to a tenant’s Permitted Use and whether such modifications requested would boost the overall value of the tenant composition and the development itself. A crucial aspect that a landlord should incorporate in any Permitted Use provision is the tenant’s responsibility to conduct its own due diligence regarding its intended use; that is, the landlord does not represent that any use complies with any governmental rule, law, regulation, or recorded instrument.
Tenant’s Exclusive Use:
Generally, an Exclusive Use will be granted to anchor tenants or tenants with well-known brands. When utilized, the granted Exclusive Use benefits both the landlord and the tenant. From the tenant’s perspective, the benefits include:
- The tenant has exclusive rights in the development to operate a certain type of use or offer certain services or products.
- The Exclusive Use prohibits other tenants at the development from operating the same business or providing similar services and products.
- This competitive edge to a tenant with no direct competitor allows higher sales along with an increase in customers and brand loyalty.
- A tenant’s potential for long-term stability is enhanced as a tenant is more confident in investing in their business (fixtures, tenant improvements, employees, etc.) at the development.
From a landlord’s perspective, the benefits include:
- Landlord is able to enhance the development’s value along with the diversity of tenants to increase traffic and revenue.
- Landlord is able to attract anchor tenants and well-known brands.
- Landlord is able to increase the chance of its tenants’ success with no direct competition, enhancing stability and ability to pay.
- Landlord is able to increase the rent charged under such leases along with increasing the term.
With both the landlord and tenant benefiting from situations that allow Exclusive Uses, what is the issue? The Exclusive Use granted is prone to misunderstandings and potential litigation if not thoroughly negotiated before a lease is signed in a clear and concise manner and understood by both parties. Therefore, when negotiating the Exclusive Use provision upfront, consider the following concepts:
- A specific Exclusive Use is preferred over a general Exclusive Use because it decreases the chances of default or misunderstanding.
- Any Exclusive Use should exclude current tenants; therefore, the tenant’s counsel must review the uses permitted under existing leases at the development.
- Any concerns regarding Exclusive Use do not end once the lease is signed. In fact, the work is just beginning, as the landlord must monitor and include in any new leases any existing Exclusive Use granted to other tenants.
- A landlord should maintain a running summary of exclusives, thereby preventing disputes and litigation.
- A landlord who has concerns that a use under a new lease might violate an existing Exclusive Use should seek confirmation from the tenant holding that Exclusive Use that the new proposed use does not infringe upon the tenant’s exclusive right.
Once the Exclusive Use is negotiated, the negotiation is not done. What happens and what are the parties’ rights if the Exclusive Use is violated? In negotiating the default under the Exclusive Use provision and remedies for a default, a landlord typically has a reasonable period to have the other tenant cease its violation of the Exclusive Use. If the landlord is unable to cure this default, the following remedies are often heavily negotiated between the landlord and tenant to include in the lease:
- Reduction of rent for the period of time the Exclusive Use is violated. A landlord should aim to limit the duration of such rent reduction, after which the Tenant must either terminate or revert to the full rent.
- Option to shorten the Term.
- A specified amount of liquidated damages, ensuring that a tenant does not need to litigate to prove losses.
- The termination of the lease. A landlord will want to limit the time period for the tenant to make this choice, and if it is not made in a timely manner, this remedy is waived.
- A combination of the remedies listed above.
Conclusion
In summary, both Permitted Uses and Exclusive Uses are essential provisions that benefit both landlords and tenants in commercial leases. However, a misunderstanding of either can lead to litigation if the provisions are not clearly understood by both parties and not explicitly stated in the lease. Such litigation can cause a party to incur substantial damages and adversely affect the tenant’s business interests as well as the value of the landlord’s development. Because including a Permitted Use or Exclusive Use is akin to creating a “deep hole,” it is crucial that these provisions are negotiated upfront and clearly defined in the final lease so that both parties fully understand their rights and obligations.
J. Jack Kubiszyn primarily focuses his practice on general real estate matters for national clients, while also representing developers, borrowers and lenders in commercial real estate loan transactions – including landlord and tenants in leasing matters. He actively represents regional clients in the acquiring and disposing of office buildings, retail shopping centers and multi-family apartments, and his experience preserves his clients’ interests while helping them avoid the difficulties, including litigation, that can result from the failure to secure effective, knowledgeable counsel.
About Christian & Small
Christian & Small LLP represents a diverse clientele throughout Alabama, the Southeast, and the nation with clients ranging from individuals and closely held businesses to Fortune 500 corporations. By matching highly experienced lawyers with specific client needs, Christian & Small develops innovative, effective, and efficient solutions for clients. With offices in Birmingham, metro-Jackson, Mississippi, and the Alabama Gulf Coast, Christian & Small focuses on the areas of litigation and business, is a member of the International Society of Primerus Law Firms, and is a Mansfield Rule™ Certified Plus Law Firm. Our corporate social responsibility program is focused on education, and diversity is one of Christian & Small’s core values.
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