Prevent Detrimental Effects of Large National Tenant's Use Change
Owners who lease space to large national retail tenants know that their demands can be hard to resist. Use of the space is the number one concern for these tenants. Often, they ask for flexibility in their use of the space that puts owners at a disadvantage. A lease that allows a tenant to use the space for a wide variety of uses—such as “for any lawful purpose” or “any lawful retail purpose”—can be troublesome.
For instance, the large tenant, which doesn’t currently compete with your smaller tenants, may later change or expand its use to one that does compete, which might violate your exclusives with other tenants. Or the big tenant might sublet or assign its lease to a store that will compete with one of your smaller tenants, which will also leave you on the hook with smaller tenants.
Even if the smaller tenant doesn’t have an exclusive, this new competition could put it out of business. And there is another problem: The big tenant (or its assignee or subtenant) might change to a use that, although not competitive with your existing tenants, simply doesn’t work for your center.
If you’re faced with a big tenant that demands lots of flexibility in how it can use its space, there is a way you can placate the big tenant while avoiding these types of problems: A flexible use clause with the right to terminate its lease and recapture its space if the proposed use is unacceptable. Here’s how you can set up this termination right in your lease.
Understand Risks of Agreeing to Broad Uses
It’s important to take the use clause of a large tenant seriously during negotiations. This is your chance to draft a lease with the protections you need. Here are examples that show what could go wrong if you agree to give in to the big tenant’s demand for a flexible use clause.
Diminished percentage rent. You and a large furniture store tenant sign a lease that lets the tenant use its space for any lawful retail purpose. For several years, the tenant uses the space as a furniture store. Meanwhile, you add a large electronics store tenant (without an exclusive) to your center. Then the furniture store decides to change its use to an electronics store. Even if you don’t have to worry that the change violates an exclusive (because the original electronics store has none), you still have a big problem. Your center doesn’t draw enough customers to support two electronics stores, so both tenants’ businesses—and your percentage rent—will suffer.
Change in synergy. You and a big clothing store tenant sign a lease that lets the tenant use its space for any lawful retail purpose. For several years, the tenant uses the space as a high-end, upscale clothing store, in keeping with your upscale shopping center. Later, the clothing store decides to change its use to an outlet or discount store, selling cheap and secondhand clothing. This change clashes with the image of your upscale center. Also, the outlet store attracts the wrong type of customer traffic to your center.
Avoiding Use Change Problems
You can set up a large tenant’s use clause, like our Model Lease Clause: Secure Right to Terminate Large Tenant's Lease for Use Change, with four key points that prevent any unacceptable use change that the tenant proposes.
Key Point #1: Require tenant to operate for “primary” use. Require the big tenant to operate for a specified “primary” use or purpose. For example, you might let the big tenant use its space to sell primarily office furnishings. Then you can add that the big tenant can also use its space for any other lawful retail use [Clause, par. a]. That makes the broader part of the clause apply to uses that are incidental to the big tenant’s primary business.
Key Point #2: Define “primary use.” Add a definition of “primary use” to the lease to avoid disputes with the tenant over its meaning [Clause, par. a]. Define it either by a percentage of a tenant’s gross sales or by the number of square feet of floor area (or percentage of floor area) the big tenant must devote to the primary use [Clause, par. a].
Key Point #3: Bar prohibited uses. Despite getting a flexible use clause, let the big tenant know that certain uses are off-limits. For example, your lease should have a “prohibited use” clause that lists uses banned from your center, such as the sale of pornographic materials. Your center’s governing documents very likely contain a list of prohibited uses that everyone at your center must abide by, and those restrictions should be incorporated into the lease. Also, note whether other leases have exclusive use clauses that would apply to the big tenant. Attach an exhibit to the lease describing the prohibited uses and exclusive uses so that the tenant knows what they say [Clause, par. a].
Key Point #4: Set out use change procedures. If the tenant (or its proposed assignee or subtenant) wants to change the primary use, the following steps must occur:
Step #1: Tenant sends notice of use change. The tenant must notify you, in writing, that it (or its proposed assignee or subtenant) intends to change the primary use. Require the tenant to give you the notice at least 30 days before the date when the change is scheduled to take effect. But say in the lease that if the tenant forgets to send you the notice, your rights under the lease will not be affected [Clause, par. b].
Step #2: You decide whether to terminate lease. Get enough time—for example, 30 days—after you get the tenant’s notice of the intended use change to decide whether you want to terminate the tenant’s lease, rather than let it (or its proposed assignee or subtenant) proceed with the use change.
Step #3: Exercise termination right or accept use change. If you decide to terminate the lease, send the tenant notice soon—for example, within 30 days—after you get the tenant’s use change notice, indicating that you intend to exercise your termination right. The tenant will probably want at least 60 days to pack up its things and move out of the space before the lease actually terminates [Clause, par. b].
If you decide to accept the primary use change, you could either notify the tenant of your acceptance or do nothing. If the tenant doesn’t hear from you within 30 days after you get its use change notice, it’s free to proceed with the use change.
Step #4: Tenant can nullify change and stop termination. The tenant will demand the right to nullify the proposed use change to avoid losing its lease. Therefore, give it no more than 30 days after it gets your termination notice to withdraw the intended use change [Clause, par. c]. If it nullifies the proposed change within that time, the lease won’t terminate. Otherwise, the lease will terminate.
Practical Pointer: The termination right should also apply to a change in use by the original tenant’s subtenant or assignee. This will protect you if its subtenant is using the space for the primary use now but wants to change its use in the future.
Compromise with Anchor Tenants
While some large tenants or those with a bit of leverage will agree to this set up, big box or anchor tenants probably won’t agree to specifying a primary use in their use clause and giving you a termination right if their use changes. Those tenants will want to use their space for any lawful retail purpose. They’ll argue that they need the right to change their use (without your consent) as the merchandise they’re selling evolves over time, or else their business will suffer. This is particularly true of stores that sell tech items because tech products will probably improve during its lease term.
When you’re dealing with these powerful tenants, you’ll probably have to forgo demanding a primary use in the use clause, as well as the right to terminate the lease, unless the use change will violate another existing tenant’s exclusive. But don’t expect these tenants to agree to other typical requirements if they have to move. Just one example is the pattern of anchor tenants requiring, as a condition of giving you the right to terminate their lease if their proposed use change will violate an exclusive, you to pay their unamortized portion of the tenant improvements that they installed at their cost in their space.
Another point of compromise will be the conditions under which the anchor tenant must observe exclusives. For example, you will most likely want the big tenant to observe exclusives granted to other tenants after the date of the big tenant’s lease. But don’t expect the big tenant to agree to that. Instead, it may agree only to honor exclusives and other restrictions already in place on the date of its lease.
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