Donut House Case Study

An exclusive use clause is a valuable and often negotiated provision in leases. An “exclusive” prohibits a landlord from leasing space to another tenant that will operate a similar business or sell similar products. For example, a gym tenant may seek an exclusive to prevent the landlord from leasing space to other gyms, or a donut shop may seek an exclusive to prevent another tenant from selling baked goods for on or off premises consumption. Consider the following tips when negotiating an exclusive use provision on behalf of a landlord or tenant.

Define the Scope of the Exclusive

Will the donut shop’s exclusive prevent the landlord from leasing to a croissant shop?

Will the gym’s exclusive protect it from a yoga studio?

Negotiating the scope of the exclusive is key. The ultimate goal of both landlord and tenant should be to arrive at a well-defined exclusive that can be understood and implemented. To protect its business from competition, a tenant is interested in negotiating as broad an exclusive as possible.
Landlords, conversely, want to preserve their flexibility to bring in additional tenants, even if some of its tenants’ products or services will ultimately overlap.
The scope of an exclusive can take different forms.
An exclusive can limit the type of business conducted or the specific products offered. The exclusive may allow the sale of similar products, but only up to a certain monetary limit (“Landlord shall not lease to any tenant whose gross sales of donuts exceeds 25% of its overall gross sales from this location”) or floor space limit (“Landlord shall not lease to any tenant whose sale of donuts utilizes more than 25% of the premises sales floor area”). Furthermore, if a landlord owns multiple properties in the surrounding area, an exclusive may be crafted to prevent the landlord from leasing to a similar tenant within a certain distance. When negotiating an exclusive related to distance, note that a landlord may operate a number of commercial properties through single purpose entities (SPEs); if so, the exclusive will need to apply to landlord’s affiliated SPEs in order to be
meaningful.
Tenants with a broader range of products or services, such as grocery stores or convenience stores, will likely find it more challenging to protect all aspects of their businesses through an exclusive. Smaller tenants, or those with less negotiating leverage, should focus on what makes their business unique or special and shape an exclusive around that feature.
A landlord must conduct its own analysis of whether to agree to an exclusive. Granting an exclusive effectively shrinks the pool of eligible tenants thereby making it more challenging to find a tenant for vacant space. Or an exclusive may require that the landlord refuse an existing tenant’s request to change its use.

Determine the Duration of the Exclusive Another key consideration of an exclusive use clause is its duration. The purpose of an exclusive is to protect a tenant’s specific business. If the tenant ceases to conduct that specific business, either by “going dark” or transitioning to a different type of business, from a landlord’s perspective the exclusive should terminate. Landlord may also negotiate to have the exclusive terminate if the tenant assigns or sublets the property.

Provide Remedies
When drafting exclusives on behalf of any party, it is important to specify the available remedies. A common remedy provides the landlord a period to cure the violation of the exclusive, after which the tenant may abate rent. This rent abatement can escalate to 50% or more if landlord fails to resolve the violation. If the violation remains uncured, some leases provide that the tenant may terminate the lease. It is important for the lease to establish a clear process, including timeframes, to enforce any violation of an exclusive.
A tenant that is violating an exclusive without the consent of the landlord is commonly known as a “rogue tenant.” To address a rogue tenant, a landlord may request that the lease provide additional time for the landlord to resolve the issue or ask that the consequences step up more slowly.

Provide Notice of Exclusives
Both landlords and tenants must be cognizant of existing exclusives early in the lease negotiations. Landlords want to avoid the consequences of violating an existing exclusive. Likewise, a prospective tenant wants to ensure its proposed use is permissible. While a prospective tenant should consider whether its immediate business would violate an existing tenant’s exclusive, it should also assess whether any future expansion of the business would cause complications. A tenant should request that the landlord provide a list of exclusives affecting the property, and ask that the list be incorporated into the lease.
To provide notice of an exclusive, a tenant may want to negotiate for the right to record a memorandum of lease, which is a public document recorded in the title of the shopping center property that provides notice of a tenant’s exclusive rights.

Conclusion
Both landlords and tenants are well served to begin discussing exclusives early in the lease negotiations. With careful consideration and precise drafting, landlord and tenant can agree upon a well-defined exclusive that makes it clear whether donuts may coexist with croissants or gyms are protected from yoga studios.