Retail Commercial Leases-The Deadly Trap

Introduction:

While all businesses need a locale to conduct business-even if only a home office-one particular type of business has a need for a particular locale more than the others.  Retail business, when not conducted entirely on line normally requires a location that is central for access to the type of customers or patrons who are its market.  It is for that reason that the large retail outlets assign an entire team of experts to locate and obtain locations after intense market research.  As one such person told the writer, “If we want to succeed, the precise location is all.  Even a block or two can make all the difference.”

This should not be surprising. In most cities two or three blocks can lead to an entirely different neighborhood with different ambiance and such matters as access to public transit or parking can have a dramatic effect on foot traffic.  Real estate brokers have a favorite saying:  “Location, location, location.”  While they apply that to residential property, it is even more critical for retail establishments.

Put simply, location is central to success and in most cases location is determined by the lease negotiated by the business. We have found in our decades of business law that relatively few clients fully understand a truth once stated by a restaurant client who was losing his lease: “I didn’t realize that it wasn’t really my business; it was my landlord’s. I was just kidding myself.”

This article shall examine the critical role of leases in retail business and make some suggestions as to how to avoid the danger expressed by the above client.

The Basic Law of Commercial Leases:

Leases define the terms, costs, and responsibilities for renting business properties, with several types including gross, net, and percentage leases.

Types of Commercial Leases

Full-Service (Gross) Lease

Tenants pay a fixed base rent and utilities, while the landlord covers property taxes, insurance, and maintenance. This simplifies budgeting for tenants but may include clauses for additional expenses beyond the base year..

Net Leases

Tenants pay rent plus a share of operating expenses. Variants include:

• Single Net (N): Tenant pays rent and property taxes; landlord covers insurance and maintenance.
• Double Net (NN): Tenant pays rent, property taxes, and insurance; landlord handles structural maintenance.
• Triple Net (NNN): Tenant pays rent, taxes, insurance, and maintenance; often used for long-term leases with lower base rent .
• Absolute NNN: Tenant assumes all expenses, including structural repairs; landlord has no financial responsibility .

Modified Gross Lease

A hybrid where tenants pay base rent and a portion of operating costs, often based on the percentage of space occupied. This provides flexibility and shared responsibility between tenant and landlord 

Percentage Lease

Common in retail, tenants pay a base rent plus a percentage of gross sales above a threshold. This is supposed to align landlord and tenant interests in business performance

Lack of Legal Protection

Unlike residential leases which often have statutory protections afforded by local statute, the commercial leases have few if any legally imposed requirements. The legislatures seem to feel that business goals should trump legal protections and the parties should be free to negotiate any terms they wish.

This usually gives landlords tremendous powers. The only protections available are those negotiated and put into the commercial lease by the parties. If the lessee fails to obtain in writing a particular right or protection, they are simply out of luck.  Thus, the negotiation before the lease is signed is absolutely critical to the lessee but often, especially with a new business, that process is not given the attention it sorely needs.

In the rush to create and plan the business, the lease is often signed without legal review and without concentrating on critical terms discussed below.  And once signed, few landlords are going to agree to alter terms. 

The Central Role of the Commercial Lease for Retail: 

There is a misconception among many retail businesses that the landlord will have an economic interest in maintaining the leasehold, renewing it as needed, and enjoying having a lessee who is running a successful business. That can be true. But not always.

A new business with a higher profit margin may be willing to take over the lease at a rental you cannot afford. The landlord may decide on a different use for the property, such as condos or an apartment building which, from their own economics, might make more sense. Or the landlord may be replaced with a new landlord who has very different goals or problems that make your lease of limited value to him or her.

Perhaps an example will illustrate this point.

One client of our office operated an Irish bar and restaurant at Fisherman’s Wharf that had occupied the location for over twenty years. It was a neighborhood landmark, always full, especially on St. Patrick’s Day, with the owner a celebrity in the locale. Called Ginsberg’s Dublin Pub,  it was in full swing when a notice to terminate the lease was received.

The original landlord had died, and his trust had taken over the lease. But the three trustees, made up of various family members, could not agree on what to do with the lease. One trustee felt a bar was inappropriate in that location. Another trustee wanted no change. The third trustee wanted to tear down the old building and build an apartment building and had an analysis by a developer showing the value of that step.  For over a year they argued although from our client’s point of view, the  lease needed to be renewed for another ten-year leasehold. They could not agree on what to do and finally terminated the lease to keep their options open. The bar and restaurant was forced to close, there were no locations nearby that could provide the space needed and twenty-two years after it was founded, the Bar closed. 

As an aside, the location remained vacant for the next five years until it was finally torn down and converted to condominiums. 

When those clients came to us, we asked to see their lease.  They could not even find it. When we did locate it, we found a lease with a ten-year term and the right to renew once for ten years. Nothing thereafter. We had to inform them they had no rights except to try to convince the trustees to allow them to stay. Our clients offered to raise the rent but the trustees, who did not depend on the income, refused to do more than offer a month-to-month lease and eventually just terminated the lease. 

The underlying lesson is clear: your economic interests as a lessee do not necessarily match those of your landlord and if their business interests conflict with yours, you will lose. 

At the Beginning: 

Your maximum bargaining position is before you invest heavily in your business and its location. You can walk away and find another location.  That is the time to bargain hard and abandon the lease if you cannot get most of the following:

• Longest term via rights to renew.  You do not want to lock yourself in so rights to renew are the best way to go and you want as many of them as you can get.  The landlord will probably want a cost-of-living increase and that is only fair. Ten years with two rights to renew for ten more years would be ideal.
• Limits on rent increases. You will have to give way on cost-of-living increase but you do not want the landlord to be able to increase rent at will.  If you allow that, the landlord can terminate simply by raising the rent enough.
• Lease is binding on the successors to the landlord. You do not want a new buyer of the building or heirs to be able to revoke your rights.
• Right to assign.  If you want to sell your leasehold or bring in related businesses, this could be critical. 
• Right to change use.  It may be you want to add another store or related restaurant. It may be you want to close the restaurant and make the entire premises into a bar since it makes more money. You need the freedom to change with the times.
• Clarify what fixtures you can take with you at the end of the lease. See our article on fixtures in commercial leases. You do not want to put in that antique bar if you must leave it behind when you lose your lease. 
• Be ready to walk.  This is not ancillary to your success.  Worst case scenario, you create a thriving business which is destroyed by a landlord who has his or her own plans.
• If you can, get an option to buy the property if the landlord wants to sell it.  You have the right for X days to match any offer made by a third party.
• And, of course, if you can afford to buy, don’t lease at all. The tax benefits alone make owning your own locale a benefit.

During the Lease: 

• If your business is a success, the value of the lease becomes even more critical to you.  You can always try to extend the lease during its term, even offering a bit more rent. You can offer the landlord a bit of the gross to make him or her a defacto partner. 
• Again, see if an option to buy can be achieved.
• Think about a second location if it is feasible so you have a fallback if the lease is not renewed. A third location is even better. 

At the End of the Lease: 

• Begin negotiations for renewal at least a year before the lease is up and do not settle for waiting until a few months before it finishes before knowing if you have to move. 
• If the landlord will not negotiate that early, you are in trouble. Your bargaining position preparing to move if necessary only weakens each month that goes by.  If you are six months before the end of the lease and still do not have a clear deal, plan on moving. And start letting your clients know the moment you have a new location found. 

Practical Lessons: 

When moving or starting your business there are thousands of details to handle, from personnel, inventory, to  phones, internet, etc. etc.  It is also an exciting and usually optimistic time.  Few in that position like to think ten years down the road when the successful business you worked so hard to create suddenly finds itself fighting for its life with no place to go. 

But as seen above, the wise businessperson will understand that certain facets of business are so fundamental that all the rest becomes unimportant if they are not addressed. A lease that is long term and can be renewed is one of those fundamentals too often ignored and usually not confronted until the time is short.

Do not make that mistake. Check your lease now. What rights do you have and how can you increase those rights?  Do it now before it becomes a crisis and if the landlord will not budge, then plan accordingly beginning now.