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Monday, July 9, 2018

Retail Tenant Remedies for Violations of Exclusives, and the Rogue Tenant Exception


 
In shopping center leases, retail tenants often negotiate for exclusive use covenants—i.e., agreements by the landlord not to lease, or otherwise
allow the occupancy of, other space in the remainder of the shopping center for uses that compete with tenant. The exclusive use rights are integral to the retail tenant’s conduct of its business, and to the value of its leasehold, within the center. If, for example, a home goods store commits to paying rent on a location for five (5) or ten (10) years (or longer), and to investing significant capital in planning, permitting and constructing a new store site, it needs to have assurances that its investment and future sales will not be compromised by the landlord leasing other space in the center to another home goods competitor.

From the tenant’s perspective, it is also important that its exclusive be enforced through a stronger enforcement mechanism than ordinary default remedies, which often include only the “nuclear option” of terminating the lease if the Landlord fails to cure the breach (and sometimes do not even allow for that remedy).

From the tenant’s perspective, it is also important that its exclusive be enforced through a stronger enforcement mechanism than ordinary default remedies, which often include only the “nuclear option” of terminating the lease if the Landlord fails to cure the breach (and sometimes do not even allow for that remedy). If, for instance, another home goods store offered the landlord 150% over market rent to lease space next to the existing tenant, the landlord could have the incentive to accept the competitor’s higher rent offer even if it means breaching the original tenant’s lease; even if the original tenant exercised its termination rights, the landlord would have essentially “traded up” by replacing one home goods tenant in the center with another home goods tenant paying higher rent. The original tenant could also file a lawsuit to enjoin the breach of its exclusive, but lawsuits are time consuming and expensive, and with exclusive use covenants there are always vagaries that make the outcome uncertain (e.g., arguments that the competing tenant’s use is not proscribed by the original tenant’s exclusive use language, and the general inclination of courts to construe use restrictions narrowly with a preference against restricting the underlying property). Accordingly, in order to address the landlord’s temptation (and to remove the economic incentive) to breach the tenant’s exclusives, tenants with sufficient bargaining leverage will often demand special remedies in the event the landlord violates the tenant’s exclusive. It is common, for instance, for the tenant to have the right to either terminate the lease or pay 50% rent (or some other significant rent reduction) while the violation continues. As this is a self-help remedy that tenant can enforce on its own (without having to file a lawsuit), it is easy and efficient to implement—the tenant simply reduces its monthly rent payments by 50%.

Faced with these potentially severe consequences, responsible landlords take care to avoid violating the existing tenant’s exclusives. The landlord can control this by (obviously) refraining from leasing other space in the center to tenants who would clearly violate the existing tenant’s exclusives. Less obviously, the landlord can carefully draft the permitted use clauses in new tenants’ leases to not only ensure that it does not permit a use that would violate the existing tenant’s exclusive, but also ensuring that the new tenant cannot make future changes in use (for example, as a result of an assignment of the lease or a sublease to another user) that could violate those existing exclusives. The landlord cannot, however, control another tenant’s decision to nonetheless engage in a use that is not permitted (or even prohibited) under its lease. This is what is commonly referred to as a “rogue tenant.” While the landlord cannot immediately control the rogue tenant’s bad behavior in engaging in a prohibited use under its lease, the landlord nonetheless becomes exposed to the severe penalties for the violation of the existing tenant’s exclusives.

For that reason, landlords often try to negotiate an exception to the implementation of the original tenant’s exclusive use remedies, if the violation is caused by a rogue tenant (a so-called “rogue tenant carve out”). The landlord argues that it should not suffer the severe consequences for violations that are caused by a third party (the rogue tenant) over whom the landlord has no control. However, from the original tenant’s perspective, it still requires protection against its business being severely affected by a competing business, regardless of whether the landlord is complicit in creating that competition or whether landlord is, in some sense, “innocent.” To the existing tenant, it is simply a matter of allocating the risk between the landlord and the original tenant. Both parties may be “innocent,” but one of the parties has to bear the risk of the consequences of a rouge tenant competing with the existing tenant’s business. If the original tenant is large tenant or otherwise has significant bargaining leverage, its response may well be that this is simply a risk that the landlord must bear. As a compromise, the parties might draft a rogue tenant carve out that is conditioned upon the landlord taking affirmative actions to stop the rogue tenant from continuing the violating use. After all, the rogue tenant’s actions are not entirely out of the landlord’s “control”; the landlord will have its own remedies against the rogue tenant for breaching the terms of its lease, such as declaring the tenant in default, exercising default remedies, seeking an injunctive or other equitable relief to stop the violating use by judicial action, or even seeking eviction of the rogue tenant. The original tenant will expect the landlord to exercise those remedies, and to aggressively pursue them, as a condition to its forbearance in exercising its remedies for violation of the exclusive use rights. At the other end of the continuum, if the bargaining leverage is more equal, the landlord may negotiate for a simpler rogue tenant carve out that simply precludes the original tenant from exercising its remedies at all if the violation is caused by a rogue tenant.

There are a myriad of other gradations in between these ends of the continuum, and many variants on how the rogue tenant carve out can be drafted. Accordingly, this is a ripe area for negotiation during the drafting of a shopping center lease, and well-represented parties will negotiate a variant that is appropriate and consistent with the business dynamics of the deal, the nature of the tenant’s business, and relative bargaining positions of the parties.

Originally posted June 30, 2018 on tlawmtm.com:
http://lawmtm.com/retail-tenant-remedies-violations-exclusives.html

Tom is a former REBA President and principal of the firm (Moriarty Troyer & Malloy LLCand chair of its Commercial Real Estate Department. Tom has over 20 years of experience in representing Fortune 500 companies, national and local banks, retailers, shopping center owners, and investors in all facets of acquisition, development, operation and leasing of commercial real estate throughout the country.

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