ALI-ABA Course of Study Modern Real Estate Transactions. July 25-28, 2007 San Francisco, California. Big Box Leasing - Questions and Answers

Transcription

1 1971 ALI-ABA Course of Study Modern Real Estate Transactions July 25-28, 2007 San Francisco, California Big Box Leasing - Questions and Answers By Richard R. Goldberg Ballard Spahr Andrews & Ingersoll, LLP Philadelphia, Pennsylvania 1999 Richard R. Goldberg. All Rights Reserved.

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3 1973 BIG BOX LEASING - QUESTIONS & ANSWERS By Richard R. Goldberg Ballard Spahr Andrews & Ingersoll, LLP Philadelphia, Pennsylvania 1999 Richard R. Goldberg. All Rights Reserved I. What is a "Power Center"? A. A Power Center is a combination of two or more large space users (also commonly known as "big box" tenants) which share common facilities which include parking, utilities and roads. The Power Center will occupy a site of sufficient size to present critical mass to the trade area. The site will be located in an area of high visibility and access. It will frequently be the most important site from an accessibility and "retail draw" perspective in the trade area. II. What is the importance of a site plan? What are the negotiation strategies? A. Individual big box tenants have unique ideas about shopping center layout and design. The construction provisions of each lease must effectively reconcile these requirements. B. Directional parking, building position, lighting, roadway designation, landscape design and location as well as other site plan features must accommodate the varying requirements of the governmental jurisdiction and the specific users. C. The lease negotiation should be conducted as a continuum, reserving rights and attempting to obtain consensus on planning issues. Frequently, the developer will retain planning consultants who represent the various big box users who will anticipate the needs of the tenants. D. Big box tenants require larger parking fields with more spaces than are found in other types of shopping centers. The proximity and direction relating to each tenant's entrance will be paramount. The coordination will frequently require multiple design revisions. It is best to address - 1-

4 1974 these issues quickly and definitively. III. How do you negotiate Exclusives? A. Big box tenants desire and require exclusivity in the merchandise categories which they represent. In shopping centers with two to five occupants, it is customary to avoid duplication by careful tenant selection. However, when there are more tenants, there is likely to be significant cross over in merchandising between individual tenants. B. It is vital to establish early in tenant negotiations that each tenant will recognize the exclusives granted to other tenants in the center. If one is in a releasing mode, the new tenant must agree to recognize the existing mix and, of course, must have a use consistent with the previously granted exclusives. A reasonable alternative is to have agreements that no exclusives will be granted. However, the more occupants in the center, the more difficult it is to achieve this objective. C. The exclusive should be narrowly drawn. It should apply to primary use rather than preclude the use altogether. The landlord should attempt to restrict the application of remedies to landlord conduct rather than standing responsible for the conduct of all center occupants. D. The importance of control of exclusives will permit a proper exit strategy to be adopted by other tenants in the event of assignment as well as grant maximum flexibility to the landlord in releasing. IV. What are the assignment and sub-lease issues? A. The power tenant will typically require an almost unlimited right to assign or sublet. Normally, the landlord will bargain to capture the bonus value inherent in the typical power tenant lease which is for lengthy terms at relatively fixed base rents without percentage rents. However, in the power center, the tenant will usually have enough influence to bargain for these rights. B. It is imperative that the landlord require that the prospective assignment require recognition by the new tenant of the existing exclusives in the center. Frequently, big box tenants will agree not to assign to a tenant with a conflicting use. - 2-

5 1975 C. The principal defense of the landlord is to negotiate for the right to recapture the leasehold in the event of a proposed assignment. The price for the recapture is usually limited to payment of the unamortized value of the leasehold improvements installed by the tenant. However, the tenant frequently will obtain reimbursement for fixtures and betterments. D. The landlord should prohibit the tenant from sub-dividing the store. In the case of large users (in excess of 50,000 square feet) the tenant may be limited to the number of stores in any subdivision. In all respects, the subdivision into an internal mall should be avoided. V. Can we obtain an operating covenant? A. Big box tenants do not typically grant operating covenants. However, landlords frequently can bargain for a covenant to open for business, which when taken with the significant capital investment often associated with these stores, is tantamount to a covenant for a limited period. VI. How do we handle CAM? A. This area has become one of the most hotly contested ones between landlord and tenant. Over the course of many years, landlords have included a number of additional expenses which are covered by the CAM clause. Recently, a trend has developed where tenants have attempted to return to the original intent of CAM reimbursement which called for the reimbursement of landlords for the operation, maintenance, security and repair of the common facilities with limited reimbursement for replacement. B. Areas of significant negotiation: 1. Capital Costs a. The issues surrounding the inclusion of capital costs in CAM clauses has become one of the most hotly debated issues in lease negotiation. As the lease form evolved, landlords departed from the traditional formula of including maintenance expenses along with certain traditional capital repairs and replacements (i.e. parking lot paving and restriping, lighting standards, utility facilities) and included items such as roof replacement, utility up-grades, common - 3-

6 1976 area renovation and redesign, and other similar costs which went beyond repair and like-kind replacement. It is incumbent upon counsel to carefully review the complete list of items in the CAM expense clause if representing the typical tenant to glean those that may be inappropriate as an expense to be recovered. b. In dealing with the definition of capital expense, lawyers frequently rely upon the supposed standard set forth among Generally Accepted Accounting Principles (GAAP). This is an illusory definition. The specific standard in GAAP embraces a policy adopted by the landlord. The obvious effect is to write a blank check for the landlord in establishing capital policies and definitions. The lease should be specific about the type expense, the length of amortization of capital expenses, and the useful lives of each includable capital expenditure. c. The tenant should always insist that includable capital expenses be amortized over a specific period of time. Tenants frequently request amortization over the "useful life" of the improvement. Landlords favor a shorter period of years. d. Frequently, capital expense is defined as any expense or collection of expenses for the same improvement over a sum certain. This is a useful compromise. 2. Management Fees a. Landlords frequently attempt to recover management fees and expenses incurred by it as a part of CAM. This recovery is in addition to the traditional administrative override discussed later in the outline. b. Counsel should be aware of two types of recovery. First is the salaries and expenses of management personnel of all kinds which supervise the performance of services by employees whose costs are includable in CAM. Second is a percentage fee paid or imputed to be paid to a third party independent fee manager. The first form of payment is obviously more acceptable. The second fee includes costs that go well beyond direct supervision. 3. Administrative Expenses - 4-

7 1977 a. CAM reimbursement clauses usually include a reimbursement feature for administrative expenses based on a percentage of the total CAM expenses. For example, the typical enclosed mall lease calls for a fifteen (15%) per cent addition to CAM expenses based on the total CAM reimbursement charge. Other retail leases call for smaller but varying charges. b. The issue presented is whether or not the ad 4. Expenses Involving Environmental Remediation and Other Compliance with Law Expenses C. Tenants frequently require Landlords to place a limit on the amount of increase of expenses from year to year (commonly known as a CAM Cap). The CAM Cap may be based on year to year simple increases or may involve compounded increases. 1. For example, a five (5%) per cent CAM Cap non- compounded will work as follows (all expenses expressed as $ per square foot): a. Expenses in Year One $1.00, maximum permitted expenses in Year Two will be $1.05. If actual expenses in Year Two are $1.03, maximum permitted expenses in Year Three will be $ A five (5%) per cent compounded CAM Cap will work as follows: a. Expenses in Year One $1.00, Maximum permitted expenses in Year Two will be $1.05. If actual expenses in Year Two are $1.03 in Year Two, maximum permitted expenses in Year Three will be $ b. A cumulative CAM Cap will permit the landlord to recapture unexpended CAM expenses in any year in a future year without regard to the CAM Cap. A five (5%) per cent compounded cumulative CAM Cap will work as follows: c. Expenses in Year One $1.00, Maximum permitted expenses in Year Two will be $1.05. If actual expenses in Year Two are $1.03, maximum permitted expenses in Year Three will be $ ($ plus a one time recapture - 5-

8 1978 of the unexpended $.02). If the actual expenses in Year Three are $1.09, the maximum permitted expenses in Year Four is $ ($ plus the unexpended $.02 from Year Two and the unexpended $.01 from Year Three). d. NOTE: Because the CAM Expenses in the initial year of a Shopping Center may not reflect the true expenses in the 2nd and 3rd years of the Shopping Center, be careful not to tie the Base Year to the actual CAM Expenses in the first year or to a fixed number that is too low. 3. The negotiation of the Capital expense exclusion is among the most problematic of discussions. Parties striving for a definition will frequently attempt to use Generally Accepted Accounting Principles as the benchmark for defining this expense. GAAP provides no consistent definition and should be avoided. The most commonly achieved compromise involves the designation of a specific basket of capital expenses to be permitted with a further requirement that if the expenses in the aggregate exceed a benchmark or if an individual expense exceeds an agreed to sum, the expenses will be amortized over a period of years. The period will be as agreed to by the parties or consistent with an established index such as the useful life for depreciation as defined by the Internal Revenue Code and Regulations for specific capital improvements. VII. What are Co-Tenancies? How do we negotiate this issue? A. Big box tenants will usually require levels of occupancy of other tenants as a condition to opening their premises for business and continuing levels of occupancy of other tenants in order to prevent rental reduction and ultimate termination of the lease. B. The opening co-tenancy is based on a certain percentage of tenants being open (usually based on square footage) as a condition for the opening of the tenant in question. There is frequently a designation of particular tenants who are also required to be open as a part of the condition. C. The continuing co-tenancy obligation is based on similar requirements. However, it is typical for the requirement to be the same as or lower than the opening co-tenancy. D. The key to satisfying the opening co-tenancy from the landlord's - 6-

9 1979 perspective is to base the requirement on conditions other than actual opening. For example, the landlord might condition the opening on its performance in satisfying the obligations of landlord (i.e., completing construction of a portion of the Shopping Center) which are required to enable the tenants to open rather than opening as the operative act. In addition, the importance of a tenant covenant to open may be helpful here by enabling landlords to covenant that other tenant's have covenanted to open instead of the operative act of opening. E. With respect to the continuing co-tenancy, the landlord should allow ample time to cure (replace the closed or terminated tenant) before rent reduction and termination of the affected lease occurs. Since it can take up to a year or more to replace a big box tenant, the more time before events occur, the better for the landlord. F. The importance of recapture in the event a tenant elects to "go dark" (close its store) even though rent will continue to be paid is obvious. A landlord cannot control the assertion of co-tenancy remedies if it cannot control dark or vacant spaces. Landlord's must have the ability to lease the space to avoid the potential "house of cards." - 7-

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