AMERICAN COLLEGE OF REAL ESTATE LAWYERS SPRING 2001 PROGRAM. Shopping Centers - Current Issues And Challenges

Transcription

1 AMERICAN COLLEGE OF REAL ESTATE LAWYERS SPRING 2001 PROGRAM Shopping Centers - Current Issues And Challenges March 29-31, 2001 Williamsburg, Virginia USE CLAUSES By Joel R. Hall The Gap, Inc. San Francisco, California Joel R. Hall All Rights Reserved

2 1.00 USE CLAUSES TABLE OF CONTENTS 1.00 USE CLAUSES In General Any Lawful Use Specific Use Clauses Outlet Centers... 7 Page

3 1. USE CLAUSES 1.1 In General. The tenant strives to have as broad a use clause as possible so that: (a) (b) changes in product lines can be accommodated without the need for special permission from the landlord. The evolution of merchandise lines is a natural process of all retail businesses and most especially in the case of apparel, which changes seasonally, to facilitate assignments and subleases to the broadest range of possible successors. It has been the traditional position of enclosed mall landlords that specific and fixed use clauses for all of the tenants are essential in order to achieve a balanced and diversified tenant mix. Otherwise, a shopping center would become an unmanageable and random assortment of goods and services and would likely fail. However, too many landlords attempt to achieve an almost one-of-a-kind assortment among their retail tenants and try to protect each one from competing against or even overlapping with the other. In the case of an apparel retailer, this is an impossible dream. Apparel uses are the most prolific in a shopping center where merchandise lines and price points range from dissimilar to identical. Any attempt to navigate between the various use clauses of the apparel tenants - with phrases such as casual apparel, sportswear, sports apparel, popular priced, off-price or discount - is fraught with great difficulty. Moreover, retailing since the late 1990's has seen the expansion of merchandise lines of many retailers beyond the scope of their traditional use niche. Book sellers are running cafe operations, dispensing cappuccino and exotic food items. Apparel retailers are selling cosmetics, linens and even lines of children's toys and games as well as holiday videos and CD's and are now also embarking upon the coffee and juice bar business. Sporting goods stores carry extensive lines of outerwear, duplicating much of the merchandise in apparel stores. Everyone is beginning to sell a little bit of everyone else's lines. This trend has significantly undermined the traditional utility of the use clause - to carefully and rigidly restrict each tenant's use so as to maintain balance and variety among uses and minimal overlapping of merchandise. The traditional assumption was that without tight use clauses, chaos reigns. In the context of a shopping center the truth is somewhere in the middle. The retail mapping of modem shopping centers should allow for this recent trend and tolerate a reasonable amount of overlapping merchandise lines among retailers, even those in different use classifications. The forces of the marketplace will even things out. Those retailers with the savvy to market quality goods representing real value, in well-run, customer oriented and attractive stores will thrive, even if several of them carry a little bit of similar merchandise. Everyone will share in the consumer dollar. In many cases, offering merchandise which is different from the tenant's primary use but which is done on an incidental basis, is intended more as a convenience to customers or as a promotional device - such as cafes in apparel or book stores. Such incidental uses are unlikely to seriously harm neighboring retailers.

4 Thus, while the landlord's need should be respected, within reason, it is nevertheless appropriate for the shopping center tenant to obtain a relatively broad use clause to avoid locking himself in later. Strip Centers. Because of the smaller size of these centers and the entrepreneurial nature of strip center landlords, a tenant may be able to secure a use clause that permits retail sales and avoid a product specific use clause. Generally however, if a large strip center is involved or the landlord otherwise insists on a specific use clause, then the relevant language should be stated in the most general terms, e.g. the Premises may be used primarily for the sale of wearing apparel including shoes and other footwear as well as accessories related to all of the foregoing, including but not limited to Any Lawful Use. Multi-Occupancy Buildings. While tenants generally can obtain the right to use the premises for any lawful purpose or retail sales of merchandise in multi-occupancy buildings, some multi-occupancy locations are more like downtown shopping centers than street deals and a specific use clause may be appropriate. Street deals. In street deals (i.e. downtown business districts), the tenant will in most cases be able to obtain a use clause which permits the conduct of any lawful purpose or the conduct of retail sales. This is true despite the fact that (A) there is a percentage rent clause in the Lease, (B) the landlord initially expected the tenant's specific operation with a high sales volume, or (C) the landlord accepted a percentage rent clause in return for a lower rent schedule (and in lieu of any other kind of rent escalator). This success is due to the fact that most of street deal landlords are smaller entrepreneurial individuals, not major developers or institutional owners, and they are usually concerned about the minimum rent, taxes, the strength of the tenant's signature and little else. Where there is no percentage rent clause, the landlord's argument for restricting the tenant to a specific use clause (or to even require an operations covenant) begins to vanish. In these nopercentage deals the tenant should have little problem in getting an unlimited use clause. Exception/Offensive Uses. Some of these landlords will request modest limitations on the use clause to prevent the usual offensive uses such as massage parlors, video arcades and the like. Exception/Premier Buildings. In Manhattan and other upscale neighborhoods in other cities (e.g. Michigan Avenue in Chicago), the landlords have a stronger interest in maintaining the quality of their building. In Manhattan in particular, it is ingrained as part of the landlordculture that quality restrictions be a feature of even very broad use clauses. Since quality or first class descriptions are hopelessly subjective, these must be aggressively resisted or carefully limited by the tenant (see Practices To Be Avoided infra). Limitations Upon Any Lawful Use. Although the variations are infinite, what follows are some general principles and examples of solutions that can be achieved. 2

5 1. Prohibited Uses. This puts the burden on the landlord to think of everything he doesn't like at the time he signs the lease. Unless he thinks of it then, it is too late. Courts favor unrestricted use clauses and view them permissively. They will construe them with a bias favoring a liberal approach so that what is not expressly prohibited may be conducted by the tenant. 2. Permitted Uses. This puts the burden on the tenant to come up with a list of every use he can think of. This is less desirable than the prohibited use list and should be resisted. 3. Specific Use Clause For A Limited Period Of Time. Where a specific use clause is not altogether avoidable, it may be acceptable to the parties to agree on a specific use clause for a limited period of time, never exceeding 3 years. 4. No Duplication By Tenant. It may be appropriate for the tenant to agree that it will not duplicate the use of another, even if the other tenant does not have an exclusive clause in his favor if the following conditions are met: a. Specific Protected Merchandise Of The Other Retailer. The other use which is to be protected should be defined as specifically as possible (and assuming one even knows what that use is). In other words, the merchandise to be protected must be specified with detail unless the context of the other store's use is obvious. For example, a record store may in some cases be specific enough although its good practice to describe the protected merchandise with more specificity, e.g. records, compact discs and prerecorded video and audio cassettes. Thus, the other, protected retailer can't complain if the tenant sells boomboxes even though the other retailer may carry such items in his record store. On the other hand, a gift shop is too vague of a description and greater specificity is required. Another consideration is that when you have a general class of merchandise you can have subclasses that do not compete with each other, e.g. a Radio Shack store vs. a high-end audio salon where components cost several thousand dollars apiece. Here, the customer bases are totally different. Problem. The above analysis only works with known uses. However, often tenants are usually being asked not to duplicate future uses that are not even known yet so he cannot know how to draft the clause. b. Protected Merchandise Must be Primary Use. The tenant should only be required to respect another retailer's merchandise to the extent that other retailer deals chiefly in it. Aside from the difficulty in describing the merchandise with specificity, the other retailer must carry the protected merchandise to the extent of a majority of his merchandise units or he must devote a majority of his floor area to that business. 3

6 c. Overlap Permitted. Given the nature of retailing, there may be some overlap in specific items of merchandise. Thus, the tenant must be permitted to carry up to 35% of the protected merchandise or to otherwise be allowed to encroach upon that merchandise to an incidental extent (i.e. not primary ). d. Price Differences. To be truly duplicative, the price ranges in the protected merchandise in the two stores must be within +/- 10% of each other. e. Specific Goods Of The Tenant Exempted. The tenant must identify those goods or merchandise lines which are the primary business of the tenant and which must be exempted from any obligation to avoid a duplication of business with the other tenant, e.g., an apparel use. 5. Respecting Other Exclusives. The tenant will be required to respect existing exclusives, but he must protect himself from badly drafted ones that the landlord might enter into in the future. The tenant cannot be more restricted in its obligation to respect the other fellow's exclusive than he can in his obligation not to duplicate that other fellow's use (in accordance with the principles discussed in Paragraph 4 above) in the absence of an exclusive. However, if an existing exclusive is badly drafted, this concept will require the concurrence of the exclusive holder. Figure 1-1 is an example of a clause embodying the principles of subparagraphs 4 and 5 above: Figure 1-1 Non-Apparel Use. The Premises may be used for non-apparel uses subject to the following restrictions: (a) That such new use shall not duplicate (as herein defined) the principal and primary use of any other tenant in landlord's building. The term principal and primary use as used herein with respect to another store shall mean that such other store carries the merchandise in question to the extent of fifty-one percent (51%) or more of its total merchandise (in terms of numbers of units of merchandise). The term duplicate as used herein shall mean the Tenant carries to the extent of thirty-five percent (35%) or more (in terms of numbers of units of merchandise) of its total merchandise of the same or similar merchandise (i.e., the same or similar in terms of (i) specific categories of merchandise units, and (ii) price range, plus or minus ten percent (10%)) as that carried as the principal and primary use by such other store. Notwithstanding the foregoing: (i) in the event Landlord hereafter grants another tenant an exclusive provision, Tenant shall not be more restricted in the conduct of such nonapparel use than the limitations imposed by the definition of duplication set forth above, notwithstanding the fact that such exclusive 4

7 provision may be more restrictive in its terms as against Landlord (i.e., drafted more broadly in such tenant's favor) than as provided under the definition of duplication ; and (ii) the conduct by Tenant of an apparel use may not be restricted in any manner notwithstanding the fact that (a) such business is conducted by another tenant in Landlord's building or (b) such other tenant has an exclusive provision contained in its lease (excepting from this clause (b) any such provision presently contained in such tenant's lease as of the date hereof). Practices To Be Avoided With Any Lawful Use Clause. A tenant with a general use clause should avoid the following limitations that are often advanced by the landlord: 6. The tenant should not agree to a provision that he won't carry clearance merchandise, seconds, irregulars or factory damaged merchandise. Once the landlord has accepted the notion that the tenant can conduct any lawful use in his building, he cannot then attempt to regulate the specific character of that use. However, the tenant may subject himself to a list of prohibited uses as discussed above. 7. The tenant should not agree that he will always carry first class or high quality merchandise. Nobody knows what this means. These are hopelessly subjective and informal words. While one could have a congenial discussion about the notion of first class and get a sense of the concept from the conversation, it is impossible to reduce it to descriptive words such as to guide one's conduct in a lease. However, in extremely famous landmark buildings the issue can be dealt with in a manner where certain stores are used as comparators, both acceptable and unacceptable, for a given use category. Such a list would have to be considerably long to give the tenant a wide range of choices. While this is far from a perfect solution, it does narrow the scope in which the landlord's subjective impressions or bias can interfere with the tenant's business practices. 8. The tenant should not be prevented from conducting a discount house or discount store. This should be of no concern to a landlord who has otherwise accepted the notion of an general use clause unless the tenant is in a landmark building where quality factors have to be addressed (see paragraph 2 above). 1.3 Specific Use Clauses. Where the tenant is unable to secure a general use clause (as in the case of a shopping center) the following principles must be observed when negotiating the specifics. The tenant should not do any of the following: a. agree that his merchandise or accessories will be the same as that which is carried in his other stores (or his other divisions) identified by name. 5

8 In the first instance, it is a fact that stores operating under the same tradename do not carry the same merchandise at the same point in time. A store's merchandise mix can vary from one location to the next, depending on the demographics of the area - e.g. stores in Manhattan compared to stores in Des Moines, Iowa. Secondly, the tenant could not change to another division even if the tradename clause permitted it because his merchandise would be locked-in to the original division's merchandise. Thirdly, he would be unable to assign or sublet regardless of what the assignment clause said. However, the following clause should be acceptable to the tenant: Figure 1-2 Tenant agrees that merchandise [or accessories] carried in the Premises will be 'substantially similar to that carried from time to time in other stores of Tenant operated under the same tradename as is used at the Premises This will allow the tenant to carry whatever that division carries. If he can change the division under the tradename clause, then he can sell the merchandise that goes with it. Also, the above language is not limited as to one point in time (e.g. as is presently carried by Tenant ). Also, the language only ties the tenant to his other stores, not all of his other stores nor to all of his other stores in a given geographic area. b. limit his accessories to that then or presently carried in his other stores. A tenant's merchandise assortment is constantly changing - this is endemic to any business. This fact has been dramatically illustrated by the explosion of merchandise lines from a tenant's traditional niche to multitudinous assortment of goods and services. However, a tenant might accept a limitation similar to Figure 1-2 immediately above. c. specify a particular brand of merchandise. The reasons are fairly obvious as merchants change vendors all of the time in the natural evolution of a tenant's business. Such a clause would unduly freeze the tenant's business operation to that which existed at a single point in time. This is a particularly serious limitation for a retailer who primarily carries private label merchandise but who occasionally carries other brands. d. agree that his merchandise will not duplicate another's or that his use will not violate another's exclusive. A request by the landlord that the tenant's use not evolve to the point that its duplicates the use of another, where the other party has not otherwise bargained for exclusive protection, would be a serious limitation and difficult to observe. It would have the effect of paralyzing the natural growth and evolution of the tenant's business. So long as he otherwise stays within the confines of the specifics of his use, that should be sufficient. See also the 6

9 discussion above under Any Lawful Use Clause. With respect to exclusive issues, so long as the tenant has been made aware of another party's exclusive rights and the tenant otherwise stays within the confines of the use clause, this issue should never arise; therefore a covenant to this effect is unnecessary and probably dangerous. See discussion under 2.00 of these materials. e. agree that he won't carry clearance merchandise, seconds, irregulars or factory damaged merchandise. The tenant must retain the right to conduct clearance sales from time to time in the normal course of its business. As to seconds or irregulars, he could agree to this provided no other store in the shopping center is doing so; otherwise, if the landlord has permitted another to sell such goods, then the tenant cannot be restricted in this manner. f. agree that he will always carry first class or high quality merchandise. As stated under 1.02 above [Any Lawful Use Limitations], nobody knows what this means since it means different things to different people. These are very subjective and informal terms. It is impossible to reduce it to descriptive words such as to guide one's conduct in a lease. g. agree not to conduct a discount house or discount store. If Retailer A regularly sells goods for $22.00, which is marked down from $30.00 (and the merchandise label so states) while Retailer B sells the same item at his everyday price of $22.00 and which is not marked down or discounted from any higher price, is Retailer B a discounter like Retailer A? Is one good and the other bad? Because landlords are hopelessly imprecise with this concept and only know there is something there that they don't like (but can't define it), the tenant must simply delete it. Or, in the event the parties do agree on what that term means, the tenant should be permitted to engage in that business if anyone else is the shopping center is permitted to do so. This is a serious problem found in apparel use clauses (and exclusive clauses) in strip center and outlet center leases. h. agree that the tenant not convert his regular operation to his outlet division. Although outlet divisions of a retailer have until recently been located in specialty centers for that purpose, their increasing appearance in regular malls and other strip centers has blurred the distinctiveness of that business from power centers and value centers in general. There no longer is a strong justification for excluding such operation from mainstream retail complexes. See also 1.04 below. 1.4 Outlet Centers. Outlet centers until recently have been treated as a very specialized phenomenon, with their own locations and special use provisions. The classic function of the outlet business was to create a place where consumers could shop the name brands of merchandise but at a substantial discount. Therefore, outlet landlords attempted to make the tenants lease not only use specific but brand specific with respect to the merchandise sold therein and tradename specific with respect to the tenant's operation. In addition, they attempted to specifically limit or regulate the prices that the tenants could charge for their goods to ensure that 7

10 those goods would sell at prices lower than what the same branded goods would sell for at full retail in regular malls. Often, these are ill-defined concepts drafted by those without actual realworld retail knowledge. While such specialized restrictions were consistent with the classic concept of an outlet center, they also paralyzed the tenant in the way he could conduct his business when the forces of the marketplace have evolved away from this orthodox view of the outlet business. Further, the ability to assign or sublease becomes virtually impossible without the landlord's sole discretion consent. Each brand name retailer conducts his outlet business somewhat differently from the others. Some tie themselves exclusively to one manufacturer or brand. Others mix their goods with other branded products (assuming the proper authority to do so) while others maintain price levels with respect to specific goods comparable to their regular stores. Some derive all or part of their goods as clearance merchandise from their regular stores ( dump stores ) while others have outlet goods specifically manufactured for the outlet division. Amongst the outlet developers themselves, some are more orthodox than others some emphasize price as a key factor, others on strict adherence to brand-name. Therefore, each tenant must be permitted to decide for himself what his outlet business is and must not be forced into the landlord's pre-conceived notion of it. Accordingly, only the tenant can decide whether price restrictions, brand restrictions or tradename restrictions are consistent with his concept of that business. 8