Negotiating Restrictive Covenants that Diminish the Ability of Landlords to Enter into Leases and Grant Signage Rights

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1 Negotiating Restrictive Covenants that Diminish the Ability of Landlords to Enter into Leases and Grant Signage Rights By Stuart Mass 1, Steven Monteforte 2 and Noah Shapiro 3 Putting aside governmental regulations, such as zoning regulations, landmarks regulations and laws prohibiting transactions with entities believed to be conducting business with terrorists, one would think that the owner of a commercial building could freely lease its space to the most qualified and attractive tenants, and could grant identifying signage rights to these tenants to facilitate the consummation of a deal. But this is not always the case. By way of example, if you were a tenant negotiating a lease in a shopping mall for a high-end coffee shop, wouldn t you insist that the landlord not lease other space in the same shopping center to one of your competitors? If you were the managing partner of a law firm negotiating a lease for seventy percent of an office building that would highlight your firm s name at the entrance to the building and on the wall behind the concierge desk, wouldn t you insist that the landlord not grant exterior or lobby signage rights to another law firm? Wouldn t you also insist that any identifying signage granted to another non-law firm tenant of the building be far less prominent than your firm s signage? The examples listed above may seem simple on their face, and relatively easy to resolve. A commercial office building owner negotiating a law firm lease for seventy percent of a building in a neighborhood where law firms do not constitute a substantial percentage of the target tenant base might not find it too painful to accept the fact that, in leasing the remaining thirty percent of its building, it may not be able to attract other law firm tenants, because it could offer them only a small identifying plaque on a column at the building entrance, or on a small podium in the building lobby manned by a receptionist of the law firm. In the coffee shop example, the landlord of the shopping center might relent because, from a practical standpoint, another coffee shop might be reluctant to come to a location where it would face direct competition, and it might be more profitable for the landlord to provide shoppers with a more diverse tenant mix. But the devil is always in the details. Before we get started on a discussion of how these issues tend to get worked out at the negotiating table, it is important to note that the parties need to be aware of statutory provisions in the applicable jurisdiction that might limit their ability to implement their desired agreements. By way of example, Section 674-a of the New York Banking Law effectively renders null and void any purported agreement between a banking organization, bank holding company, national banking association, federal savings and loan association or foreign banking corporation and an owner of an interest in New York real property that bars such owner from leasing, selling or otherwise disposing of any interest in real property to any other banking organization, bank holding company, national banking association, federal savings and loan association or foreign banking corporation. 4 This statute has been interpreted broadly to prohibit 1 Stuart Mass is a partner in the New York office of the law firm of Haynes and Boone, LLP. He devotes substantially all of his professional time to commercial real estate leasing transactions. He may be reached at stuart.mass@haynesboone.com or Steven Monteforte is a partner in the New York office of the law firm of Haynes and Boone, LLP. He represents large, institutional tenants in all aspects of their corporate facility needs in New York City and throughout the country. He may be reached at steven.monteforte@haynesboone.com or Noah Shapiro is a partner in the New York office of the law firm of Haynes and Boone, LLP. He focuses on office, retail and ground leasing of mostly Class A properties and is involved in all aspects of the leasing process. He may be reached at noah.shapiro@haynesboone.com or This statute affords an injured party the right to sue for treble damages.

2 restrictions on the installation of Automatic Teller Machines in or about the owner s real property. We suspect (based on more than mere conjecture), that this statute would also prohibit an agreement between a bank and a landlord that would prevent the landlord from giving identifying signage to another bank tenant (the theory being that, from a practical standpoint, the inability to grant identifying signage arguably bars such owner from leasing, selling or otherwise disposing of any interest in real property to a bank). How to Define Competitor This is perhaps the toughest issue in negotiating restrictive covenants in leasing (sometimes referred to as exclusive use clauses) and signage rights. Let s start with the coffee shop. Is a breakfast restaurant that serves coffee a competitor? Is a store that sells coffee beans and ground coffee, but not brewed coffee, a competitor? How about a designer cupcake shop that serves coffee to wash down the calories? Is a book store that has a little coffee shop tucked away in the corner of the store with no visibility from the interior of the shopping center a competitor? If it is determined that, under the coffee shop s lease, any of the above constitute a competitor of the coffee shop, then the landlord s attorney might need a shot of scotch in his or her coffee before being called on the carpet to face the music. So what could the lawyers have done to come up with a clear and mutually acceptable definition of competitor in the coffee shop s lease? Does the lease need to take into account that there may be existing leases at the shopping center that would require the landlord to be reasonable in considering a request from an existing tenant to assign its lease or sublet its store to a competitor of the coffee shop? Should the exclusivity provision of the coffee shop s lease apply only if the coffee shop tenant is actively selling coffee from the store (as opposed to having closed down or changed its primary use)? Here is some lawyer language that attempts to cover these bases: Provided, and only for so long as (x) Tenant is not in default under this Lease beyond any applicable notice and cure periods, and (y) Tenant is using the entire Premises in compliance with (and for) the Permitted Use set forth in Section hereof (collectively, the Restrictive Covenant Criteria ), Landlord agrees, as Landlord s sole obligation under this Article, that Landlord will not, during the term of this Lease, lease any space in the Shopping Center to any entity whose primary business is the retail sale of brewed coffee (the Restricted Use ), and that Landlord will not permit an assignment of, or a subtenancy arrangement under, a lease for space in the Shopping Center to any entity that will engage in the Restricted Use, but only if in Landlord s reasonable opinion, Landlord clearly has the right to withhold consent to any such assignment or subtenancy pursuant to the terms of the lease in question; provided, however, that Landlord reserves the right to lease space in the Shopping Center to entities whose business may include the retail sale of brewed coffee, as long as brewed coffee is not the primary product sold by such business at the Shopping Center (the Restricted Use Covenant ). Tenant understands and agrees that the provisions of this Article shall not (i) apply to any space in the Shopping Center not controlled by Landlord or its affiliates, (ii) apply to any temporary special events or programs within the Shopping Center conducted or sponsored by Landlord, its affiliates or any unrelated parties, which may include vendors, manufacturers and distributors whose primary business purpose is the Restricted Use or (iii) prohibit any existing tenant (or existing subtenant of any existing tenant) of the Shopping Center from using its store for the Restricted Use. If at any time Tenant is not in full compliance with the Restrictive Covenant Criteria, then thereafter the terms and provisions of this Article shall be deemed to be null and void and of no further force and effect, provided, however, that if Tenant thereafter resumes full compliance with the 2

3 Restrictive Covenant Criteria and Tenant shall give Landlord written notice thereof, then as of the date such notice is received by Landlord, the Restricted Use Covenant shall be reinstated subject to all of the terms and conditions of this Article, but such Restricted Use Covenant shall not apply to any leases, assignments of leases or subtenancy arrangements completed or being negotiated by Landlord or tenants of Landlord, as the case may be, at the time Tenant resumes full compliance with the Restrictive Covenant Criteria and gives written notice thereof to Landlord. Moving on to the office leasing context, defining a competitor can become somewhat more complex. A broad definition could put undue restraints on the ability of a landlord to enter into leases with a wide range of potential tenants and/or to grant signage rights that may be needed to induce a prospective tenant to enter into a lease. As prospective tenants diversify and expand their operations and lines of business, they often consider a very wide array of companies (and sometimes even parent entities or affiliates of such companies that are involved in unrelated lines of business) to constitute their competitors. One way of dealing with the problem of an unmanageable and vague scope of entities that will fall within the definition of competitors is to attach a relatively short list of competitors to the lease that can be updated from time to time under certain agreed-upon circumstances. Here is a complex example of a hypothetical provision that covers how the competitors of a substantially diversified real estate brokerage company might be defined and addressed: During the term of this Lease, provided that the Occupancy Requirement is satisfied, Landlord agrees that (i) no signage shall be displayed (whether to identify an occupant of the Building or a managing or leasing agent of the Building) in the Building s lobby (including, without limitation, the elevator banks and vestibules of the lobby), on the exterior of the Building, or in any common or public area of the Building located on floors that comprise the Premises that in any of such cases bears the name and/or the logo of any Competitor of Tenant (it being understood, however, that nothing contained in this clause (i) shall preclude Landlord from including a Competitor s name in a directory for the Building located in the Building s lobby), (ii) the name by which the Building is commonly known shall not be changed to the name of a Competitor, and (iii) Landlord shall not lease to a Competitor any portion of the Premises that Landlord has subleased from Tenant in accordance with the recapture provisions of Section hereof. The term Competitor shall mean, collectively: (i) any Exhibit A Competitor and (ii) any entity this is both a Provider of Real Estate Services and a Derivative Entity of an Exhibit A Competitor. Subject to the terms of this Section, the term Exhibit A Competitor shall mean any entity that is identified on the list of ten (10) entities attached hereto as Exhibit A. Tenant shall have the right, by giving Landlord at least ten (10) Business Days prior notice, to replace any entity on Exhibit A from time to time with a top-tier Provider of Real Estate Services; provided, however, that in no event shall Tenant have the right to designate more than ten (10) entities on Exhibit A (and thus there shall never be more than ten (10) Exhibit A Competitors) or to propose a replacement entity for a then-current Exhibit A Competitor that is then in (or in the prior six-month period has been in) active negotiations with Landlord to lease space in the Building. For purposes hereof, a toptier Provider of Real Estate Services shall mean one of the top twenty-five (25) Providers of Real Estate Services, measured by gross revenues derived from the provision of Real Estate Services in the United States. If (i) at any time from and after the date hereof, Landlord concludes that a particular Exhibit A Competitor no longer constitutes a top tier Provider of Real Estate Services, and (ii) Landlord notifies Tenant thereof, then such entity shall no longer constitute an Exhibit A Competitor as of the twentieth (20th) day after the date that Landlord gives such notice to Tenant, unless Tenant objects thereto by 3

4 notice to Landlord given within such period of twenty (20) days, in which case the parties shall seek in good faith to resolve the dispute (subject, however, to Tenant s right in accordance with all of the applicable terms of this Section to add such entity to Exhibit A at a later date if such entity has once again become a top tier Provider of Real Estate Services). Landlord and Tenant shall each have the right to submit to an Expedited Arbitration Proceeding any unresolved dispute pursuant to the preceding sentence (it being agreed that during the pendency of such dispute or the disputes detailed in the preceding sentence, such entity shall be deemed to constitute an Exhibit A Competitor). Following any such resolution which involves the removal of a particular Exhibit A Competitor from Exhibit A, Tenant shall be entitled to replace same on Exhibit A with another entity pursuant to and in accordance with the terms of this Section. The term Provider of Real Estate Services shall mean any entity, or any division or business unit of any such entity, that in either case (i) derives all or a substantial portion of its revenue from providing any of the following services to third parties: commercial real estate brokerage, real estate investment sales, including lodging and leisure sales, property management, facilities management, project management, real estate appraisal and valuation, commercial real estate mortgage brokerage, commercial real estate market research and market analytics, real estate debt placement, real estate transaction consulting, lease administration (it being agreed, however, that if an accounting firm [or a firm providing similar non-real estate services] provides lease administration services to one or more third parties, then such accounting firm shall not be deemed a Provider of Real Estate Services solely by reason of such provision of lease administration services, provided further, however, that any distinct division or business unit of such accounting firm [or a firm providing similar non-real estate services] that provides lease administration services shall be considered a Provider of Real Estate Services if it otherwise meets the definition of Provider of Real Estate Services), real estate investment management and strategy and real estate fund management (collectively, Real Estate Services ) or (ii) (x) derives a material portion of its revenue from providing Real Estate Services to third parties (but does not derive all or substantially all of its revenue from providing Real Estate Services to third parties) and (y) is generally known as a provider of Real Estate Services (so that, for example (1) if, as of the date hereof, XYZ Corp. derives a material portion of its revenue from providing Real Estate Services to third parties (but does not derive all or substantially all of its revenues from providing Real Estate Services to third parties), then XYZ Corp. would nevertheless constitute a Provider of Real Estate Services as of the date hereof if XYZ Corp. is otherwise generally known as a provider of Real Estate Services as of the date hereof, and (2) if, as of the date hereof, Microsoft derives a material portion of its revenues from providing Real Estate Services to third parties (but does not derive all or substantially all of its revenues from providing Real Estate Services to third parties), then Microsoft would not constitute a Provider of Real Estate Services as of the date hereof because Microsoft is not generally known as a provider of Real Estate Services as of the date hereof); it being further agreed, however, that a Financial Services Provider shall not be deemed to constitute a Provider of Real Estate Services. The parties hereby acknowledge that an entity that is not generally known as a provider of Real Estate Services to third parties, but which has one or more affiliates, divisions or business units that provide Real Estate Services to third parties, shall not necessarily constitute a Real Estate Service Provider itself, but its particular affiliate, division or business unit that provides Real Estate Services to third parties shall constitute a Real Estate Service Provider (so that, for example, if (a) Wells Fargo Real Estate Services is in the business of providing Real Estate Services to third parties, and (b) Wells Fargo Real Estate Services comprises 4

5 only a small component of the total business of Wells Fargo, then Wells Fargo Real Estate Services shall constitute a Provider of Real Estate Services, but Wells Fargo shall not constitute a Provider of Real Estate Services [merely by virtue of Wells Fargo having such affiliate, division or business unit that is a Provider of Real Estate Services]). The term Financial Services Provider shall mean an entity, division or business unit that derives at least seventy-five (75%) percent of its revenues from providing financial services to third parties. The parties hereby acknowledge that the operation of a real estate fund, or providing investment advice to a real estate fund, constitutes the provision of financial services. The term Derivative Entity" shall mean an entity that (a) is an affiliate, division or business unit of an Exhibit A Competitor, and (b) has a name which includes a word or phrase that is, or that includes a combination and/or abbreviation of one or more words or phrases that are, derived from the name of such Exhibit A Competitor. Thus, for example, if Cushman & Wakefield, Inc. is an Exhibit A Competitor, then C&W Lease Administration Services and C&W Real Estate Appraisal and Valuation would constitute Derivative Entities of Cushman & Wakefield, Inc., but C&W Steak Houses would not constitute a Derivative Entity of Cushman & Wakefield, Inc. Landlord and Tenant shall each have the right to submit to an Expedited Arbitration Proceeding a dispute with respect to the provisions of this Section and/or the determination of whether an entity is a Competitor. Note from a landlord s perspective, the provision appearing directly above presents a troubling level of uncertainty and number of prospective tenants that may constitute competitors. When landlords are willing to inject the concept of competitor restrictions in a lease, the strong preference is for the attachment to the lease of a list (as short as possible) with a set number of competitors, subject to substitution of competitors on the list from time to time under limited circumstances. How Common are Restrictions Against Leasing to Competitors in Large Office Buildings? To begin this conversation, we should note that restrictions on leasing to office tenants come in a variety of shapes and sizes. Without attempting to catalog every possible scenario, here are the main types of such leasing restrictions in order of severity from a landlord s perspective: a complete restriction against leasing any space in the entire building to a competitor; a restriction against leasing space in a particular elevator bank to a competitor; a restriction against leasing space to a competitor on the same floor on which the subject tenant is leasing space; and a restriction against leasing to a competitor space that has been recaptured by the landlord from the subject tenant. As you might assume, the last two types of restrictions are more prevalent, while the first two types are somewhat rare in large, New York City office buildings (unless, the tenant requesting the restrictions has agreed to lease substantially all of the rentable area of the building or of a particular elevator bank, as the case may be). The determination of whether it is a worthwhile expenditure of a tenant s time and goodwill to engage a landlord in prolonged discussions of any of these restrictions will depend on factors such as (i) the percentage of the rentable area of the building that the tenant will be leasing, (ii) the likelihood that a competitor will be in the market for space in the same building, (iii) the building s vacancy rate and 5

6 (iv) the level of the landlord s need or desire to complete the transaction for reasons other than the merits of the deal itself (e.g., the landlord wishes to refinance its mortgage loan). The likelihood that a tenant will need, and a landlord will consider, a restriction against leasing to a competitor space that has been recaptured by the landlord from the subject tenant will also depend on factors such as (i) whether the tenant will remain in the building following the recapture by the landlord and (ii) if so, whether the recaptured space is only part of a full floor leased by the tenant (a landlord may tend to be more sympathetic to a claim by a tenant that it could not live on the same floor with a competitor). The Scope of Signage Restrictions In the negotiation of restrictive covenants on the granting of signage rights, it is not only competitors that concern some tenants particularly the ones taking a very substantial portion of a building. Often, these tenants will restrict their insistence on signage exclusivity to the exterior of the building, or perhaps the portions of the building in the direct vicinity of the entrance or entrances to the building, while recognizing that the landlord s leasing program will, at the least, require the ability to grant lobby signage, albeit less prominent, to other tenants of the building that may meet a minimum threshold of occupancy. When negotiating signage restrictions, there are a few things that both the landlord and the prospective tenant should consider: The exterior of the building is arguably a vague term. Is it limited to the façade of the building, or does it also cover anything within the property lines, such as planters or monuments erected to list the names of building occupants? Is there a flagpole (or could there be one in the future)? The lobby of the building is also arguably a vague term. Is it limited to the portion of the first floor of the building between the entrance and the wall behind the concierge desk, or does it include all first floor wall surfaces, including the entrances to and the walls of each elevator bank? In limiting exterior signage, should retail signage be excluded? Should signs located in the Building but visible from outside the Building be prohibited? Should potential customers be required to rely on their sense of smell to find a Starbucks? In limiting lobby signage, is directional signage in a complex of buildings connected by a common lobby excluded? When Does a Signage Restriction Effectively Constitute a Leasing Restriction? Now we are really getting to the heart of the matter. How much should a landlord care if it can get the same rents and not lose a prospective tenant just because it can t offer that prospective tenant a plaque outside the building or at the entrance to its elevator bank? Perhaps not much. Is this the way it works in the world of leasing to high-profile tenants taking large blocks of space? About as often as you can squeeze the toothpaste back into the tube. Not all tenants are equally focused on signage. Some tenants are exceptionally private, and don t want any signage at all (rare). But for the most part, big tenants expect signage and signage exclusivity commensurate with their level of occupancy in the building. Let s take a hypothetical 1,000,000 square foot building. A 300,000 square foot tenant in the building has extensive signage on the exterior of the building and in the lobby. A prospective 400,000 square foot tenant comes along that happens to be a competitor of the 300,000 square foot tenant, and says to the landlord: Look, I don t need to be a pig, just give me exterior and lobby signage that is equally prominent to that of the smaller guy who got here first. The landlord replies: I m really sorry, but the smaller guy s lease prohibits me from giving you any exterior signage at all, and the best I can do is give you the right to 6

7 install a two square foot plaque with your name in the lobby at the entrance to the elevator bank in which you are leasing all of the space, but not in the elevator bank that services both you and the other guy. The 400,000 square foot tenant then says: Have a nice day. Conclusion When representing a large tenant with a significant amount of bargaining power, remember to consider whether there are leasing and/or signage restrictions that are required or desired by your client. When representing a landlord, remember to Just Say No or, at a minimum, fight tooth and nail to keep the restrictions at a level that will not come back to bite the client in the future. 7