Shopping Center Exclusives: Avoiding Unintended Consequences

By David P. Kassoy and Nicolas M. Kublicki*

An exclusive use clause (“Exclusive”) is a powerful incentive for shopping center landlords to attract specialty tenants. An Exclusive may grant to and impose on a tenant a variety of rights and restrictions. Typically, an Exclusive gives a tenant the exclusive right to sell certain products or services in the shopping center, thereby inducing the tenant to make an investment in its business that might not otherwise be justified in an unregulated competitive environment. To avoid unintended consequences, however, landlords would be well advised to limit the scope both of the Exclusives and of tenant remedies for alleged violations.

1. Anchor Tenants, Other Existing Tenants, Future Major Retailers

The Landlord is unlikely to have leverage to impose restrictions on what anchor tenants may sell and cannot impose any restrictions on existing tenants retroactively. The Exclusive should exclude anchor tenants, existing tenants whose rights could conflict with the Exclusive, and future large retailers.

With the exception of (i) existing tenancies in the Center as of the date hereof, but only to the extent that they already have the right to do so, or (ii) future tenants occupying ________ sq. ft. or more under a single trade name at any time, or (iii) so-called anchor tenants or any occupant of a building located on land leased to or owned by any of such anchor tenants, Landlord agrees not to rent, lease or allow the use of any space in the Center by any person, business or entity whose principal business is the retail sale of______________ (“Exclusive”).

2. Principal Business

Exclusives based on a percentage of gross sales require frequent audits and are difficult to regulate. It is preferable to express the restriction in terms of maximum floor area, which facilitates enforcement and provides greater flexibility in negotiating leases with other tenants.

The term “principal business” shall mean being engaged primarily in the retail sale of _________________ or, even incidentally, if one is utilizing more than 10% of the gross leasable sales area in the premises (or 500 square feet thereof, whichever is greater) for display of _________________________.

3. Laws Relating to Restraints on Competition.

The more an Exclusive restricts use and geographic scope, the greater the risk that it will conflict with laws relating to restraints on competition. The landlord should insist that the risk of “unenforceability” remain with the tenant. If the Exclusive is challenged, the lease should not terminate, but should continue with the tenant having the choice of waiving its Exclusive or, alternatively, indemnifying the landlord against any damages.

Tenant acknowledges that (i) the Exclusive could in the future come under scrutiny by the Federal Trade Commission and/or various state and local governmental agencies, or (ii) by another existing tenant or prospective tenant claiming or alleging violation of federal or state antitrust statutes, discrimination or unfair business practices. If Landlord receives from any federal or state or local governmental agency written notice of any enforcement proceeding or threatened litigation, commenced or to be commenced by such an agency with regard to Tenant’s Exclusive, or if Landlord receives a communication from a tenant or prospective tenant threatening that litigation will be or has been filed with regard to the enforcement or protection by Landlord of Tenant’s Exclusive, Landlord shall give Tenant written notice thereof, after which Tenant shall have ten (10) days in which to elect either (i) to waive the Exclusive which is the subject of such proceedings, litigation or threat of litigation, or (ii) to decline to waive the Exclusive and to require Landlord to continue to defend and enforce the Exclusive, in which event Tenant shall defend, indemnify and hold Landlord harmless from and against any and all liabilities, damages, penalties, claims and expenses, including Landlord’s actual attorneys’ fees and costs, in connection with any proceeding or litigation so threatened or that may arise from Landlord’s honoring the terms of the Exclusive. Failure by Tenant to give a timely written undertaking (in a form reasonably satisfactory to Landlord’s attorney) to defend, indemnify and hold Landlord harmless, shall be deemed an election by Tenant to waive the Exclusive in each instance. If Tenant elects to waive its Exclusive as hereinabove described, such waiver shall extend only to the threatened governmental proceeding or litigation, or to the particular other tenant or prospective tenant of the Center, as the case may be, and only to the particular items which are the subject of the claims of such governmental agency, tenant or prospective tenant, as the case may be, it being the intention of the parties that any such waiver shall be narrowly construed.

4. Tenant Remedy for Third Party Violation of its Exclusive

If the landlord fails to enforce an Exclusive against another tenant in the shopping center, the tenant entitled to the Exclusive may have the right to terminate its lease or to seek injunctive relief and/or monetary damages against the landlord. However, the exercise of such broad remedies may be proscribed without diluting the objective of the tenant’s Exclusive.

If Tenant contends that its Exclusive is being violated, Landlord agrees that, unless Tenant waives its Exclusive hereunder, and provided Tenant acknowledges its indemnification obligations (but only if required as provided below), Tenant’s remedy shall be as follows: Tenant shall deliver to landlord written notice of the violation of Tenant’s Exclusive by another tenant in the Center (“Violation Notice”). Landlord shall then have a period of sixty (60) days in which to commence good faith efforts to cause the cessation of such violation by such other tenant. If Landlord fails to commence a good faith effort to cause the cessation of such violation within sixty (60) days or to cause such violation to cease within one hundred twenty (120) days of Landlord’s receipt of the Violation Notice, Tenant shall be entitled to pursue the termination of such violation by such other tenant at Landlord’s expense (except as provided below) and to collect from Landlord Tenant’s reasonable out-of-pocket expenses associated therewith. Notwithstanding the foregoing, Tenant shall not be entitled to reimbursement from Landlord for the cost of contesting a violation of its Exclusive or any other remedy against Landlord, if: (i) another tenant or occupant in the Center violates a provision of its lease or license agreement regarding its premises, which either does not permit or specifically prohibits a use that violates tenant’s Exclusive hereunder, (ii) Landlord provides timely notice of the lease or license agreement violation to such other tenant or occupant, and (iii) Landlord offers to commence an action (or arbitration, if required by such lease or license agreement) against such other tenant or occupant, and to make a good faith effort to enforce its rights under such lease or license agreement and to obtain judicial relief (without being required to appeal any adverse decision) subject to Tenant’s timely undertaking (in form satisfactory to Landlord’s attorney) to reimburse Landlord for the reasonable enforcement costs actually incurred.

5. Tenant’s Remedy for Alleged Violation by Landlord

If the landlord violates a tenant’s Exclusive by entering into a lease with another tenant, that allegedly permits it to violate the Exclusive, the landlord may nonetheless reserve an opportunity to cure a conflict with the Exclusive. Even if the landlord fails to cancel or amend the violative lease, it may be appropriate to postpone the lease termination right and limit the tenant’s initial remedy to suspending the payment of minimum or base rent, while still being required to pay percentage rent on all sales and all other normally recoverable expenses.

If Landlord violates Tenant’s Exclusive by entering into a lease or other occupancy agreement, or by amending an existing lease or occupancy agreement, which allows another tenant in the Center to exceed the square footage restriction described above, or Landlord is otherwise deemed to be materially in violation of its obligations hereunder, Tenant’s exclusive remedy shall be as follows: Upon Tenant’s determination that Landlord has so violated its Exclusive, Tenant shall deliver to Landlord a Violation Notice. [SAME 60 DAY RIGHT TO CURE AS IN SECTION 4] If Landlord has not so cured the violations of its obligations hereunder, Tenant shall be entitled to suspend the payment of base or minimum monthly rent and, in lieu thereof, to pay only percentage rent on all sales, common area maintenance costs, taxes, insurance, and other recoverable expenses, if any, for so long thereafter as neither of the above-referenced remedies have been effected or the violation of its obligations hereunder by Landlord has not been cured. If said violation continues for one hundred eighty (180) days after the expiration of said 60-day period, then, in addition to not paying base or minimum monthly rent, Tenant shall also have the right, but not the obligation, to terminate this Lease upon ninety (90) days written notice to Landlord and, only upon such termination, to pursue its remedies at law for compensatory damages as a consequence of Landlord having violated its obligation hereunder. Such termination right shall expire if not exercised within one (1) year after the expiration of said 60-day period.

6. Waiver of Exclusive Upon Exercise of Option After Violation

Tenants are under no compulsion to exercise options to extend their leases. The landlord may insist that the tenant be deemed to have waived its Exclusive if the tenant exercises its option to extend or renew the lease after delivering a violation notice to the landlord.

Notwithstanding any other provisions in this Lease to the contrary, if Tenant knowingly exercises an option to extend or renew this Lease pursuant to Section ____ at any time after Tenant has given Landlord a Violation Notice, then Tenant shall be deemed to have waived its rights and remedies available under this Article including, without limitation, Tenant’s right to terminate this lease or Tenant’s right to pay percentage rent in lieu of base or minimum monthly rent, as provided above.

7. Inapplicability of Electronic Sales

Advances in technology may enable a retail tenant to offer customers its own branded merchandise not available or permitted at its store. To avoid potential violations of another tenant’s Exclusive, the landlord should limit the Exclusive’s scope by allowing the purchase of excluded products (i) by another tenant’s customers from its own branded offsite source and (ii) from another tenant by an offsite customer through the internet, the telephone, or other electronic means.

No other tenant in the Center shall be deemed to be in violation of Tenant’s Exclusive due (i) to the presence in such other tenant’s premises of an internet, telephonic or electronic ordering terminal whereby such other Tenant’s customers may order otherwise excluded merchandise from an off-premises supply source, provided that the electronic ordering process from such terminal is direct to that other tenant’s own branded internet or ordering site and does not provide direct access to sites or ordering programs for any other merchandise sellers or (ii) to the purchase from such other tenant’s premises of otherwise excluded merchandise by off-premises customers through the internet, by telephone, or by any other electronic means, in either case provided that the principal business conducted in that other tenant’s premises is not in violation of the Exclusive.

9. Bankruptcy

A tenant’s reorganization under Chapter XI may expand the use clause in its lease to the detriment of another tenant’s Exclusive. Landlords have little or no ability to prevent this and should protect themselves against liability to a tenant whose Exclusive may be so violated.

If Landlord receives a written notice of a bankruptcy proceeding for the approval of a lease assignment or sublease by a trustee or a debtor in possession that would allow a use in the Center that may be in violation of the Exclusive, Landlord shall give Tenant a written notice [SAME NOTICE PROVISION AS SECTION 3] If tenant does not waive the Exclusive and requires Landlord to appear in the bankruptcy proceeding to oppose the approval of the assignment or sublease, it must first agree to indemnify Landlord for the costs of such proceedings, including Landlord’s actual legal fees and expenses. Tenant shall have no remedy against Landlord for a violation of the Exclusive as a consequence of such an assignment or sublease if Landlord did not receive a written notice of such bankruptcy proceeding or, after receipt of such notice Landlord makes a good faith effort to oppose the approval of a lease assignment or sublease by a trustee or debtor in possession that may be in violation of the Exclusive, but is unsuccessful. Landlord shall not be required to appeal the decision of a bankruptcy judge. Tenant’s failure to timely respond to Landlord’s written notice in any of the circumstances described above shall be deemed Tenant’s election to waive the Exclusive in that instance.

Landlords cognizant of the foregoing issues can grant Exclusives to encourage tenants to invest in specialty businesses with a measure of security, and still protect themselves from painful unintended consequences and disproportionate risks.

* David P. Kassoy is a senior partner and Nicolas M. Kublicki is a senior associate in the Real Estate Department of Ervin Cohen & Jessup LLP in Beverly Hills, California. Their areas of practice include the representation of landlords, tenants, and lenders in complex commercial leasing transactions.

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