Exclusive Use Provisions: Avoiding Common Pitfalls in Retail Lease Agreements

• Publication year: 2014
• Author: By Karla Kraft, David Keithly, and Kenneth Hsu

Exclusive Use Provisions: Avoiding Common Pitfalls in Retail Lease Agreements

By Karla Kraft, David Keithly, and Kenneth Hsu

©2014 All Rights Reserved.

I. INTRODUCTION

The world of retail is competitive. Competition for the same customers by established brands, new brick-and-mortar concepts, and the ubiquitous threat of online competition all make it increasingly difficult to maintain a successful, profitable retail business. We all are familiar with the headlines that periodically proclaim the demise of well-known national retail chains. To survive and succeed in this hyper-competitive world, retailers look for every possible advantage. Exclusive use provisions in retail leases provide one such advantage by limiting geographical competition between a tenant and its rivals.

From the retail tenant's perspective, exclusive use provisions are a tool to protect its investment and market share in a particular geographical area. Food service retailers in particular, including restaurants and grocery stores, face fierce competition and are constantly looking for ways to survive on thinner and thinner margins. As a result, retailers frequently request and rely upon exclusive use provisions in their leases to effectively eliminate nearby competitors. For example, the owner of a Del Taco franchise would not want to invest in a specific location, only to have a Taco Bell open up next door.

However, from a landlord's perspective, exclusive use provisions are an obstacle to filling spaces in a shopping center. Landlords likewise face fierce competition in attracting and retaining in-demand retailers who contribute to the diversity of dining, retail and shopping options and make their center attractive to customers. By granting an exclusive use provision, a landlord restricts its ability to lease to a similar business, even if, in the landlord's judgment, the two businesses would complement each other and not diminish each other's market share. Exclusive use provisions reduce a landlord's profits and may lead to vacancies - a result which is harmful to landlords and tenants alike. An exclusive use provision that is not precisely drafted is also likely to lead to disputes between the landlord and the tenant, and may even lead to litigation over whether a new tenant violates the provision.

New retail concepts add another layer of complexity to this equation. Restaurant concepts that seek to blend two or more categories of food potentially run afoul of exclusives granted to existing tenants, particularly if the exclusive was drafted years before a new concept emerged. Food trucks, for example, have become trendy and delicious in the last few years. A restaurateur may not have worried about a food truck parking at the center once a week ten years ago, but now could lose a significant percentage of its lunch traffic to the newest food truck concept that pulled into the parking lot. A previously drafted exclusive use provision may not encompass the food truck, or may be hopelessly ambiguous with regard to this new concept. As retailers increasingly seek to provide unique experiences to consumers—how about Mexican-Korean fusion, or Thai-Italian fusion for dinner tonight? —commonly used terms and existing exclusives become almost certainly vague and difficult to apply.

Bruxie, LLC is a good example of one such concept currently challenging existing definitions. Bruxie is a restaurant that offers "gourmet waffle sandwiches." Bruxie's menu includes both savory and sweet options that simultaneously inhabit the breakfast, sandwich, and dessert categories. This new concept begs the question: is a Bruxie "sandwich" a breakfast food, a traditional sandwich, or a dessert? In addition to creating fodder for cocktail party debate, the ambiguity presented by this and other new concepts also presents a unique challenge in drafting and enforcing exclusive use provisions.

Exclusive use negotiations often are reserved for leasing agents. However, in the atmosphere of heightened retail competition and new concepts, counsel should be involved at an early stage in drafting exclusive use provisions, and must be aware of potential pitfalls to insulate their clients from the risks that result from imprecise drafting. Despite their competing interests, retail landlords and tenants can both benefit from more precise exclusive use provisions that specifically detail both parties' expectations and eliminate ambiguities that lead to strained relationships, uncertainty, and ultimately disputes and litigation.

II. EXCLUSIVE USE PROVISIONS

A tenant generally has the right to use the leased premises for any lawful purpose without interference from the landlord unless the use is prohibited by law, results in waste or destruction of the premises, or is forbidden by an express or necessarily implied provision of the lease.¹ Landlords can expressly restrict a tenant's use of the premises in two ways—through permitted use provisions or through exclusive use provisions.

Permitted use provisions detail for what purpose a tenant may use the leased property in precise terms.² For example, a landlord leasing a large restaurant space may require that the tenant use and occupy the property only for "general food services and dining purposes." This prevents a sudden, unacceptable change in the type of business occupying the space, so that the landlord does not unexpectedly find the restaurant has become, say, a gym or a computer retailer. Use provisions are a first line of defense in allowing landlords to control the mix of retail experiences within their centers.

While permitted use provisions benefit the landlord, exclusive use provisions, or "exclusives," benefit the tenant. Exclusives are restrictive covenants of the landlord written into a lease for the benefit of the tenant that prohibit the purposes for which the landlord or other tenants may use their leased premises. For example, a landlord may grant a tenant the exclusive right to sell "delicatessen or submarine type sandwiches"³ or "insurance and insurance-related products."⁴ Such exclusives restrict the landlord's ability to rent to future tenants seeking to engage in the activities detailed in the exclusive use provision. Under California law, use restrictions are valid and enforceable so long as they are reasonable.⁵

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There are two categories of violations of exclusives: violations by landlords and violations by other tenants. Landlords have a duty to uphold and enforce exclusive use provisions.⁶ Thus, if a landlord and a new tenant enter into a lease that breaches an existing tenant's exclusive, the landlord is liable to both tenants. Under California law,⁷ if the landlord is directly at fault for such a breach, it is not entitled to a reasonable opportunity to correct the breach.⁸ Another tenant can be liable for violating an exclusive if it infringes upon an existing tenant's provision. In these cases, the landlord is only indirectly at fault for the breach, and is entitled to reasonable notice and time sufficient to try to correct the breach.⁹

Courts generally construe exclusive use provisions broadly.¹⁰ In addition, the implied covenant of good faith and fair dealing, which is implied in every contract, also applies to exclusive use provisions.¹¹ If a violation is found, remedies for the breach of an exclusive include rent abatement, money damages (including lost profits),¹² and excuse from further performance under the lease (including non-payment of rent).¹³ In determining the amount of any award, the calculation must be based upon "unspeculative" evidence showing "with reasonable certainty both [the] occurrence and extent" of the lost profits.¹⁴ In addition, California courts may award injunction relief to prevent interference with contractual relations.¹⁵ When a landlord attempts to lease to a tenant who will violate an exclusive, the tenant who holds the exclusive may seek injunctive relief.¹⁶

III. RECENT CALIFORNIA CASES

California state courts apply general principles of contract interpretation to interpret and enforce exclusive use provisions.¹⁷ Thus, if a tenant wishes to prevent a landlord from leasing to a competitor on the grounds of an exclusive use provision, the terms of the provision must clearly restrict the landlord.¹⁸ Especially in recent years, courts have continued to rely first upon the plain language of the lease to determine the precise scope of the tenant's exclusive right. Pursuant to the parol evidence rule, courts typically refuse to consider oral or written extrinsic evidence to vary, alter, or add to the scope of the provision.¹⁹ Even when such extrinsic evidence is considered, the text of the provision remains the focal point for the courts' analyses. In sum, cases considering exclusive use provisions are very fact-specific, and closely analyze the language of the provision at issue. An overview of pertinent California case law therefore is helpful.

In City Best Insurance Services, Inc. v. Corona Town Center, LLC,²⁰ for instance, the Court of Appeal for the Fourth Appellate District found a shopping center that leased to an insurer did not breach the express terms of the lease's exclusive use provision when another tenant, a supermarket, began subleasing 100 square feet of its space to a competing insurer. The court focused on the plain language of the provision: "[The shopping center] shall not execute and deliver any lease for space in the Project pursuant to which [the center] authorizes the use of the premises demised by said lease primarily for the sale of insurance and insurance-related products (the 'Exclusive Use')."²¹ The provision also did not apply to any portion of the shopping center "the use of which is not controlled by [the center] as of the date of the Lease."²²

The court of appeal affirmed the trial court's finding that the supermarket's sublease fell directly within this exception because the center technically did not "control" the use of the subleased space.²...