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Commercial Law Contracts Litigation

Challenges in Drafting a Restaurant Exclusive Use Clause

The reasonable and typical middle ground in the struggle between the parties regarding the scope of the "exclusive" is to protect only a tenant's "core" or "primary" business. Using such an approach, if properly drafted, will allow the tenant to avoid the two-coffee-shop situation, but will still permit the landlord to lease to multiple tenants with overlapping but not fundamentally competing uses.

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An exclusive use clause is one of the most important and heavily negotiated business issues in a shopping center lease, and therefore, it is usually negotiated by the principals or brokers in the letter of intent. In a typical shopping center lease, the tenant has committed to invest considerable sums to open its store, and expects to be able to recover such sums and earn additional profit based upon projections at that store. These projections are often built upon the anticipated demand for the tenant’s product in the particular location, and the location’s ability to support the demand.

Profit margins for retailers can be quite thin, particularly for restaurants and food-service tenants. Consequently, a restaurant tenant will contend that adding additional restaurants with overlapping cuisines or products could severely infringe upon its profits, thereby changing the tenant’s projections and the economics of the deal. The tenant, therefore, seeks to include broad, exclusive-use protection to preclude such overlapping and to afford the tenant the most likely path to success, which success benefits both the landlord and the tenant. Such protection, the tenant will argue, is baked into the rent as consideration for the deal.

Conversely, the landlord will likely resist granting an exclusive use right or seek to narrow the scope of an exclusive use clause so as to limit impediments to leasing and provide objective guidance for future tenancies. The landlord will argue that the rent is consideration for the opportunity to be located in the shopping center, and that the landlord should not bear the burden of the tenant’s fear of competition. If the tenant’s product is good enough and properly priced, the other tenants in the shopping center should be irrelevant.

Just as the tenant must rely on a customer base to support its business, the landlord must rely on rent stream from leases. Any restriction on use imposed by the tenant will necessarily limit the pool of tenants from whom the landlord can collect rent, and may ultimately result in dark space and a devalued and less desirable shopping environment, which scenario benefits neither the landlord nor the tenant.

The reasonable and typical middle ground in the struggle between the parties regarding the scope of the “exclusive” is to protect only a tenant’s “core” or “primary” business. Using such an approach, if properly drafted, will allow the tenant to avoid the two-coffee-shop situation, but will still permit the landlord to lease to multiple tenants with overlapping but not fundamentally competing uses.

Floor Area

Restaurants create a unique problem in drafting exclusive use clauses due to the difficulty in defining a tenant’s primary use in an objectively measureable way. In a typical retailer’s store, the tenant will allocate certain floor space in its store to various products. A pet store, for example, should be able to protect its primary business by limiting the area permitted to be used in another tenant’s store for sale and display of pet supplies to a specified percentage, or amount, of square footage. Unlike most retailers, a restaurant does not have the luxury of using floor area as a test for primary use. If a restaurant serves hamburgers — even if it is one of many dishes offered — hamburgers will be served in potentially 100% of the restaurant’s floor area.

Gross Sales

With floor area being a less useful test for restaurants, many restaurant leases use a percentage of gross sales to determine a restaurant’s primary use. A test based upon percentage of gross sales, however, has its own deficiencies. First, many restaurants will not report gross sales per company policy, claiming that such sales are proprietary and disclosures thereof could affect a tenant’s business. Additionally, even if a restaurant will agree to report sales, many will not be able to break down sales reports in a manner that entirely segregates the gross sales of the restricted items. Second, the time period during which gross sales are assessed can create issues. Using annual gross sales may require an aggrieved tenant to suffer for an entire year before its remedy is ripe. Such a lengthy time period would also deprive the landlord of being able to cure the violation, as the aggrieved tenant will not likely want to afford landlord another year of bleeding without recourse. Third, a tenant subject to a restriction based on annual gross sales may have difficulty ceasing the sale of a specific menu item if the sales of such item approach the maximum threshold near the end of a year.

While using a shorter period of time, such as a three-month measuring period, will allow the landlord and the violating tenant a practical period of time to cure the exclusive-use violation, it is not often a true test of a competing or violating use. Restaurants typically introduce new menu items or promote existing menu items based upon seasonal popularity. If the menu modification falls within the shorter measuring period, the test may not fully address the concerns of the parties.

Menu Items

Because of the pitfalls of measuring floor area and gross sales as possible tests for determining the primary use of a restaurant, landlords and tenants will often turn to the restaurant’s menu to characterize a core cuisine. Menu items can provide guidance to a consumer (and therefore to a landlord or prospective tenant) as to the primary business of a restaurant. If a substantial portion of a restaurant’s menu is not comprised of Italian cuisine, the restaurant is not likely to be deemed to be an Italian restaurant. However, assigning a maximum percentage of core cuisine items to the menu does not conclude the drafting. The percentage must be negotiated in light of the size and nature of the menu, and the protected cuisine. A restaurant’s menu may contain sides, appetizers, beverages, entrees and desserts. Some of these categories should be excluded from the calculation of a percentage of a menu’s items, as they are not generally reflective of the primary type of cuisine being served. Entrée items are most likely to define the restaurant’s primary cuisine; a percentage of entrée menu items, therefore, is the most accurate measurement to use.

Tying an exclusive-use restriction to a percentage of entrée menu items also has its challenges. Using the hamburger example above, a restaurant may have only one entrée item for a hamburger, but may provide multiple options for condiments and other variations under the same menu entry. Pizza is an even better example as to how exclusive-use provisions based on menu items may contain traps. An Italian restaurant or pizza and sub shop may only have one menu item listing pizza, but may have many toppings available, thereby hundreds or thousands of potential orders. The parties must make sure that these possible variations are addressed (whether included or excluded) in determining a percentage of menu items.

Although assessing menu items is a more objective and practical approach than using floor area or a percentage of sales in determining a restaurant’s primary use, a clever tenant could tinker with its menu by adding unpopular entrée items or creating subcategories of items to circumvent the exclusive use clause.

Types of Restaurants; Cuisine; Examples

Defining the types of restaurants and offering examples can also be an effective tool in clarifying the scope of a restaurant’s exclusive use. Merriam Webster’s Dictionary defines a restaurant as a business establishment where meals or refreshments may be purchased. “Restaurant.” Merriam-Webster.com. Merriam-Webster, n.d. Web. 6 Feb. 2017. By definition then, an exclusive use clause for a restaurant could apply to grocery stores, convenience stores, pharmacies, dollar stores or primarily take-out food establishments such as coffee, beverage or dessert stores. While individual restaurants are all unique, they can usually be placed into one of three categories: 1) full-service restaurants (where orders are taken from, and delivered to, seated customers); 2) fast-casual restaurants (where orders are taken from customers at a counter and are delivered to customers at the counter or brought to seated customers); and 3) quick-service or take-out specialty restaurants (where seating is either nonexistent or very limited), such as coffee, cookie, candy, blended beverages, ice cream and other dessert stores. Even though there are many variations within these categories that may warrant additional defining characteristics (such as types of tableware, furniture, drive-thru or counter service volume, etc.), many restaurant operators in one of these three categories may feel that restaurants in the other categories will not infringe upon their businesses.

An exclusive-use clause for a particular type of ethnic cuisine can also cause unintended consequences, and the parties should be as specific as possible as to the cuisine that is to be protected. As an example, Mediterranean cuisine describes food from many different countries, only some of which overlap. Likewise, “Asian-Fusion” restaurants have become very popular, but Japanese, Chinese and Mongolian food can be entirely different cuisines. The parties should address the specific cuisine that is sought to be protected in any exclusive use provision. Listing particular food items or restaurant examples, whether they are examples of items or restaurants that are included within the scope of the exclusive use provision or are not included within the scope of the exclusive use provision, can also lend to the objectivity of the clause.

Combining Tests

Consumers will likely be able to identify a particular type of restaurant using Justice Potter Stewart’s definition of pornography: “I know it when I see it” (Jacobellis v. Ohio, 378 U.S. 184, 197 (1964)). But drafting an unambiguous exclusive use clause that enables the parties to administer it requires additional clarification. A hybrid approach in which several factors are considered to determine a primary use may be the best way to diminish ambiguity while still providing protection for the tenant.

Essentially, the ambiguity inherent in each factor becomes less ambiguous when multiple factors are used. Revisiting our hamburger restaurant hypothetical, the following is an example of how combining the above factors can help satisfy the concerns of each party in an exclusive use provision:

Landlord covenants that it will not lease any premises in the Shopping Center to a fast casual restaurant (where orders are taken from customers at a counter and are delivered to customers at the counter or brought to seated customers) whose primary use is the sale of beef hamburgers (“Hamburger Restaurant”). “Primary Use”, for the purpose of this Section shall mean that (a) more than twenty percent (20%) of a tenant’s main-course menu items (expressly excluding side dishes, appetizers, desserts and beverages) are beef hamburgers, (b) beef hamburgers constitute more than twenty percent (20%) of a tenant’s gross sales over a three (3) full calendar month period, (c) the sale of hamburgers is a general theme of such restaurant in terms of décor, trade name or public identification. Each condiment or topping on a hamburger or a combination of such condiments or toppings shall not be deemed to create a separate menu item. Each condiment or topping on a hamburger or a combination of such condiments or toppings shall not be deemed to create a separate menu item. Examples of a Hamburger Restaurant include ________________________ (fill in the blank).

***** Stephen Levey (slevey@hsphlaw.com), a member of this newsletter’s Board of Editors, is a principal at the law firm of Hirschel Savitz Parker & Hollman P.C. in Gaithersburg, MD, where he primarily represents developers in anchor leases and mixed-use projects.

The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.

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