The realities of retail tenancy, according to Mason Sier Turnbull

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As many franchisors and franchisees have learned, shopping centre owners and their landlords rarely negotiate changes to the leases they offer prospective tenants. Because they have the upper hand, leases are usually offered on a 'take it or leave it' basis, with owners or landlords making changes only to incorporate agreed commercial terms. Making concessions or offering special conditions is not the norm.

Even a big name franchisor has its hands tied, to some degree, about where it will be allowed to locate a franchised business because centres are typically divided into precincts. However, if the franchisor has a number of leases in a variety of shopping centres that have the same landlord, it and its franchisees are often in a better bargaining position when it comes to leave negotiations. In fact, many franchisors have been able to negotiate standard national terms with their shopping centre landlords.

At some point, either the franchisor or the franchisee will be required to sign a leases to obtain the right to occupy the premises. In franchising, the starting point for negotiating a lease is to ask 'who is to be the tenant?' The decision as to who will hold the lease is usually made by the franchisor. In franchising, the most common property holding options are:
- The franchisor holds the lease and grants the franchisee a licence to use or occupy the premises
- The franchisor holds the lease and enters into a sublease with the franchisee; or
- The franchisee holds the lease

If the franchisor is to hold the lease but the franchisee is to occupy the premises, either under a licence (contained in the franchise agreement or in a separate licence agreement or a sublease, the landlord's consent to such occupancy will be required.

Most leases contain provisions requiring the landlord's consent before a sublease or licence is granted to a third party. In most cases, the lease will set out a process for obtaining such consent. This usually required the sub-tenant or licensee to provide financial information and references about its financial and business experience.

In the franchise context, and to avoid the need to go through such processes, the franchisor should try to negotiate a clause that allows it to grant a sublease or licence to its approved franchisee. Most shopping centre landlords have standard clauses to this effect, which deal with franchising and streamline the whole process of obtaining a landlord's consent. These clauses should allow the franchisee (on the franchisor tenant's behalf) to make all payments to the landlord and provide the landlord with any security deposit or bank guarantee required by the lease.

If the franchisee is to hold the lease, the franchisor should consider entering into a separate agreement or negotiating into the lease itself provisions about transferring or assigning the lease to the franchisor (if the franchisor so requires) when the franchise agreement terminates. If this is not done, a franchisor wishing to maintain a presence in the shopping centre after its franchisee's franchise agreement has ended could find itself without premises because the lease is held by the franchisee.

Key terms to watch out for in shopping centre leases
The commercial terms of the lease are the terms that are specific to each lease. These include the term (length) of the lease, further terms, the rent and other amounts payable under the lease, and rent reviews. Those franchisors that control the leasing process generally have teams of staff devoted to negotiating the commercial terms of each lease. The commercial terms are the terms that provide the most scope for negotiation.

The term
The term of the lease is an important consideration in the franchising context. Ideally, the term of the franchise agreement and the term of the lease should be identical. However, this rarely happens because shopping centre landlords prefer not to offer retail tenants leases longer than five to seven years. Nor do they usually offer further terms or options. Accordingly, franchise agreements will either provide for an initial term that either exceeds the term of the lease or for options to renew, which go beyond the term of the lease.

Payments
The amounts payable under a shopping centre lease are also important. These typically include:
- The rent
- Percentage rent or rent based on turnover
- A marketing or promotional contribution, again based on turnover
- An opening promotion contribution, which is usually a one-off fee
- Contributions towards the premises' or centres' outgoings and operating expenses

Although negotiable, these terms can be difficult to negotiate because very little comparative information is available that would provide ammunition for debate. This lack of information is caused by many factors, including the fact that some tenants are bound by confidentiality undertakings in their leases and cannot divulge details of their leases.

However, in some states, leases have to be registered and this means that copies are readily available. When negotiating leases, the franchisor and franchisee should undertake their due diligence enquiries and try to obtain as much information as possible about the centre and the lease terms negotiated by other tenants.

Permitted use
The permitted use in shopping centre leases often requires considerable negotiation. Landlords generally want very precise descriptions of the permitted use and often wish to include the tenant's trading name in the description of permitted use.

The difficulty with such precise uses is that if a tenant later wants to get out of the lease (excluding the case where it is selling the business) and assign the lease to another party that trades under a different name and/or has a slightly different use, this may be impossible. If the use is to descriptive, it may also substantially limit the products and/or services that can be sold and changes to the product/service mix. A prudent tenant should try to negotiate a more general use and certainly one that does not contain its trading name.

Relocation and demolition clauses
These clauses are peculiar to shopping centre leases. Relocation clauses allow the landlord to relocate the tenant to another part of the centre when redevelopment work is proposed.

Although each state has retail legislation that prescribes some minimum relocation terms that will be implied into leases to which such legislation applies, these clauses require careful consideration. As a minimum, they should be amended to provide:
- Continuity of trade, otherwise the tenant could be ousted from a centre for a long period
- Rent for the new premises to be the same rent per square metre as the premises being vacated
- Premises of a similar size and in a similar position
- The landlord to pay the tenant's reasonable costs of relocation, including payment for fixtures fittings, plant and equipment that cannot be relocated, de-fit costs for the old premises, and legal costs associated with the new lease documents and the surrender of the old lease.

The demolition clause allows the landlord to terminate a lease (usually on six months notice) where there is a genuine demolition or redevelopment of the centre proposed that cannot be carried out without vacant possession of the leased premises. Again, many states have retail legislation that prescribes minimum terms to apply on demolition. However, some do not go far enough. Where possible, the demolition clause should be deleted and, if that is not possible, it should be negotiated to ensure the landlord pays compensation for the fit out and other costs.

Refurbishment/redecoration clauses
Where the term of the lease is five years or less with no option for a further term, tenants should resist the inclusion of such clauses.

Other peculiar clauses
Other clauses to watch out for and remove from the shopping centre leases are:
- Clauses that require the tenant to pay a penalty for failure to open. This is usually a dollar amount for reach hour that the premises are not open
- Clauses that require a payment to the landlord or the promotion fund if the lease is assigned within a certain period (although these are not often seen these days due to changes in retail legislation)
- Clauses that provide for a tenant to forfeit its fit out and property when the lease is terminated

Final thought...
Although all leases contain common provisions, there is no such thing as a standard lease. Accordingly, there is no substitute for reading the lease thoroughly and obtaining professional advice about what it says and what it means.

An accountant can provide advice about the financial commitments the lease entails. A lawyer can advise on the legal implications of signing the lease, and will also be able to explain the terms of the lease (highlighting any terms that are unusual or excessively onerous) and also negotiate changes.

A lease is a legally binding arrangement and is generally binding for a long period, usually a minimum of five years. If the lease is terminated by the landlord - for example, because the tenant has breached the lease in some way - this does not relieve the tenant of its legal obligations under the lease. In such circumstances, the tenant will still be liable to compensate the landlord up until the time the lease would have otherwise expired or until a new tenant is found.

This article appears courtesy of Mason Sier Turnbull .

3/10/2007

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