Episode #5 Key restaurant lease terms every tenant must consider

SUMMARY OF KEY RESTAURANT LEASE TERMS

1. Business plan
   • How many pizzas are you capable of making in a day?
   • How many pizzas do you need to sell to break even?
   • What is your construction and buildout budget?
   • What is your operating budget and estimated operating costs (including CAM, taxes, insurance, percentage rent, permit and license fees, etc.)? Should be <30% of anticipated gross sales.
   • How much are utilities each year (be sure to compare to similar restaurant in area, rather than other type of commercial T)?
2. Permitting and licensing
   • Issue: T cannot obtain permits, licenses, etc. to operate
   • Terms: Right to terminate that includes the following:
     • T must diligently pursue within reasonable contingency period
     • Identify each necessary permit, license, approval
     • LL has right to pursue permits if T unable
     • Termination fee (usually includes out-of-pocket costs to lease to T, such as brokerage commissions, etc.)
3. Delay in Delivery of Possession
   • Issue: LL doesn’t complete work on time or holdover T won’t leave
   • Terms:
     • Delay rent commencement until after punch list completed and possession delivered.
     • Require LL to evict holdover T
     • Termination right after reasonable time
4. Build-out, improvements, FFE
   • Issue: What needs to be done? Who does what? Who pays for what? Who gets to keep what at end of lease term?
   • Terms:
     • Due diligence before and after LOI. Consult professionals to draft construction plan and budget.
     • Exchange and approval of T’s and LL’s Plans. Specify process, timelines, deadlines, scope and standards.
     • Build-Out Scope & Cost.
       • Who is responsible for what? LL deliver in Vanilla Box/Shell? How many outlets needed?
       • Cost of build-out; T Allowance.
         • T Allowance – capped at $/sq. ft.
         • Split – LL will likely demand a cap on its costs if splitting with T. Make sure cap is reasonable and large enough to include any structural, roof, shared space improvements. 
     • Signage. What will LL approve/allow? Does T have franchise agreement requirements?
       • Common issues: Bowflags, signs secured to roof or face of building, pylon signage, lighting and maintenance of signage.
     • HVAC/grease trap. Specify who will be responsible for installation and maintenance. If LL installs, LL should warrant it. If it runs up to roof, LL may prefer to install & maintain and pass costs on to T(s). LL may require preventative maintenance contract for HVAC service.
     • Utilities. Items to flush out:
       • Separately metered?
       • Tap-in/connection fees – place on LL, if possible
       • Who will be responsible for bringing utilities to the premises? If it’s a large enough job, it should be LL’s responsibility.
       • Specify in LOI utilities that must be in premises upon Delivery of Possession (e.g., retail electricity use 200 amp vs restaurant use 1200 amp)
       • Is an easement required to install/maintain utilities?
     • FFE & Removal.
       • Identify what will remain property of T, what becomes property of LL, what must be removed at end of lease term, etc.
       • T responsible for any damages caused during removal.
     • LL’s lien. Negotiate out of or compromise by subordinating LL’s lien to any other liens if T’s FFE are financed.
5. Maintenance
   • Issue: restaurant has special maintenance considerations
   • Terms:
     • Shared equipment/services. LL should maintain, pass costs to Ts based on proportionate share or usage, as restaurant Ts produce more trash, require more frequent HVAC cleaning, etc. than other commercial Ts.
     • Single-user equipment/services. T should maintain, unless LL better equipped to do so and pass costs to T.
       1. Preventative maintenance contract maintained by T
     • Dumpsters and used oil storage. Restaurants make more trash and require refuse for used oil. LLs require trash to remain in designated areas. T must ensure enough dumpsters and in convenient location for frequent and late runs to dumpsters. 
     • Pest control.
6. CAM Expenses
   • Issue: LL wants to include everything and increase annually without limit.
   • Terms:
     • Comparable estimated costs. During LOI stage, as part of due diligence.  
     • Limit definition of CAM by excluding the following:
       •  costs of sale, financing, refinancing, mortgaging, selling or change of ownership of the building or improvements;
       • moving expenses of other Ts;
       • any costs, fines or penalties due to LL’s violation of law, code, ordinance, etc.;
       • interest portion of capitalized leases;
       • cost of repairs caused by LL’s negligence or intentional misconduct;
       • amortization of mortgages;
       • depreciation of the property;
       • leasing commissions or legal expenses from lease negotiations;
       • costs arising from the presence or removal of any hazardous or toxic wastes, materials, or substances (can limit by excluding costs caused by T, in which case T shall be responsible);
       • LL’s personal property or income taxes;
       • percentage rent;
       • promotional charges;
       • merchants’ association dues; and
       • capital expenses. 
     • Non-cumulative cap on the annual increase of 3-5%.
7. Percentage Rent
   • Issue: LL wants to collect a percentage of annual gross revenues over a certain threshold.
   • Terms:
     • Negotiate out, if possible.
     • Exclude as much as possible from “gross sales/revenues” definition, including:
       • Any items that produce little or no profit
       • Amounts T does not actually keep (e.g., sales taxes paid by T directly to the government, refunds);
       • Amounts earned from incidental or ancillary services
8. Gross Sales Termination
   • Issue: T’s gross sales are so poor that T is struggling to operate or pay rent
   • Terms: T can terminate the lease if annual gross sales below a certain threshold.
     • Items to negotiate:
       • Threshold amount
       • Period during which T’s gross sales are measured. T wants it earlier (so that T can terminate sooner), LL wants it later
       • Termination fee. Made up of several months’ rent, unamortized brokerage commissions and build-out costs
9. Permitted Use.
   • Issue: LL wants to control T mix and prevent T from switching to an undesirable business or violating another T’s exclusivity clause
   • Terms: T should negotiate to make this provision as broad as possible.
     • Compromise as follows:
       1. T agrees not to violate exclusivity clauses of other leases
       1. Incidentals are permitted
       1. Limit square footage allocated to or gross revenues received from a broader use outside of the permitted use
     • Example: Starbucks selling coffee-related merchandise and music in a shopping center with other big box or music stores selling the same.
10. Exclusivity
    • Issue: competing business opens in shopping center, threatening success of T’s restaurant
    • Terms: Prohibit LL from leasing to a competing business within the shopping center. Negotiate the following items:
      • Definition of “Exclusive Use.” Identify the type of restaurant and food
        1. E.g., Panera’s lease prohibits other Ts from selling sandwiches, but does not define a sandwich. Qdoba opens up, the court holds burritos and tacos are not within the common definition of “sandwich” and thus LL did not violate Exclusivity provision by leasing to Qdoba.
      • To whom it applies. Future Ts, those with a nominal percentage of square footage and/or revenues from exclusive use
      • LL’s duties to enforce. Balance with LL’s desire to keep Ts
      • T’s remedies. Liquidated damages, termination (compromise by contingent on low gross sales), rent abatement
      • When exclusivity right is terminated. E.g., T assigns lease
11. Guaranty
    • Issue: T is new business, or finances not strong, etc. and LL requires business owners to personally guaranty lease
    • Terms: Limit with the following provisions:
      • Guaranty terminates after certain time if T does not default beyond cure period
      • Limit the amount of money guarantor can be liable for (e.g., so many months of rent or damage to building up to dollar amount)
      • Offer greater security deposit or pre-paid rent
12. Security Deposit
    • Issue: LL requires T to pay deposit equal to one or two months’ in addition to first month’s rent before business even open
    • Term: The Security deposit is applied to rent after a certain time if T does not default beyond any cure periods