Protecting against Competition: Exclusive Use Clauses and Radius Restrictions in Commercial Leases

When drafting a commercial lease, both the landlord and the tenant should consider how future competition will affect the new lease. For the tenant, the concern typically is competition from third parties—the landlord may lease space in its shopping center to a new tenant that engages in the same or a similar business that will negatively impact the tenant’s sales. For example, if Home Depot leases space in a center, it would want to take proactive measures to ensure that, as long as Home Depot is operating in the center, the landlord will not also lease space to Lowe’s or any other home improvement store competitor. This may be accomplished by negotiating certain exclusivity rights into the lease.

The landlord’s competition concerns are slightly different. For example, in a lease where the tenant is paying percentage rent, that tenant’s sales (and, correspondingly, the percentage of those sales paid to the landlord as rent) likely would suffer if the tenant opens another store just down the street. The landlord’s interests are best served by including restrictions in the lease that would prevent the tenant from competing with itself.

Exclusive Use Provisions

What Is an Exclusive Use Provision?

Although many use provisions aim to limit the behavior of the tenant, an exclusive use provision is provided for the benefit of the tenant and limits the landlord’s ability to lease other space in the shopping center to a competitor or other business that may be undesirable, in the tenant’s view. For big-box anchor tenants, obtaining exclusive use rights is usually a prerequisite to the tenant’s agreeing to enter into lease negotiations for space in a particular shopping center. Because of the immense bargaining power, economic importance (including an influx of people coming to the shopping center), and expansive variety of products offered by major tenants, exclusive use provisions may need to include carveouts or exceptions to ensure that the exclusive is not too broad or overly restrictive for the landlord’s future leasing opportunities in the shopping center.

Exclusive use provisions also may give small business tenants the necessary protection to successfully conduct their operations. These businesses often have small margins or limited cash flow, and the emergence of a competitor within the same shopping center (especially a large, big-box competitor or national chain) may produce dire consequences, including rendering the tenant unable to generate sufficient sales to meet its rent obligations. Unfortunately for these smaller tenants, they frequently have less bargaining power in lease negotiations and often must concede on carveouts or limitations required by the landlord for any exclusive.

What Concerns Should a Landlord Have in Agreeing to Exclusive Use Provisions?

Granting any tenant exclusive use rights will restrict the pool of additional potential tenants for other spaces available in the landlord’s center. In most cases, however, landlords recognize that a successful shopping center should have a well-balanced mix of retail tenants. A good tenant mix attracts more customers to the center, bolsters the tenants’ financial stability, and increases the landlord’s percentage rental income. Rather than refusing to grant exclusive uses, most landlords will strive to ensure that any exclusive use granted is narrowly tailored to avoid unintended consequences. An exclusive use provision that is not carefully drafted may lead to confusion about what type of business is allowed or restricted. This, in turn, may lead to disputes over an alleged breach, including costly injunctive hearings and litigation.

For example, an unwary landlord leasing space to a cookie shop might agree to an exclusive use provision in the tenant’s lease restricting the landlord from leasing other space in the center for the sale of “baked goods.” That landlord may have expected the exclusive language to be narrowly interpreted to only prevent leases to other tenants primarily engaged in the sale of cookies. The cookie shop tenant would be well within its rights to claim—much to the unwary landlord’s surprise and chagrin—that its exclusive use has been violated even if the landlord signs a new lease with a bakery specializing in the sale of bread and breakfast pastries. The landlord would have been better served by negotiating exclusive use language that aligned directly with the tenant’s business and only restricted future leases to other cookie shops.

Similarly, landlords should ensure that reasonable restrictions and carveouts are included in any exclusive use clause. For example, it might appear reasonable for a coffee shop tenant to request an exclusive use clause prohibiting other tenants from engaging in the sale of coffee products; however, because most restaurants offer coffee on their menus, this exclusion may prohibit the landlord from entering into a future lease with any restaurant selling coffee. A better drafted exclusive use clause for a coffee shop tenant would limit future leasing to tenants engaged primarily or exclusively in the sale of coffee products (i.e., other coffee houses) or carve out sit-down restaurants that happen to offer coffee on their menus.

When drafting exclusive use provisions, landlords must also confirm that their pre-existing leases are protected from the new use restriction so as not to automatically trigger a breach of the new lease. This exclusion should also address the renewal of any of these pre-existing leases, the relocation of a tenant to a different building within the premises, and the replacement of a tenant in the case of a default.

How to Draft an Exclusive Use Clause?

Generally, there are three ways to draft exclusive use provisions.

First, an exclusive use provision may be drafted using a specific list of competitors to whom the landlord is restricted from leasing. This level of specificity ensures that the exclusive use provision is not subject to judicial scrutiny or considered too ambiguous, which could lead to it being interpreted more broadly or narrowly than the parties intended. The downside, however, is that any potential competitor not named in the list is likely “fair game” for the landlord to engage in negotiations for a new lease within the shopping center. Attorneys therefore should be as thorough as possible when drafting lists of named competitors.

An exclusive use provision may also include prohibited categories of business. This allows a broader range of businesses to be excluded, and tenants do not have to worry about a missed party in their descriptive list. Tenants and potential tenants, however, run the risk of the categories being too broad, creating ambiguity, and increasing the risk of litigation. Alternatively, the landlord runs the risk of excluding a much wider swath of potential future tenants.

Finally, parties may choose to draft an exclusive use provision by the “belt and suspenders” method. This strategy uses a combination of the specific list and prohibited categories methods to allow for both precision and broader protection. Because courts generally favor the unfettered and unrestricted use of real property, a provision that unreasonably or too thoroughly limits potential tenants or types of businesses may be invalidated by a court. To minimize this risk, parties should consider including a percent revenue requirement in the definition of prohibited categories when defining potential prohibited competitors or activities. Returning to the coffee shop example, if the tenant wishes to prohibit other coffee shops from leasing space in the shopping center (but not all restaurants that serve coffee), the exclusive may include a restriction that the landlord may not lease to any business that derives more than 15 percent of its revenue from the sale of coffee.

What Are Common Remedies in Exclusive Use Provisions?

Rent Abatement

One of the most common remedies for a violation of exclusive use provisions is the abatement of rent. Abatement occurs during the period that the restriction was breached. Rent may be diminished completely or by a set percentage. Additional rent such as common area maintenance (CAM) charges and real property taxes usually are not abated. Landlords often seek to include notice and cure provisions in the agreements to allow time to remedy the violation and avoid the rent abatement. Tenants should push back against this because a violation of an exclusive use clause produces immediate harm to the tenant’s business.

Termination

Also common in these provisions is the tenant’s ability to terminate the lease. This right is usually triggered if the violation continues for an extended period of time.

Liquidated Damages

The parties may set liquidated damages in the case of a breach by the landlord of an exclusive use restriction. This gives the landlord a predictable amount of liability yet ensures the tenant does not have to expend substantial resources in the difficult endeavor to prove lost profits.

Rogue Tenant Exceptions

The existence of exclusive use provisions may require the landlord to constantly monitor business activities of its tenants, both to ensure that the provision has not been violated and to ensure that the exclusive use tenant has not waived a potential claim to enforce the provision. To avoid this constant policing of all tenants’ activities, the landlord could include carveouts in the new lease for activities by “rogue tenants” (tenants who, without prior consent or without the landlord’s knowledge, start selling prohibited products or using their premises for prohibited uses). Specifically, the landlord can require that the tenant not pursue any remedies for exclusive use violations by rogue tenants as long as the landlord uses commercially reasonable efforts to cause the rogue tenant to cease violating the restrictions. If an exception for rogue tenants is included, the landlord need only attach to all future leases an exhibit listing all exclusive uses in the shopping center and include language in the lease restricting any tenant from violating such exclusive uses.

What Happens after the Exclusive Use Is Agreed Upon and the Lease Is Signed?

Once the tenant and landlord reach an agreement on the exclusive use language and the lease is executed, the tenant should ensure that the exclusive use language is included in its recorded memorandum of lease. Recording the restriction provides future tenants with constructive notice of the restrictions.

How Are Exclusive Use Provisions Waived?

Waiver often occurs when the tenant is not using the property as originally intended by its lease. At that point, the need for the exclusive use ceases. Inaction over a sufficient period of time may trigger this waiver. As good practice, landlords also should seek waivers whenever existing tenants change their business model where the new business concept conflicts with an exclusive use provision.

How Do Courts Interpret Exclusive Use Clauses?

If the meaning of an exclusive use provision is not adequately defined and litigation ensues, courts analyze these provisions narrowly, favoring unrestricted use of the real property. Courts may not expand the scope of an exclusive use provision “beyond that clearly indicated by its language and shown to have been intended by the parties.” Bookman v. Cavalier Court, 198 Va.183 (1956) (citing 51 C.J.S. Landlord and Tenant § 238, p. 865). As a result, a provision may be pared down for being too broad with its categories of prohibited uses and products. On the other hand, a bargained-for specific list of specifically restricted competitors is typically not subject to judicial alteration.

Radius Restrictions

What Is a Radius Restriction?

A radius restriction is a commercial leasing provision that prohibits a tenant from opening a similar business within a specified radius of the leased premises during the term of the lease. Landlords often seek radius restrictions in lease agreements when rent is based on a percentage of the tenant’s gross sales from the premises.

What Are the Benefits of Radius Restrictions?

Radius restrictions provide the landlord with a sense of financial security. When leases are calculated based on a percentage of gross sales from a specific location, a radius restriction helps ensure that the tenant will not open another location near the leased premises that may diminish the tenant’s sales. Additionally, landlords can employ radius restrictions to ensure vibrancy in their shopping centers. Having the only branch of a store within a certain geographic area in your shopping center means more customers entering your center, increasing sales for that tenant and other tenants in the center. Radius restrictions also may help prevent potential tenant defaults because of reduced sales and customer diversion.

What Are Some Downsides of Radius Restrictions?

Many tenants view radius restrictions as an obstacle to the development of their business. If the tenant is a major retailer or chain, it will not value its particular lease individually, but as a part of a larger business plan. Most national retail tenants meticulously scout and choose potential locations based on a variety of factors. They examine the sales performance of their existing locations (compared to the terms of their lease), identify “underperforming” locations, aim to improve net sales, and propose new locations based on the amount of working capital they have in a given year. The potential restriction of a retail tenant’s ability to freely execute its business plan may deter that tenant from leasing space in a landlord’s center.

What Are the Main Factors in a Well-Drafted Radius Restriction Provision?

Lawyers drafting a radius restriction provision in a lease agreement should consider the below factors:

The Geographic Boundaries of the Radius Restriction

Establishing the centerpoint and extent of a radius restriction is the essential first step in drafting these provisions. Parties must establish a geographic limitation that properly protects against a tenant opening a new location in such close proximity to the existing location that it cannibalizes sales from the premises yet not unreasonably hinder the tenant’s plans for future expansion. The boundaries established in the agreement should reflect a legitimate business interest that the landlord seeks to protect. The restriction should not be overly broad in either geographic scope or duration. The determination of what constitutes an overly broad geographical restriction has varied widely among courts. However, parties should aim to draft radius restrictions such that they do not extend farther than a few miles in nonurban areas or more than one mile in cities. Establishing boundaries that extend beyond these distances increases the likelihood that the restriction will be declared unenforceable by a court.

Another important question when assessing geographic boundaries is where the radius begins. Landlords may prefer that the radius begin from the outer boundaries of the shopping center itself, but tenants will prefer that the calculation begin from the outer walls of their individual premises. A well-drafted provision will define exactly where the radius’s centerpoint is located, thus helping avoid ambiguity and potential litigation for stores opened on the fringes of the radius.

The Parties Affected by the Radius Restriction

A well-drafted radius restriction should also adequately identify the parties subject to the restriction. Many retail and chain-restaurant tenants are not merely single-purpose entities but are part of much larger affiliated groups. They do not exist to open and operate just one location. As a result, lawyers should be careful to include all relevant affiliated parties in the restriction. This includes the tenant, its affiliates, and its owners. Failure to include such affiliates may prompt the parent company to form a new single-purpose entity to open and operate the chain within the boundaries of the radius, free from the restrictions. By contrast, tenants should seek to limit the restriction only to those affiliated entities that conduct substantially similar operations.

Remedies Available to the Landlord

A common remedy for breaches of radius restrictions is the landlord’s inclusion of gross sales from the violating location in the calculation of gross sales for the original premises. This remedy typically is used in leases with percentage rent clauses. Implementing this remedy eliminates the burden to the landlord of proving actual damages in litigation and deters tenants from violating the terms of the radius restriction. Alternatively, the landlord may provide for liquidated damages for each day the violating location remains open for business. In the absence of adequate monetary remedies or stipulated damages, a landlord may petition to enjoin the operations that violate the radius restriction.

The tenant also may request advance notice of any violation of a radius restriction and reasonable time to cure before the landlord may exercise any remedies. Note, however, that notice and cure periods for a breach of a radius restrictions may not always be helpful to the tenant. To cure this breach, the tenant would have to shut down operations at the violating location, which could be costly.

What Are Some General Exceptions to Radius Restrictions?

Generally, radius restrictions provide carveouts in two scenarios.

First, a carveout usually is included by a tenant or its parent or affiliate. If, during the lease negotiations, the tenant is considering purchasing a chain, the provision likely will include an exception for the operation of that new chain in the restricted area.

Additionally, radius restrictions often provide exceptions for existing stores. Tenants should ensure that the radius restriction language does not suggest that a renewal of an existing lease for a store operating within the restricted area would violate the radius restriction.

When Should Radius Restrictions Be Waived?

Radius restrictions may be waived for many reasons. These restrictions often are waived when a tenant has a new, noncompeting concept that would not infringe on its sales at the premises and would pose no actual threat of economic harm to the landlord. Additionally, radius restrictions may be waived when a landlord owns an adjoining development within the radius and wants to expand the potential number of new tenants. By waiving the radius restriction, the landlord may attract a wider array of businesses, including those affiliated with the restricted tenant.

Final Considerations

Thoughtful and well-negotiated exclusive use clauses and radius restrictions protect both the landlord’s and tenant’s financial interests and increase the appeal of a shopping center, without placing onerous burdens on either the landlord’s future leasing flexibility or a retail tenant’s future development plans. It is essential for both parties to consider the long-term effects of these clauses and carefully craft the language both to survive judicial scrutiny and to avoid unanticipated effects on either party’s business.