There is no more important tool to assure that your deal closes timely than a well-crafted Letter of Intent (“LOI”).
Whether or not you include all of the business terms or just the most significant to your client, drafting a concise and detailed LOI will prevent later problems and delays in the negotiation of the lease.

Often LOI’s cover the most important, but not all, deal points. The most important deal points often include the following:

(a) Term of the Lease; (b) Rent; (c) “Additional Rent” components” including “Percentage Rent” and “Common Area Maintenance Costs”, (d) Rent Commencement (e) Description of the Premises (this usually includes the store #, square feet of space, and frontage); (f) Option Periods; (g) Obligations for repair and maintenance; (h) Tenant construction allowance; (i) Exclusivity; (j) Co-Tenancy; and (k) Termination Rights; (l) Signage.

While each deal point will need to be negotiated, provided below are a few areas of often highly negotiated provisions that demonstrate the importance of having issues agreed upon in the LOI.

Exclusive Use

As opposed to office or industrial leases, retail leases “use” clauses are generally far more restrictive since they are specifically intended to limit the tenant’s business to its particular type of store/product. Landlords that take the time to plan and administer such exclusivity clauses often generate greater returns to the landlord and the tenants in the shopping center. In converse, without landlord’s attention, it may lose significant percentage rent returns and negatively impact tenants. Of note, landlords should always negotiate that exclusive use would only apply to future tenants.

Tenants need to clearly set forth the services or products that they are protecting and include a remedy if there is a violation of the provision.  Tenants should also not use general terms when describing its use in the premises. Such terms as “primary use” or “majority” are too broad. A suggestion is to include a percentage to define such terms such as “60% or greater of a violating tenant’s sales area”.

Rent Commencement Date

The Rent Commencement Date needs to be carefully negotiated to address the realty of the time periods required by the landlord and tenant to complete their respective obligations.

Landlords usually want the Rent Commencement Date to occur upon the earlier of:

1. The date that the tenant opens for business; or

2. A certain number of days following the date that the landlord delivers possession of the premises to the tenant.

For the tenant, it will want the Rent Commencement Date not to occur until tenant has built out the premises after the last to occur of:

1. The date that the Lease is fully executed;

2. The date that the landlord completes “Landlord’s Work” within the premises and delivers possession of the premises to the tenant;

3. The date landlord approves the tenant’s plans; and

4. The date upon which the tenant obtains its building permit(s) (usually including a clause that Tenant will make best efforts and diligently prosecute same).

Percentage Rent

It is common for retail leases to include landlord’s right to share in tenant’s sales proceeds generated by the increased sales of the tenant mix in the shopping center due to the efforts of the landlord (including a merchants association). The parties usually agree that upon the tenant’s sales hitting a certain amount of sales (the “breakpoint”) annually, the tenant will pay the landlord a percentage of tenant’s sales over the breakpoint. “Natural Breakpoint” means the tenant achieves the sales in an amount that is equal to the annual base rent the tenant pays, multiplied by the agreed upon percentage. What sales are included and excluded from calculating gross sales is a highly negotiated area.

Landlords want to include as much as possible, such as the requirement for tenants to keep detailed and complete recording of gross sales, audit rights, and subsequent penalties including termination rights or loss of “kickout rights” should a tenant fail to comply with the provision. Further, landlords will include radius restrictions and often include in the gross sales other stores a tenant may open in violation of such radius restriction. This now goes so far as to include off-sight/on-line sales generated or shipped from the premises.

Tenants, especially anchor or larger store chains with leverage, will want to exclude such items as: customer returns, exchange of merchandise between stores, taxes on such sold items, a percentage for employee discounts, bad debt to a certain percentage, and certain charitable contributions.

Common Area Maintenance Caps

In most retail leases tenants often enter into “triple net leases”. This means that common area maintenance costs, real estate taxes and insurance costs are “passed through” to the tenants usually based on the tenant’s percentage of its premises versus the leased or leasable (another issue to be negotiated) area of the shopping center. It is now mostly standard for the parties to negotiate caps on the common area maintenance costs. Caps on the common area maintenance costs are usually of two types: (1) – a true “cap” (“an amount not to exceed”), or (2) – a fixed fee with automatic increases.

Tenants will want to make sure to negotiate a “base year” or time period for the cap not to exceed i.e.) first year of the lease. It is critical for the LOI to set forth this point.

Often landlords will want to exclude ‘uncontrollable costs” such as snow plow, security and utilities from such caps as well as periodic charges such as parking lot paving. In such cases, a tenant may want the right to audit such “uncontrollable costs”.

Conclusion

Having a well drafted Letter of Intent, will provide the parties’ counsels with a framework that removes many of the significant deal point issues that otherwise inevitably delays the lease negation process and requires the business people to re-negotiate points that could have been resolved upfront before attorney involvement.

By KSN Attorney Scott Weinstein

 

Since 1983, KSN has been a legal resource for condominium, homeowner, and townhome associations. Additionally, we represent clients in real estate transactions, collections, landlord/tenant issues, and property tax appeals. We represent thousands of clients and community associations throughout the US with offices in several states including Florida, Illinois, Indiana, and Wisconsin.

 

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