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Making
Leases Work for Landlords and Tenants in the New EconomyBy
Jay Hollander
Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.
The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances. Summary: Traditional
leases between retailers and shopping-center landlords
may not work well in the era of e-commerce. If a retail
store conducts significant sales online, a landlord that
takes some rent as a percentage of in-store sales may be
dissatisfied. This article explains some alternative approaches
to make these leases work for e-commerce.
How
E-Commerce Affects Traditional Leases
The growth of e-commerce over the last few years has caused
quite a stir when it comes to evaluating what impact the escalating
sales from virtual storefronts have had on their brick-and
mortar-counterparts.
For
awhile, traditional storefront retailers were terrified
that their sales would dry up in favor of the new "George
Jetson" style of click and shop.Commercial landlords also
were understandably concerned about how growing Internet
sales would impact their retail tenants, especially in
shopping centers, which traditionally have served as destination
addresses for retailers. Would e-commerce drive them out
of business? Would it result in empty or underutilized
shopping centers?Fast forward to the present and, to everyone's
surprise, it is actually many of the brick and mortar retailers
that have most successfully adapted to the Internet, supplementing
and facilitating their traditional sales with online information,
the ability to buy merchandise online and pick it up at
a store, or a host of other innovations that, in retrospect,
show the Internet to have been largely a good thing for
traditional retailers with physical storefronts.Still,
every solution brings a new problem, and now the success
of this outlet for retailers has led to disputes between
tenants and their landlords.What do Internet sales have
to do with shopping center leases? Plenty.The perceived
problem for tenants lacking an Internet presence, or who
sell products or services that don't benefit from Internet
sales as greatly as others, is that substantial Internet
sales may keep potential customers away from the center
and, as a result, their stores, driving down their sales
in the process.To date, there aren't enough reliable statistics
to conclude authoritatively if this fear is justified at
all or, to what extent, since the impact may vary widely
from shopping center to shopping center and from one type
of business to another. Then, there's also the issue of
what's to blame for any particular decline in sales from
any given physical stores: the Internet's impact or the
slowing economy in general.While landlords are sympathetic
with this tenant complaint, the problem for landlords is
actually different. Once fearful of losing tenants to Internet
competition, landlords now want to make sure they are cashing
in appropriately on the benefits that Internet sales have
brought their retail tenants.How do they do this? Mostly
through the use of two extremely powerful lease clauses
common to shopping center retail leases: the "percentage
rent" clause and the "radius" clause."
Percentage Rent" Clauses
and E-Commerce
In its simplest form, the "percentage
rent" clause works like this: Landlords will select a mix
of tenants for a shopping center that they think will draw
the most traffic and, ultimately, sales. Then, landlords
typically will charge a tenant a little less than the going
rate in monthly rent in exchange for getting a specified
percentage of the store's monthly gross sales as additional
rent.While it's true that this can work against a landlord
in slow times, the risk is limited in that the base rent
still represents a minimum income to the landlord. But,
the benefit in good times is potentially unlimited as the
landlord gets a percentage of increased sales made.The
issue with Internet sales in this context is whether --
and how much -- to include sales that a store generates
on the Internet as part of the gross sales attributable
to a particular store. The resolution to the issue has
been made more difficult because many leases with percentage
rent clauses in them were drafted before anyone contemplated
Internet sales.So, tenants have argued that such sales
should not be included, while landlords have taken the
opposite tack.The mainstream compromise that is increasingly
being struck, and which you can use to guide your own negotiations,
is one reminiscent of the resolution that came out of a
previous economic battle fought between landlords and tenants
over mail order, telephone and catalogue sales.Yes, hard
to believe, but the Internet is not the first instance
of fights over cannibalization of in-store sales by means
of remote shopping. Ever since stores began distributing
catalogs and circulars, allowing people to place their
orders by telephone, the same fights about percentage rent
occurred -- until a truce was called.In the case of catalog
and phone orders, the resolution involved including, in
gross sales, those remote sales that involved the brick
and mortar store in one way or another.For example, orders
placed by calling a phone number in the store and buying
by credit card would be included. Similarly, if a toll-free
catalog number were called and the merchandise picked up
at a particular store, that order might be included as
well. In this way, a connection with the store could be
reasonably inferred to justify qualifying these remote
sales to be included in the store's gross sales in a way
that's consistent with the theory of a percentage rent
clause.To fully implement this approach with respect to
Internet sales, however, landlords and tenants need to
take note of another lease clause that traditionally also
has been part and parcel of brick and mortar shopping center
leases where percentage rent was involved."
Radius" Clauses
and E-Commerce
That clause, known as the "radius" clause,
was used by landlords and tenants to place some limitation
on outside remote sales attributable to the store's percentage
rent by placing geographical boundaries on which remote
sales would be deemed allocable to a particular store location
and which would not.For instance, if someone from Idaho
called the Sears catalog, the same catalog used by a Sears
store in New York, the New York store would not want to
have the Idaho sale included in its rent.Thus, one of the
purposes of a radius clause is to attribute sales from
within a given geographical area to the particular store
involved, while not unreasonably imputing unrelated sales
to it.How should this be implemented in the Internet era,
where orders can come from anywhere?There are a couple
of ways, the specific one chosen depending on the nature
of the business and the negotiating leverage of the parties.One
method, alluded to earlier, is to count sales, no matter
where the customer is located, if the sale was procured
through or with the use of the particular store. So, if
the product was ordered on the Internet from another state,
but fulfilled through the store, that sale could count
as being generated within the agreed-upon geographical
area of the store and, hence, includable for percentage
rent purposes.Alternatively, and arguably with more justification,
one could try to put both parties in the same position
they would be in if the Internet was not involved, by only
counting Internet sales coming from customers living within
a certain geographical zip code denominated area, in driving
proximity to the store involved.Both of these possibilities
-- and others -- are being applied increasingly to help
redress the balance between landlords and retail tenants
in commercial shopping center contexts.No doubt, newer
leases have adapted quickly and have taken pains to include
Internet sales as components of percentage rent, with negotiations
centering on the issues identified in this article.Where
older leases, lacking Internet-specific language, are being
examined, it is the expressed intention of the parties
to include certain types of remote sales, whether by telephone,
mail order, catalog or otherwise, which are being relied
upon in interpretations favoring or disfavoring inclusion
of Internet sales.Going forward, landlords would do well
to expand their percentage rent clauses not only to take
Internet sales into account, but also to further make it
clear that the percentage rent clause is neutral with respect
to the medium used to communicate the order. This will
provide protection against future technology innovation
to some degree.On the tenant's side, as technology advances,
allowing a store's marketing message to reach further and
further, care must be taken to avoid having potentially
worldwide sales drawn into the ambit of percentage rent
clauses.
In
a world where more and more businesses can market to customers
from anywhere, some of the traditional assumptions about
what drives traffic to shopping centers and sales to individual
stores in them will need to adjust to new realities of
e-commerce. For their parts, landlords and tenants also
will need to adjust their historical leasing arrangements
in a way that accommodates the legitimate objectives of
percentage rent clauses with the legitimate restrictions
of radius clauses, to continue to reward landlords for
shopping center infrastructures that improve store sales,
while not unfairly penalizing tenants for sales generated
without any aid from the landlord. Copyright © Jay Hollander, 2007. All Rights Reserved.
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