12 Questions to Ask (and Answer) Before Signing Your Restaurant Lease

As I’ve written here before, perhaps the document that will have the greatest impact on the success of your restaurant will be your lease. It sets the terms of your relationship with your landlord, governs the manner in which you may use your space, and determines what you must pay – each and every month – just to maintain the right to open your doors. For all too many restaurants, whether they succeed or fail is predetermined at the moment the lease is signed.

But leases are also complex documents, which are drafted by the landlord, and can be confusing to tenants without a strong legal or business background. When reviewing a lease, it can be hard to know where to start. To provide some guidance, here is a list of some of the questions you must ask – and have answered clearly in your mind – before you execute a lease and commit yourself to its terms. This list is not exhaustive, however, nor is it intended to replace the guidance of an experienced restaurant leasing attorney. With that said, here are some of those key questions:

1.   Who is the Tenant?

You may be saying to yourself, “what does he mean, who is the tenant? Aren’t I the tenant?” Well, maybe not. Most often, tenant restaurants will form a new entity for their restaurant business (a limited liability company, or LLC, for example) and it will be that entity that is the actual tenant on the restaurant lease. Signing a lease on behalf of an entity provides an extra layer of liability protection for the individual owners of the business (subject to the guaranty – see below) if the business fails to meet any of its lease obligations, such as if it cannot pay its rent. If you are the tenant on the lease individually, however, you will be personally liable for all rent and other obligations under the lease. Similarly, if you are a multi-unit operator and sign all your leases in the name of the same entity, rather than create a new entity for each location, you put the assets of all your restaurants at risk if one defaults on its lease.  So make sure you understand when you sign your lease, who is responsible if things don’t work out.

2.   What is my personal obligation on the guaranty? 

The corollary to the explanation above to question 1 is that, if the tenant is an LLC, the Landlord is going to want some real live person to “guarantee” that the terms of the lease will be followed, and be liable on the lease if the LLC cannot meet its obligations (which is often the case if the restaurant goes out of business). This “personal guaranty” as it is known can, however, be limited such that the guarantor is not liable for the full extent of any damages caused to the landlord by the tenant’s breach of the lease. Among these limitations are that the guaranty is capped at a certain amount (e.g. 24 months of base rent), or that it “burns off” after a specified period of time such that there is no further guarantor liability if rent is paid on time for some specified period. Not all landlords will agree to such limitations, and much will depend on who the tenant is, but as with Number 1 above, understanding the extent of the guaranty (and seeking to limit it where possible) is critical to understanding your personal exposure and risk in signing the lease.

3.   Can I get a liquor license for this space?

Many restaurant owners are surprised to know they can’t just get a liquor license anywhere. Many locales have strict limits on where businesses that sell alcoholic beverages can be located, and others have a cap on the number of new licenses they will issue. If you sign a lease without understanding how these local laws may effect your planned business, you could be placed in a situation where you are either (in the former situation) unable to get a liquor license at all, or (in the latter) be required to spend significant and unanticipated sums to purchase an existing license. In either case, if your restaurant depends on a liquor license for its survival, this miscalculation can doom your restaurant from the start.

4.   When do I have to start paying rent?

Unlike residential leases, where you start paying rent as soon as you move in, many restaurant leases will provide you with several months before you have to make your first monthly rent payment. This delay is to permit you to do whatever buildout you may need to do for your restaurant, and perhaps even give you some time to get up and running before you must start meeting that monthly rental obligation. How long you will be permitted before you have to start paying will of course be a key topic of negotiation, and every extra month will make a big difference in whether you get off on the right foot or are playing from behind right from the start.

5.   What do I really have to pay every month? 

Of course you have to pay your monthly rent. But what else? If your restaurant lease is what we call a “net lease” you will have to pay your share of other expenses incurred in the operation and maintenance of the property. These charges, which are often called “pass throughs,” because the landlord pays them directly and passes them through to the tenant as an additional monthly cost, can include property taxes, common area maintenance (CAM) costs, and insurance – and in the case of a “triple net” or NNN lease will include all three. As these costs can be significant, and can change from year to year, it is critical to your monthly budgeting to understand as precisely as possible how much you should expect to pay in pass-throughs every month. You do not want to sign a lease for what you think is a reasonable rent, only to find out that the pass-throughs add another 50% to your monthly obligation.

6.   Do I owe my landlord a share of my sales?

You may want to consider this question 5a, because as with the above, it relates directly to what you will really be paying every month. That is because, in addition to pass-throughs, your lease may also require you to pay to the landlord some percentage of your sales every month in the form of “percentage rent.” This extra rent effectively allows your landlord to share in your success (but good luck getting him to reduce your rent if you are struggling). Sometimes, this percentage rent only kicks in after a certain sales threshold is reached, but in any case, a restaurant tenant absolutely must have a firm grasp on when he may owe percentage rent, how much, and what reporting and document requirements he may have to support the sales figures used to calculate this extra rent.

7.   Do I have an exclusivity provision?

I always encourage my clients to request that their restaurant leases contain a provision that states the tenant has exclusive rights to sell a certain style of food – e.g. that tenant will be the only one in the shopping center who can sell fast casual Mexican or sit-down Mediterranean or carry-out Chinese.  If you do not have an exclusivity provision, there may be nothing stopping the landlord from leasing to a competing business who sells the same type of food you do, just because the landlord may think they make a better tenant, or if they just need to fill the space.  For that reason, such a provision is strongly advised. And more than that, if your lease has such a provision, it is critical that it also protects your exclusive use by imposing real financial penalties on the landlord if your exclusivity is violated.

8.   Can I change the concept of my restaurant if it is not working?

Again, we have a corollary. One of the reasons landlords will agree to include exclusivity provisions in the lease is they have a strong interest in ensuring the proper mix of tenants in their shopping centers. That is to say, the landlord may not want two fast casual Mexican places. But with that interest in ensuring a good mix of tenants, comes with it an interest in controlling the type of offerings their tenants provide. As such, landlords generally will include in their restaurant leases a use provision that sets forth the type of restaurant the tenant is going to operate, and which requires that the tenant not deviate from that use during the term of the lease. Or, at least, that the restaurant does not do so without the landlord’s approval.

9.   Can my landlord make me move to a new location in the shopping center?

Like most of us who own property, landlords want to preserve maximum flexibility with respect to how they use their property – and long term leases can get in the way of that. To deal with that fact, landlords will often request that relocation provisions be included in restaurant leases such that if they want to redevelop the portion of the shopping center in which your restaurant is located, they can move you to another location. While that desire may be reasonable, the lease terms must also be reasonable and ensure (among other things) that the new space you are moved to is similar (in size, access, visibility, etc.) to that from which you are being moved, that your business will not be unduly interrupted by the move, and that you are given a chance to participate fairly in the selection of the new space without fear that the landlord will simply kick you out and terminate the lease if you do not agree.

10.   What happens if I am late or miss a rent payment?

This is a biggie. You know you have to pay your rent on time, right? But what actually happens if you don’t? The answer is, as one of my law professor liked to say, “IAD. It all depends.” And on what does it depend? Many things: how late you are; whether you’ve been late before; what your relationship is like with your landlord; and, for many, who your landlord is (some are bigger sticklers than others.). Like anything else, however, what actually will happen is less important at the time you sign your lease than what could happen. And what could happen will depend on only one thing: the terms of the lease.

In many leases I see what could happen is the nuclear option: termination and eviction. After one missed or late payment, you ask, really? Yes, really. In these leases, the landlord reserves the right to terminate the lease and evict the tenant if one single rent payment is late by defining such a late payment as a default under the lease. You’re late, you’re in default, simple as that. Now you are at the landlord’s mercy, as all default remedies available under the lease are now in play. A better option? Take a good hard look at those default provisions and do all you can to get some wiggle room in the event of a late payment – notice and an opportunity to cure being the most obvious. Sure, maybe the landlord won’t evict you for one late or missed payment. But the fact that he could should be enough to make you worried.

11.   Can I assign this lease if I want to sell my restaurant?

Ten years, which is the length of most restaurant leases I see in my practice, is a long time. People’s lives change a lot over ten years – families grow, people relocate, health deteriorates, businesses struggle…. Maybe after a time, running a restaurant just does not seem like the best option for you anymore. But if you are tied to a long-term restaurant lease, what do you do? For many, a strict restriction on assignment (the process by which someone assumes your obligations on a lease) seems like a trap from which escape to another life in impossible. Thankfully, that is not altogether true.

Generally, a landlord wants a good tenant who is invested in their business and wants to and has the capacity to be successful. If that is no longer you – for whatever reason – and you bring to the landlord someone who wants to buy your business and take over the lease, most landlords will be receptive (even if the lease has a strict prohibition on such assignments). That does not mean, however, that you should ignore such prohibitions at the negotiation and signing stage. You should still make sure you understand the limitations on assignment built into the lease and, to the greatest extent possible, do what you can to carve out the broadest allowance for such assignment that you are able. The less you are dependent on your landlord’s good graces, particularly if you meet with times of struggle, the better.

12.   What are my renewal options?

Again, ten years is a long time and a lot can change over that time. Not the least of those changes is the value of real estate and the associated market rates for rental property. If you were a pioneer and your restaurant is now located in an area where people are moving in and rents are skyrocketing, the terms on your option to renew (assuming you have one) can make the difference between whether you can stay (and benefit from your foresight in opening in this hot neighborhood), or have to find new space, perhaps at a higher rate or in a less desirable neighborhood.

The determining factor may be whether your renewal option is on the same terms as the primary term of the lease (e.g. a fixed annual percentage increase) or whether it is at market rate, which can lead to a whole new round of negotiations with the landlord and is, in many ways, not a real renewal at all. So pay attention to those renewal terms and, for goodness sake, certainly keep in mind when you have to provide notice of your intent to renew. You don’t want to negotiate favorable renewal terms at the time of your lease, only to lose that benefit by letting your renewal deadline to lapse.

 

Again, this list is not exhaustive and others will no doubt be important in your restaurant lease negotiation (e.g. who pays for repairs to the building or its systems? what rights do I have to use the sidewalk or patio?), but I hope it begins to convey the range of issues in play. I hope it also conveys to you that the assistance of an experienced restaurant leasing lawyer may be advisable, if not an absolute necessity.

If you need help answering one of these, or any other question, as you review and negotiate your restaurant lease, please give us a call.

Yes, Your Business Needs an Operating Agreement

agreement

Imagine this scenario:

A couple of years ago you partnered up with a few associates and started a new restaurant business. Because you did not know much about the business, you opted to take a background role, with your contribution largely being financial. You trusted your partners, who had experience as chefs and restaurant managers, to run the day-to-day operations of the business. After a few rough months, the restaurant started doing really well and is now thriving, but you have not really seen much in the way of a return on your investment.

You have started to wonder and have asked your partners whether you will start seeing some distributions any time soon. You also called a local lawyer you know who has experience with small businesses and asked her for some advice. You and she scheduled a meeting, and she asks you to bring a copy of the company’s operating or partnership agreement. You check your files and review your emails from a few years back only to discover there is no such agreement, that you and your partners never entered into one. You were too excited to get going and didn’t want to spoil the good vibes between you all.

You mention this all to the lawyer when you meet with her, and explain the overall situation, before asking her, “What are my rights?” Her answer (not in so many words, and perhaps a bit more gently): “Who the heck knows?”

While it is true that the corporate and business law of the state you live in may provide some answers, the lesson of this imaginary story is this: It is impossible to overstate how important a good operating agreement** is if you are embarking on a restaurant (or any business) venture with anyone other than just yourself. With the possible exception of your restaurant lease, it is probably the most important document you will deal with. That is because, while your lease may be a key factor in whether you succeed or not, your operating agreement will be the determining factor of what happens if you succeed or not. And, as I tell my clients, sometimes the worst thing that can happen if you do not have a good operating agreement is that you do succeed, because then there is actually something worth fighting over.

So, why do you need an operating agreement? It is, among other things, to answer the most critical questions about how your company will be run:

  • Who has primary responsibility for managing the day-to-day affairs of the company?
  • What are the manager’s duties, obligations, and responsibilities?
  • Which matters get put to a vote of the members and which are left to the discretion of the managers?
  • What happens if the manager of the business is failing in his duties and needs to be removed?
  • How are profits of the business distributed to the members?
  • What happens if a member of the company wants to leave and be bought out?
  • How does the company raise more money if it is needed?
  • What if the company wants to take on investors as new members?
  • What happens if the company gets purchased?
  • What happens if the business fails?

The time to get on the same page with your business associates regarding these questions is at the start of the business, not when they come up later on.  Because if you wait until then, and you do not have a good operating agreement, the answer to each of these questions can be the same as the one the lawyer gave in the story above: “Who the heck knows?”

 

** NOTE:  I’ve used the terms “operating agreement” and “members” in this post because most of my clients structure their businesses as limited liability companies (LLCs), but the same would be true of a partnership or shareholder agreement if you were structured a partnership or close corporation.

The Facebook Trap: Social Media, Solicitation, and Securities Law

You have a great idea for a new business – it is a fantastic new restaurant concept that incorporates some of the hottest trends in the industry, with a new twist that is uniquely your own. You put together a business plan, determine how much money you will need to get it off the ground, and then prepare a deck of slides for potential investors. Then you log into Facebook and post the news of your exciting new venture and tell all your “friends” that they should contact you if they are interested in investing.

Guess what? You likely have just engaged in what the Securities and Exchange Commission deems a “general solicitation” for investment. What does that mean? You have inadvertently significantly restricted the pool of investors who will be eligible to invest in your restaurant business. Whoops.

To understand why this is, you must understand the concept of “accredited” versus “non-accredited” investors, and also understand the role the SEC assumes in protecting the latter in particular from dubious or even fraudulent investment schemes. Put in simple terms, an “accredited” investor is someone with a high income and/or net worth and who, according to the SEC, is sophisticated enough to make wise investment decisions, or at least wealthy enough to not be ruined by an unwise one. Because of this purported sophistication and wherewithal, accredited investors are permitted to invest in business ventures that non-accredited investors are not.

Among those ventures are those with investment offerings that the proponents of the business have advertised to the general public. This is known as a “general solicitation.” If the business proponent wants to engage in such general solicitation, and also not have to register their securities formally with the SEC, they may only accept investment from accredited investors. Non-accredited investors will be completely shut out and barred from investing. So that Facebook post, which is probably intended to reach old friends, associates, or college buddies who would enjoy investing and supporting you in your venture, could have the unintended consequence of making it impossible for those precise people to actually invest – unless they also happen to be wealthy.

So, you ask, why is a Facebook post considered a general solicitation? Aren’t I just making it known to my friends and family? Well, while the answer is not as clear as we may like, the SEC seems to understand that what Facebook considers our “friends” and LinkedIn considers our “contacts” is significantly broader than the traditional meanings of those terms. Indeed, the SEC agrees that a communication made only to those people with whom we have a preexisting relationship would not constitute a general solicitation. Rather, it is only when the communication gets made in a manner that the target audience is not specifically limited and controlled that it rises to a general solicitation. In most instances, however, given the nature of social media and the inherent inability of users to strictly limit who sees their posts, the default position is likely to be that a social media post inviting investment in your startup will be deemed a direct solicitation.

So think hard before you hit “post” or “publish” on that Facebook posting. (Which, come to think of it, is actually a pretty good policy in general.)