Limiting the Personal Guaranty in Your Restaurant Lease

If you are getting ready to sign a restaurant lease, you are almost certainly being asked to provide the name of someone who will provide a personal guaranty of payment on the lease.  This person, whether it be you yourself, or someone with whom you are associated, will be personally on the hook if the tenant (usually an LLC or some other corporate entity) itself does not pay.  The reason the landlord requires this is because, unless the tenant is a big corporation with a lot of assets separate and apart from this restaurant (and, regardless, we usually advise our clients to set up new entities for every location they open), a personal guaranty is the only way the landlord can have some assurance that you won’t simply walk away from your restaurant (and the lease) if business gets bad.  The landlord wants someone on the hook.

Many restaurant tenants do not realize that they do not have to agree to a full guaranty – i.e., one that will make them liable for all payments due under the lease, for the full term, if there is a default.  On the contrary, landlords will often agree to limit the personal guaranty on on the lease, and thereby limit the personal liability that can result if your restaurant does not succeed.  The two most common forms these limits take are a cap on liability, and a “burn off” provision.  Most common is some combination of the two.

A liability cap means that the guarantor’s liability is capped at some dollar amount or, more commonly, some number of months’ rent due under the lease.  For example, the guaranty could provide that, in the event of default, the landlord’s maximum recovery against the guarantor be (let’s say) 24 months of rent.  This would be true even if it takes the landlord much longer to find a new tenant or incurs significant expenses in securing such a tenant (such as in brokerage fees, rehabbing the space, or in concessions to the new tenant).  One can imagine such a cap being particularly valuable if a restaurant fails early in a long-term (e.g. 10-year) lease.

burn off provision means just that, that the lease guaranty will “burn off” at some point, provided the tenant has met all other requirements under the lease.  For example, a restaurant lease guaranty could provide that, after five years of on time payments by the tenant, the guarantor would have no further liability and the guaranty itself would terminated.

Again, most common is a combination between these two liability limitations.  In one formulation we negotiate for our clients quite often, the liability will be at some amount during the initial years of the lease, then burn off, or “burn down,” as time goes on: perhaps from a full guaranty to 24 months after some number years of on time payments; then from 24 down to 12; and then maybe eliminated altogether.  In this way, a tenant is incentivized to keep paying rent on time (especially early in the lease, when the liability is the greatest), and rewarded for being a good tenant later in the lease.

Of course the specifics of what a landlord will agree to will depend on the financial viability and business history of the tenant, but this all where an experienced restaurant leasing attorney (or restaurant real estate broker) can be immensely helpful.  The limits your lawyer or broker can negotiate for you can make the difference between bankruptcy, and being able to pick your self up and give it another try some time the future.

New Restaurant Location? Strongly Consider a New LLC.

I often say that opening a restaurant is like becoming a parent.  It keeps you up late at night, it occupies most of your time and attention, it makes you worry whenever you leave it with someone else…. But like parenthood, restaurant ownership can also get easier over time. And, when it does, you may actually start thinking, “hey, I’m beginning to get the hang of this.” If you are lucky enough for that to happen to you, you may also think like the parents of a moderately behaved toddler – “maybe it’s time to think about number 2.”

That decision (as related to restaurants, at least for these purposes) is fraught with many more issues than I could ever cover in one blog post.   So I will allow this post to cover only one such issue – whether you need to create a new entity for the new location. My answer, in almost all instances, is a resounding “Yes.”

The main reason is this: you will need to sign a new lease for your new location. And, with that new lease, comes another set of significant obligations and financial liabilities. If you don’t create a new entity, not only will your new restaurant be responsible for those liabilities, so will your first one. That is to say, if the new restaurant flops and goes out of business, but the first one is continuing to do well, failure to form a new entity can allow the Landlord for location Number 2 can go after the bank accounts and assets of location number 1. In short, Number 2’s debts can bring down Number 1 along with it.

If you create a new entity, however – call it McSwiggen’s Ale House Number 2, LLC – only the assets of that entity will be available to satisfy any liability under that Lease. The assets of McSwiggen’s Number 1 LLC will be protected by laws of limited liability (that’s what the two L’s in LLC stand for, after all). Yes, of course, you personally may be on the hook for any personal guaranty on Number 2’s lease, but the first restaurant – the one that was doing so well that it caused you to think about Number 2 in the first place – will still have the chance to live to fight another day.

To use a different analogy from the one I started with, you can build your restaurant business like an apartment building or a suburban subdivision. And if you think of your restaurants like that, think of financial difficulty like a fire. If you use the same LLC entity for each new location, financial difficulty in one will threaten to bring down them all, just like a fire in that apartment building. But LLC laws allow you to treat your restaurants like suburban homes on a cul de sac. They may all look the same, and be constructed the same, but they all stand on their own. And, while a fire in one will not be welcome to the neighbors, they’ll all still have some place to sleep that night.

Getting good advice and doing things right the first time will help you sleep at night too.  Before you open your second location, consult with an experienced restaurant lawyer to make sure you do all you can to protect the first.

 

Tough Market Makes a Good Restaurant Lease More Important than Ever

2017 has not been the easiest year for restaurants, particularly for sit down casual dining restaurants. Reports of store closures, missed earnings, and abandoned concepts have been a common occurrence this spring, as restaurants have tried to recover from its worst year since the recession. Even fast casual chains, which had been thought to be insulated from many of the challenges of the larger restaurant sector, have felt the pinch.

In recognition of this broad trend, we have been advising our clients that it has never been more important to focus like a laser on your lease, and not sign one you don’t fully understand and feel comfortable with.  First of all, restaurant owners need to make sure that the rent is affordable. As concepts proliferate (many of which are backed with investment dollars), rents have escalated in many markets. While a location may be attractive, if you cannot collect revenues of approximately 10 times your monthly rent, you are probably paying too much. When you are scouting space, be sure to keep this closely in mind. Second, as it relates to your lease terms themselves, you should be sure to focus (and push back hard) on key provisions such as:

  • Assignment rights. If you ever want to sell your restaurant, or just get out of a concept that is not working, you will need to be able to assign your lease to someone else. Make sure your lease provides for the ability to do that.
  • Guaranty limitation. You will almost certainly be personally liable for any damages to your landlord if you breach your lease. There are ways to cap that liability, however, and limit any damage to yourself personally if you have to close or walk away.
  • Default provisions and remedies. Can your landlord kick you out if you are a few days late with your rent? Do you have any opportunity to cure the default if you are late? Many leases have very strict default provisions. You can soften those to allow you to recover if you hit a rough patch.
  • Exclusivity provisions.  Competition is tough in the restaurant business, but if you can, you should keep any direct competition out of your backyard.

Certainly rents are going up and there is a lot of competition for restaurant space, but the spate of restaurant closures, as well as softness in the broader retail market (as Amazon and other online retailers force closures in that sector), can present opportunities to negotiate. And, you can negotiate.  Too many restaurant owners simply sign the lease they are provided, thinking they have no choice.  You do — especially now.

If you know what questions to ask, and what pitfalls to avoid, at the time you are looking as space and signing a lease, there is no reason your restaurant can’t be among the success stories.

Can My Landlord Lease to One of My Competitors?

GARY T. MILLS/The Times-Union -- Jan. 2012 -- Quiznos Sub recently closed at 7159 Philips Highway.

(GARY T. MILLS/The Times-Union — Jan. 2012)

My family and I had dinner this past weekend at the newest location of a locally-based fast casual restaurant chain.  It had a line nearly out the door and every table was full.  After dinner we noticed that, in the same shopping center, was an existing restaurant serving the exact same type of food.  It was nearly empty.  And I have to figure it will not long survive.

Competition can be brutal in the restaurant business, of course.  And no one can — or should — expect to be protected from competition entirely.  Competition is, after all, necessary.  And it is even desirable in many ways.  It drives innovation and fosters outstanding customer service.  If you can’t stand competition, go find another business to get involved in.

But should restaurant owners be able to expect their landlords to give them some protection?  Or at least not undermine them directly by bringing a competitor into their same shopping center?  The answer is: not necessarily.

I wrote a while back about the need to seek exclusivity provisions when negotiating restaurant leases, and for those provisions to have teeth.  Your landlord is not your partner, and not your protector.  The only way your landlord will keep your competitors out of your shopping center is if it is financially harmful for them to do so.  And those provisions have to be included and negotiated at the time the lease is being signed.

I don’t know what this smaller, older restaurant’s lease said about exclusivity – or if it said anything at all.  But I do know that if it did say anything, it was not strong enough for this landlord to hesitate in bringing in a shiny, new, well-financed competitor.  And because of that, the smaller competitor is probably going to go out of business.

In Restaurant Sales, its You and Me and the Landlord Makes Three

img_broken_handshake_540x360When involved in a restaurant transaction, the parties (understandably) spend much time and effort on examining the health of the business and the terms of the deal itself. The buyer will, among other things, study the restaurant’s revenues and operating expenses, any potential liabilities, and the condition of the equipment involved. On the other side, especially if there is seller financing, seller will examine the creditworthiness and financial wherewithal of the buyer, as well as their experience in running such a business. And both sides (of course) will focus great energy on negotiating the purchase price.

Often forgotten in this exchange of information and examination of risks is the landlord. The landlord is a necessary party to almost all restaurant deals, because almost all restaurant leases contain provisions that require the landlord’s consent to the assignment of the lease from the seller to the buyer. If the landlord does not provide that consent, the deal is off – even if the seller and buyer are in complete agreement on all terms.

For this reason, if you are considering listing your restaurant for sale, you should consult with your landlord to determine (or at least get a sense of) the conditions it might place on any such assignment. Is there a restriction on a change of format (e.g. the type of food)? Will the landlord require the new tenant to meet some threshold of financial strength? Determining these factors early on can save you from wasting time with a prospective buyer that has little or no chance of being approved by the landlord. And if you are a prospective buyer, among the first things you should ask the seller is if he has had these conversations with the landlord.  That question may save you from spending time and money (i.e. lawyer’s fees) to negotiate a transaction that will be snuffed out by the landlord down the road.

So the lesson here is that, while it may take two to tango, it often takes three to finalize a restaurant deal.

The Four Relationships that Can Make or Break Your Restaurant Business

restaurant kitchenThe restaurant business, like almost all businesses, is about relationships. And, of course, the most important one you will have is with your customers. If you don’t preserve that relationship, you won’t have a business for very long. But there are other relationships that must be protected just as jealously, because if any of them sour, they can bring down your business just as quickly as if customers stop coming in the door.

In our experience, these are those four relationships:

1.      With Your Partners (and Investors).

If you go into business with anyone else, that person has control over the success or failure of your business – regardless of whether they have any involvement in its day-to-day operations. If your restaurant is struggling, will your partners and investors have the patience to allow the plan to work, or will they want to bail out at the first sign of trouble? And, if they do bail out, can they pull their money out and leave you with all the responsibilities and liabilities? Alternatively, if the business is doing well, will they insist that the profits be paid out in distributions to the partners, or will you have the ability to put that money back into the business to enable it to grow and thrive? And, regardless of whether you are succeeding or failing, how will decisions be made about how the restaurant is managed? What if there is a deadlock – can a decision be made at all?

These are all questions that must be answered well before you open your doors – and well before the first sign of discord. That is why we advocate that preparing a written operating agreement should be among the very first things you do when you embark on your restaurant business. If you are in agreement on all these things – great, finalizing the agreement should be easy. But if you’re not, it’s better to find out sooner rather than later.

2.      With Your Landlord.

Perhaps no single person (or entity) has more control over the future of your restaurant business than your landlord. A tough-nosed landlord can stick you in default over the slightest deviation from the strict terms of your lease, whereas a more lenient and accommodating landlord can work with you through rough patches and allow your restaurant the time it needs to get up and running and the room it needs to prosper. So while you need to understand the terms of your lease, you also need to understand who your landlord is – and how they operate – before you sign your lease.

But even a lease with a well-meaning landlord needs to be reviewed thoroughly and completely – every word – because landlords can change, and what today is a small local landlord with a reputation for working with their tenants can tomorrow be an out-of-state investment trust that does not care that you’ve had a few tough months and it always picks up in the Spring. In those cases, your only protection will be your lease. Indeed, the lease you enter into with your landlord is probably the document that will have the greatest impact on the success of your restaurant. For all too many restaurants, whether they succeed or fail is predetermined at the moment the lease is signed. Make sure you not only sign a lease with a good landlord, but that that lease itself is top notch too.

3.      With Your Employees.

As with any service business, a restaurant’s employees are its lifeblood. They are its face to the world and, without them, the food doesn’t get prepped, cooked, plated, or served. Without good employees, even a perfectly formulated restaurant concept will assuredly fail. But taking care of your employees means more than just showing them gratitude, paying them well, and giving them appropriate time off. It also means complying with the letter of the law when it comes to wage and hour and other employment laws.

Federal and state lawmakers, for good reason, have made it a priority to ensure that unscrupulous employers do not take advantage of low wage workers, and the restaurant industry’s heavy reliance on tipped employees makes them a target for government regulation as well as lawsuits from disgruntled employees who may not have been properly paid. To protect themselves, restaurants must keep impeccable employment records and strictly adhere to all employment and wage laws. Take a lesson from those who haven’t, and have paid dearly.

4.      With the Government.

As businesses that prepare food for public consumption, and often serve alcoholic beverages to go along with that food, restaurants are among the most highly regulated small businesses in the country. From food safety permits to liquor licenses, there is almost nothing that restaurants do that does not require government approval or subject it to government oversight. The IRS is also notorious for making restaurants among its favorite audit targets. As with the employment issues highlighted above (which is another area of government oversight and regulation) strong compliance programs are essential. No one is ever going to be perfect, but if you are found to have violated a law, it is better to be able to show it was in spite of your best efforts at compliance, not because of a lack of such efforts.

 

Don’t Even Think About Buying a Restaurant Without Answering These Four Questions.

menu-restaurant-vintage-tableFor generations, owning and operating a restaurant has been a common dream for would-be entrepreneurs. Unlike many other businesses, most of us think we understand how restaurants operate (we all eat at restaurants, don’t we?), and there is a certain charm and allure to the idea of welcoming our friends and neighbors to a place all our own. Beyond that, while individual failures are plentiful, the restaurant industry as a whole has been remarkably resilient, even in tough economic times.

Still, we all have heard the legendary statistics regarding new restaurants’ failure rates, and wonder if there is a way to mitigate that risk and still pursue the dream of restaurant ownership. For many, the answer is to purchase an existing restaurant, which may have a reliable customer base, an established location, a proven concept, and a well-known name. If you decide to pursue that route, however, we encourage you to ask yourself (or your lawyer) a few questions early on in the process:

1.     What, exactly, am I buying?

Yes, you’re buying a restaurant. We know that. But it’s really not that simple. In most cases, if you are buying a single restaurant, you will do so through what’s called an asset purchase agreement (APA). In such a case, you will buy all the assets of the restaurant business, including both tangible (tables, chairs, kitchen equipment, point-of-sale system, etc.) and intangible (trade name, intellectual property, good will, etc.). When restaurant deals are accomplished this way, the buyer takes over all the operational aspects of the restaurant, but does not (generally speaking) assume the debts and liabilities of the prior owner, as the buyer would if they simply bought the company that owned the restaurant outright. Moreover, regardless of the structure of the deal, all buyers should conduct their due diligence such that they assure themselves they are not “buying” anything they didn’t bargain for, such as long term payment obligations, liabilities to employees or vendors, or pending regulatory violations and associated fines,

2.     Do I need a new lease?

Often, when a buyer purchases a restaurant, they simply take over the existing lease of the prior owner through a process called an assignment. An assignment, however is not always possible or advisable. In most instances, for example, a landlord will have the right to approve any proposed assignment and may not wish to engage with the new owner on the same terms as the prior one. In that case, the landlord may insist on a new lease with more terms more favorable to the landlord than those of the existing lease. Conversely, the buyer may object to certain terms in the existing lease – a demolition clause, or the lack of renewal options, or simply that there is not enough time remaining on it – and request a new lease as a condition of proceeding with the sale. Whatever you case may be, any agreement to purchase a restaurant should include a contingency that the buyer be afforded time to secure either an assignment of the existing lease or a new lease altogether.

3.     Am I able to transfer the liquor license?

For many restaurant sales, the transfer of the existing liquor license is essential, especially in jurisdictions where the issuance of new licenses is limited in some way. In such instances, buyers must take appropriate measures to ensure there is nothing that could prevent the restaurant’s liquor license from being transferred from the seller. Such things could be a poor compliance record that could cause the transfer to be protested, a pending violation that could lead to revocation, or some other factor related to the buyer himself that might cause local authorities to deny the transfer. Investigation into such matters should be part of any buyer’s due diligence, and appropriate contingencies should always be included in any agreement.

4.     Will I have full rights to the restaurant’s trade name?

Here we have the very simple matter of ensuring that, if you are buying “McFinley’s Tap House,” you can still call it “McFinley’s Tap House” after you take over. As stated above, most asset purchase agreements will include the restaurant’s trade name and other intellectual property as being among the intangible assets of the business.   In some cases, however, a third party may have granted the seller the rights to use a restaurant’s name, and may still be entitled to assert some control over who uses that name. Any seller should therefore be required to demonstrate that he has the right to transfer the trade name to you, and that no third party licensor has any ability to prevent you from using it.

Three Common Mistakes to Avoid When Starting your Business

slip-up-danger-careless-slipperyLet’s get one thing out of the way:  when you are starting a business you are going to make mistakes — a million of them.  That’s okay.  It’s how we learn and grow, and it also keeps things interesting.  But what’s not okay is when we make mistakes that are easily avoidable, and which can have serious repercussions for the future of our businesses, whether they succeed, and what happens to us if they don’t.

These are three such mistakes (I hope you’ll avoid them all):

1.    Delay in setting up your LLC or Corporation

No matter what anyone tells you, establishing a corporate entity for your business is not difficult, and should not be expensive. But it is one of the most important things you can do to protect yourself from personal liability for the debts and obligations of the business. If you delay in setting up your LLC or corporation and sign (even a few) contracts in your individual capacity, you can be exposing your personal assets, and those of your family, to risk in the event any of those contracts goes bad. The same would be true if you engage in a business where someone could be hurt while visiting your business or while working for you. If any of those losses occurs before you’ve property established your entity, you are probably going to be on the hook personally. It is therefore imperative that you set up your entity – and know how to use it properly — such that any person harmed (either physically or economically) by your business can only sue the business, not you personally

2.    DIY Your Lease Negotiation

I see this way too often in my practice, especially my restaurant practice: someone signs a lease without having it reviewed by an attorney, trying to avoid another upfront expense. I get it. You’re spending a ton to get your business off the ground and this seems like one you can avoid. After all, the lease is pretty standard, right? Wrong. Most often, the lease was prepared by the landlord’s lawyer and has many clauses in it that skew strongly to the landlord’s benefit. Why wouldn’t it, after all? If you were preparing the lease, wouldn’t you do the same thing? Here’s the thing, though: many of these terms are negotiable, especially for a landlord looking to make a deal. For the worst provisions, I will simply request that they be removed entirely. But if you try to do this yourself, will you know where those bad terms are? Will you know how hard you can push back? Doing it yourself may cost you your best (and last) opportunity to ensure the lease is as fair as possible, and that you have the best chance to succeed in your business.

In many cases, your lease will commit you to pay hundreds of thousands of dollars over the next 5, 10, or 15 years. Your lease has the power to make or break you, especially in the restaurant business, and a bad lease can doom even the best operators. That is why going it alone on your lease is one of the most penny-wise and pound-foolish things you can do. You owe it to yourself to do all you can to ensure you understand what you are signing, and that you have achieved the best terms possible.

3.    Don’t Put Your Operational Agreements in Writing 

            When you start a business with other people, there are only two possibilities: that you see everything exactly the same way as to how to manage the business, or that you don’t. Very often, however, people think they are in the first category, but they are really in the second. The best way to find out is to put everything down in writing. There is really no excuse. And, as I often tell my clients, if you don’t. the worst thing that can happen to you may be that the business is successful. Then there will actually be something to fight about. Don’t put yourself in that situation. Put it all in writing (and make sure you understand it all before you sign).

What are Your Options? Negotiable or “Market Rate” Lease Renewal Provisions

timetorenewIn a changing real estate market, especially one with rising commercial property values and rental rates, whether you have a renewal option in your commercial lease and the terms of any such option can be critical. It is highly preferable to have an option provision that specifies the rate of any renewal, e.g. some set percentage over the last year of the initial term. It is not uncommon for a lease to say the renewal will be at “market rate” or something similar, then it will be subject to negotiation and agreement between the Tenant and Landlord, leaving the renewal subject to negotiation and agreement between the Tenant and Landlord.  Of course, when this is the case, it largely turns the renewal “option” into simply an exclusive right to negotiate and takes significant control away from the tenant.

If your lease has a market rate or negotiable option provision, here are a couple of things to keep in mind:

  • First, see if there is any provision in your lease that requires the landlord to give you notice of its proposed renewal terms in advance of the date by which you have to give notice of your intention to renew. If there isn’t any such requirement, still go ahead and request that the landlord let you know as much in advance as possible what renewal rate it will be requesting. That will give you a little more time to negotiate with the landlord, or will give you a heads up that the landlord may be looking for much more than you are willing to spend. If you will need to move at the end of your lease, having that bit of extra time may be invaluable.
  • Second, understand that you really have two deadlines: the actual end of the lease, and the date after which it will be impossible for you to find new space and have it ready to move into if you can’t work out a deal with the landlord on your renewal. Is that 6 months before the end of the lease? 9 months? More? You need to have a good sense of this, because if you let that deadline pass, you may be stuck taking whatever deal the landlord is offering because you don’t have anyplace else to go. With restaurant leases this timing factor is critically important because the permitting and buildout requirements of new restaurant space will require much more lead time before any move.
  • Finally, pay close attention to your lease’s holdover provisions. Almost all commercial leases I see in my practice contain drastic rent increase provisions if you stay in the space beyond the end of your lease, with it being common for rent for any holdover period to be 200% the last year of the initial term.  If that is the case in your lease, you must make sure, if you cannot negotiate the renewal term, that you are ready to move when the initial term of the lease is up.

Of course, many of these terms are subject to negotiation at the time you sign your lease and that is the best time to address them. But if you must deal with them later, you should work with your real estate lawyer to ensure you are able to renew your lease on favorable terms or, failing that, have as much time as possible to find a new space.

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.