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.

Landlords Come and Go. It’s What Your Lease Says That Matters Most.

Commercial leases, like most contracts, are subject to interpretation. Clauses and terms that may seem clear at the time they are drafted can later become ambiguous, or subject to more than one understanding, especially when words on paper become applied to real life situations. Or the terms may be unclear on their face, and such lack of clarity is simply not recognized until the lease has commenced and the tenancy begun. This reality is something that all business people and their lawyers must deal with, and must understand is part of doing business. Oftentimes landlords and tenants, given the passage of time and over the course of an extended term of dealings come to an understanding on the meaning and applicability of certain lease terms and engage with one another pursuant to that understanding. In the best circumstances, the landlord and tenant work together to ensure neither party is deprived of the benefit they believed they were obtaining at the time of the lease.  It is just good business to make it all work.

But what happens when a commercial building is sold and a new landlord takes over? While the words of that lease may stay the same, the new landlord’s understanding of what they mean (or its motivations in reviewing them) may be different – and perhaps be in conflict with that of the tenant and how it has been previously conducting its business under the lease. Or imagine where the previous landlord had tacitly (or even explicitly) agreed to disregard a lease a provision because it made good business sense to do so. What happens when the new landlord decides to adhere to – and enforce – the precise letter of the agreement?

Something like one of these scenarios appears to have happened in New York City where the high end health club Equinox had been operating its business under a lease for some fifteen years. Throughout that time it appears to have enjoyed a good relationship with its landlord and neighbors in a mixed used building in the Tribeca neighborhood of the City. Then, the building was sold and, earlier this year, the new owner served notice that Equinox was in breach of its lease due to the noise and vibrations its operations emitted. The landlord served Equinox with notice of default and sought to remove them from their long-standing home.

Equinox, not surprisingly, responded that nothing had changed in their operations and the prior landlord had never taken the position that the amount of noise and vibrations emanating from their business was in violation of the lease.  Moreover, Equinox had renewed the lease and invested a great deal in the space in reliance on that long-standing position. The owners of the gym filed suit to stop any eviction and to seek a judgment that they can remain in the premises. They have also claimed millions in damages to account for the investment made in the space based on the understanding the gym would be permitted to remain.

In our practice, we increasingly see this situation arise with our restaurant clients as various real estate investment companies purchase shopping centers and retail buildings. Often smaller local landlords, who have long standing relationships with their tenants, are replaced by out-of-state investment trusts which may not have the same level of tolerance and flexibility when it comes to lease compliance. And in other instances, it may simply be that the new landlord wants the old tenant out for some reason (to renovate, to redevelop, to seek a new tenant mix, etc.) and takes a fresh look at lease to see where a point of leverage – or an opportunity to evict – may be.

For these (as well as many other) reasons, we advocate for a thorough and detailed reading of any commercial lease before our clients commits to it. And we caution against placing too much faith in the past reasonableness or forbearance of a certain landlord. At the end of the day, it is the lease language that controls and it is only that language which is permanent. As such, the only way to ensure the lease’s terms will be read in a manner that is in keeping with your understanding, and that such interpretation will persist for the life of the lease, is to make that language as clear and unequivocal as possible at the time you sign it.

 

 

Lawsuit: DC Waterfront Developers Trying to Drive Us Out of Business

In a federal lawsuit filed last month, the owners of two fish markets and a seafood deli located at the Maine Avenue waterfront in Southwest Washington, DC, have sued the developers of the massive “Wharf” project for violating their lease and trying to drive them out of business.

As expected the lawsuit has gotten significant media attention, as the Wharf development (and the related redevelopment of the fish market) is one of the most ambitious in decades in the Southwest quadrant of DC, and these projects look to reshape the city’s waterfront for generations.   That this redevelopment is occurring at the oldest continuously operating fish market in America (dating to 1805) was bound to lead to disruptions.

But the lawsuit says that the interferences with the plaintiffs’ businesses have gone beyond the simple disruptions that a tenant could or would expect when a major project is being undertaken nearby.  For example, the lawsuit alleges that the developers are purposefully interfering with their use of the common areas (something they are entitled to under their lease), are blocking access to customers and delivery trucks, and ticketing and towing customers’ cars — all part of a “conspiracy” to drive the existing tenants out of business.

As with most landlord-tenant disputes, the outcome of this case will depend on the close reading and interpretation of the parties’ lease, and the provisions contained therein related to use of the common areas, and landlord liability in the event of business disruptions (especially those caused by the landlord itself).  As the developer/landlord has stated in this case, “with any large-scale project in a dense urban area, some temporary disruption is inevitable.”  I see this out my window here in Bethesda, throughout Montgomery County, and I certainly see it whenever I am down in Washington, DC.

But how much disruption is too much?  And where the disruption threatens a long-term business’s viability, what are the tenant’s rights?  Does it have any rights?  Or is its business just the price to be paid for progress?

 

Planning a Brewery? Think Zoning Zoning Zoning

Have you ever wondered why Annapolis, our state’s fair capital city, does not have any craft breweries?  After all, Frederick and Baltimore are home to multiple world class craft beer producers.  Well, the answer is both simple and amazing:  the zoning codes of the City of Annapolis and Anne Arundel County do not include brewing beer as a permitted use.  That means, essentially, there is no building or parcel of land in the entire city or county for which brewing is permitted.

Although, at least as it relates to the County, that may change this year.

This change, if it came, would be thanks in large parts to the efforts of two Maryland brewers — one aspiring and one established — the latter of which who was foreclosed from his first choice of Anne Arundel County and therefore opened his highly successful Jailbreak Brewing (outstanding, by the way) in the more welcoming Howard County instead.  Their efforts, and a few receptive local officials, has prompted a proposal to change to the county’s zoning laws to open the door to brewing in the county.  As a recent news article indicates, the door is not opening all that wide just yet, but it is a start.

Of course, this serves as an important reminder of how although state laws regarding beer making — be it by production breweries, microbreweries or farm breweries — get a lot of the attention, it is often the minutiae of local zoning ordinances and county alcoholic beverage laws that delineate the ability of people to make, sample, and sell their beer.

 

 

 

Things To Consider Before Signing a Restaurant Lease: Exclusive Use Provisions

Nearly all 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 will 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 absolutely essential, and it is similarly essential that you protect it.

To that end, you must do more than just make sure your lease has an exclusive use provision, you must consider what the penalties are to the landlord if they violate it.  Does it just mean you have a right to get out of the lease?  The landlord may, quite frankly, not care much about that.  Imagine you are a small Tex-Mex operator and the other company who wants to move in is Chipotle.  “Go ahead and leave,” the landlord may say.  “It’s been nice having you, but we’re not turning down Chipotle.”  You’re left with the choice of leaving behind your business, or going toe-to-toe with a giant – and very likely watching your business die a slow painful death.  If the landlord faces real penalties – and by that I mean substantial monetary damages – if it knowingly does something to violate a tenant’s exclusivity rights, however, it is much less likely to think of you expendable if a bigger fish comes along.  So make sure the lease has real teeth, ready to bite if your exclusivity rights are violated.

Another thing a tenant must also consider under what terms it can lose its exclusivity rights.  Many restaurant leases contain provisions that state you can lose your exclusivity rights if the event of default, either one or multiple.  Before you sign your lease you need to understand these default provisions clearly, as your exclusivity may be one of your most important assets.  How many defaults will it take for you to lose your exclusivity?  What if you cure the default within a reasonable period of time?  What if you dispute that there is a default at all?  As always, the details of how the lease is drafted are critical.

In sum, you need to make sure your lease includes a clear exclusive use provision, that it causes a real penalty to the landlord if it violates it, and that it cannot be taken from you unreasonably.

UPDATE: SHA Opts Not to Appeal Pre-Condemnation Ruling from Montgomery County

This is to provide an update on this story from earlier this year, where we successfully defended a property owner’s right to deny the State Highway Administration’s efforts to gain access to his property for environmental testing, and actually had the statute in question declared unconstitutional.  As matters turned out, the State Highway Administration did not appeal this ruling.  Some observers argued that SHA had no choice but to appeal, as this statute was essential to their condemnation powers.

Perhaps, however, SHA determined that it would rather lose the ability to gain access to this one piece of property than risk an unfavorable opinion from the appellate courts of Maryland, which would have effectively invalidated the statute for all prospective eminent domain actions throughout the state.

Relatedly, the California Supreme Court is reviewing a lower appeals court’s finding that California’s similar pre-condemnation exploration — or, as the Maryland court called it, “test drive” — statute was also unconstitutional.  The parties are currently in the process of submitting their briefs and oral argument likely will be held next year.  We certainly will be watching.

Liquor License Provisions in “Fast Casual” Restaurant Leases

The Washington Post has an article today on the proliferation of Chipotle-inspired “fast casual” restaurants that allow customers to customize their meals with a variety of fresh ingredients. The article notes that, while more traditional fast food establishments (think McDonalds or Wendy’s or Taco) are struggling to find new opportunities for growth, fast casual restaurants are booming. One of the things missing from the story’s analysis of why these restaurants are so popular is the fact that many serve alcohol. For Millennials on a budget, or Generation Xers looking for a place to get dinner with three little kids (like my wife and I, for example), the prospect of getting a beer with my burger or burrito is an attractive one. It makes the whole dining experience seem just that much more civilized.

In my own law practice, I work regularly with fast casual restaurant clients lately on liquor license and leasing issues. In the latter instance, one of the critical elements of my lease review and negotiation is to ensure that the lease contains provisions related to liquor licenses, including that service of beer and wine be included in the permitted uses and, where possible, the inclusion of a liquor license contingency, i.e. a provision that allows the tenant to terminate the lease if it cannot obtain a liquor license for the establishment.

Where the lease is for a more traditional sit-down restaurant, such provisions may be included as a matter of course, but where a tenant is seeking to open a small burrito shop, that may not be the case.  Indeed, the landlord may not even be aware of the tenant’s intention to apply for a license to serve beer and wine, or the importance of such a license to the tenant’s overall business model. If not, the landlord (who generally prepares the first draft of the lease) may not include a liquor license contingency, or even include the service of alcoholic beverages among the permitted uses at the establishment. If either is not included, it can create significant problems down the road.

Of course, that is why a thorough review of any proposed lease is necessary before the tenant signs, preferably by a lawyer with a strong familiarity with the restaurant business — and who has discussed with the tenant in detail his specific business plan.

Montgomery County Judge Declares Key Maryland Eminent Domain Statute Unconstitutional

On Monday, July 14, a judge of the Montgomery County Circuit Court declared unconstitutional a long-standing law that permits the Maryland State Highway Administration (SHA) to obtain a court order allowing it to enter private property, without the landowner’s consent, and conduct intrusive drilling, soil sampling, and subsurface engineering studies.  The law has been on the books for over thirty years and appears to have never before been subject to significant judicial scrutiny.

Sean T. Morris of The Morris Law Firm, LLC, successfully argued the case on behalf of a shopping center owner who objected to SHA’s demand that the landowner allow SHA engineers to drill multiple 50-foot deep holes through the shopping center’s parking lot in an effort to determine if the property is suitable for condemnation to construct a noise barrier along Interstate 270.  Upon receiving such objection, SHA’s attorneys sought a court order requiring the shopping center owner to grant such access.  The shopping center owner opposed the petition and the matter was set for hearing this past Monday.

During oral argument, the court characterized the relevant provision of the state’s eminent domain law as a “test drive statute” and questioned why the state should be permitted to engage in such actions without providing just compensation for the intrusion as required by the Maryland and United States Constitutions.  Ultimately, the court concluded that the state should not be permitted to do so, finding that such actions amounted to a taking, even if it were only a temporary one.  The court denied SHA’s petition to enter onto the shopping center property and declared the statute “clearly unconstitutional.”

In reaching its opinion, the court engaged in a detailed review of challenges to similar statutes around the country, many of which have previously been found to be unconstitutional by appellate courts around the nation.  One such case appears headed for the California Supreme Court for resolution later this year or next year.  Whether this case is similarly destined for Maryland’s appeals courts remains to be seen.

Bethesda Apartment Building Construction Causing Closures, Spawning Lawsuits

In the last two years, the Woodmont Triangle area of downtown Bethesda has seen a building boom in high-rise luxury apartment buildings.  Construction of one of those buildings, however, appears to be taking its toll on some established local businesses, and has now caused the closing of two local restaurants and an automotive repair shop.

To read more on this ongoing controversy, and the multiple lawsuits it has spawned, please see my post here, which summarizes the excellent coverage from the blog BethesdaNow.

Maryland Announces Plans to Take Private Property for Purple Line

The Maryland Transit Administration has recently begun informing property owners and businesses along the route of the proposed Purple Line that they might have to make plans to move.  That is because the state will begin purchasing property along the proposed route as soon as September 2013.  For those property owners who will not agree to sell — at the state’s proposed price — the state can condemn the property and take it via the power of eminent domain.  Maryland officials have estimated the costs of such property purchases at $200 million.

If you are concerned that your property might be subject to state condemnation to make way for the Purple Line, please contact us so we can review the state’s plans with you.