Exit Strategies for Retail Tenants

margolis Exit Strategies for Retail Tenants

With the shopping center-urban retail community out in full force this past week at the ICSC, and with Black Friday and e-Monday and such all in the frosty air, I figured ’tis the season for a column mainly aimed at those involved in retail and restaurant leasing.

Frankly, the getting-into-the-deal I leave to the many knowledgeable retail/restaurant brokers in our community. But the getting-out-of-the-deal should also be foremost in the thinking of retail tenants and their counsel. In fact, when I gave a continuing ed program for lawyers interested in this topic, the title of the program was (sit down, it’s a long one):

“THE SAVVY RESTAURANT LAWYER–EXIT STRATEGIES IN LEASING OR 134 legal and practical pointers, tips and principles every restaurant leasing lawyer must know AS … sooner or later your client restaurateur will want to sell the business and cash in his chips (his fish, too), or have to contemplate less balmy scenarios, such as a failing business; or the location no longer works; or the concept of the restaurant has become totally dated; or your client’s a multi-location chain and is being acquired in a convoluted takeover play, and you want to/must transfer or terminate the lease.”

So while this program was addressed to lawyers, the subject is relevant, and the principles apply to brokers and tenants of retail/restaurant (and office space) as well.

The harsh realities of restaurant leasing:

  • Statistics say you have five to seven years; then your client’s restaurant’s concept is stale; or …
  • Client is faring poorly in that location; or …
  • Concept/ strategy has changed; or …
  • Tenant was acquired in a multi-store transfer, the acquirer now has three stores within a one-mile radius, and your location is the weakest; or …
  • Client has built a very profitable business and wants to retire, or maybe go to law school!

O.K., having established the need for some protection and the foresight to have a viable exit strategy, now what? Where do you go from there?

Be proactive in lease negotiations and plan ahead for the inevitable.

 

Assignment and Subletting 101

First, some definitions:

Assignment: transfer of tenant’s entire interest in the entire premises for balance of lease term; landlord and assignee then have a direct relationship; post-assignment, assignor (original tenant) and assignee (assuming party-new tenant) have no direct legal relationship.

Sublease: transfer of less than the entire premises or less than the entire balance of lease term (even if the entire balance of the term less one day); subtenant has no direct relationship with landlord, only with tenant (sublandlord). (To throw in some legalese here, there are ancient concepts of privity and surety; that when there is an assignment, privity of contract, not estate, continues to exist between landlord and original tenant. The bottom line is that the original tenant, the assignor, remains liable for lease obligations–albeit secondarily. That’s the concept of surety. Counsel will be looking to make sure the new tenant, the assignee, gives some ongoing indemnification of the assignor-transferer-seller, just in case assignee defaults and landlord demands that the assignor-seller, at this point in time likely long gone from the scene, step back in and cure.)

Next, let’s talk about the sale or other transfer of a retail/restaurant location with the focus on favorable negotiation of assignment and subletting provisions and important related lease clauses.

If it’s a sale and you’re the buyer-transferee-assignee, with the lease already in place, then my best advice is make sure that 90 percent-plus of your due diligence time and effort is spent making sure you understand every business and legal nuance of the lease you’re inheriting. As counsel, we look to measure “transferability” of a lease through the assignment or sublet clauses and the landlord-delineated qualifications (criteria) for the new tenant. We consider the impact of both the obvious (the length of time left on the lease, requirement for landlord’s consent, etc.) and the not so obvious: so-called “silent” (not apparent from the four corners of the document) lease issues and (unhappy) consequences of not knowing where they’re lurking.

Onerous restrictions on the transferability of the lease can make it all but impossible to sell the business. So, for example, be on the lookout for:

  • Use limited to one type of cuisine (“Bulgarian kabob house and no other purpose”).
  • Signage limited to the original, named tenant.
  • An obligation, per the use clause, to operate only under the “ABC” trade name.
  • Recapture as triggered by the proposed assignment or sublease.
  • Renewal rights that disappear if lease has been assigned.
  • Ditto as to hard-fought-for Non-Disturbance Agreements from lenders that run only in favor of the named, original tenant.

In more detail, questions to consider include: When can a tenant assign? Landlord’s consent required? Criteria for consent? Must landlord be “reasonable”? Does state law mandate reasonableness? How has “reasonable(ness)” been defined in the lease? (One side note: Some criteria, while reasonable on their face, can hamstring the exiting tenant. For example, a test of the minimum net worth of the proposed assignee, without due consideration of experience in the field, de facto blocks the successful restaurant manager who has a modest bank balance.)

In the franchise scenario, has the franchisor been recognized up front as a permitted assignee? How about whether the assigning party (original tenant) remains liable for rent under the lease? Recapture rights? Sharing of “profits”? How is “profit” then defined? Where does the transfer leave the original “good-guy” guarantor? And this is only a partial list. Or, with apologies to Bill S., much ado about much.

 

IT’S THE LAW: TENANT’S RIGHT TO ASSIGN OR SUBLET.

General rule: Absent a statute or express restriction in a lease, a tenant has an absolute right to assign or sublet. 

IT’S THE REALITY.

Landlord’s restrictions on assignments and subleases, now in many cases running from a stark “Tenant shall not assign or sublet without landlord’s prior consent” to a solid 10 pages of single-spaced verbiage, all aimed at limiting tenant’s exit options.

So it’s pretty easy to outline the traditional conflict in landlord’s and tenant’s points of view. The bottom line? Bargaining power determines the outcome. Landlords favor restrictions. No surprise there: “Give me the leeway to market my property without competition from my own tenants”–especially in the shopping-center context, where the landlord wants to control the all-important tenant mix. Sounds right. After all, the landlord, not the tenant, is in the real estate business.

The tenant’s point of view–in one word: FLEXIBILITY. At very least: that consent to a proposed assignment or subletting not be unreasonably withheld (on the tenant side, I try to add “nor, delayed or conditioned”). Tenant position: free alienability–“I’ve invested, I’ve created value.” Or as one ancient chain store tenant put it: “Hey, Mr. Landlord, as long as you’re getting your rent, don’t sideswipe my chariot.” (Anonymous. Found on wall of Roman Forum Mall.)

 

NEXT MONTH, WE’LL drill down on what it means to be “reasonable” in New York City (“… like no other place in the world”); the intersection of corporate transfers and lease assignments; and the interplay of numerous other lease clauses on this important topic.

jamargolis@newyorkleaselaw.com

 

Jeffrey Margolis is the lease law columnist for The Commercial Observer. He is founding principal of the Margolis Law Firm in New York City where he specializes in “dirt law”: buying, selling and leasing.