Boutique Retailers Face Unique Challenges Negotiating Lease

By Jeff Bennett

Independent retailers are small businesses in every sense of the word. They are born from great ideas but usually have little cash. Most need heavy consumer-traffic locations to test marketplace acceptance and hedge financial risks. These sites typically are located in desirable downtown buildings, regional or sub-regional malls and the new lifestyle centers. But, in exchange for a good location the landlord demands a serious cash commitment in the form of a long term lease, payment toward tenant improvements and, typically, the retailer's personal signature on the line. In the alternative, the retailer is jettisoned to a less desirable location and, a significantly higher financial risk.

What is a tenant to do? How do you temper the financial risks associated with the high cost option? How do you deal with a landlord when, as a practical matter, the landlord holds most of the cards? Here are a few tried and true rules of thumb I believe best serve the small business entrepreneur:

1. Be Realistic. The small business has little leverage when dealing with a locationally rich landlord. Unless Rule 2 applies, don't adopt a David and Goliath attitude — it will have several adverse consequences. First, Landlord's of prime space do not "need" to deal with most independent retailers. A tenant with an attitude will wind up in "opportunity lost" territory. Second, even if the landlord is willing to talk, it will be unwilling to deal. There's no need to put yourself at a disadvantage from the get go.
   
   
2. Assert the Leverage You Have. Occasionally, but not often, an independent retailer finds itself in a position where it has some room from which to bargain. Most commonly, a retailer may have a highly specialized product that has or will capture nearly an entire market. This is attractive to a landlord and creates leverage. Sometimes circumstances have more to do with being in the right place at the right time than with the retailer itself. For example, in new construction of a smaller retail center, the landlord may need space leased in order to meet lending requirements. In either case, some leverage is better than none, and it should be used to your advantage. Always know what leverage you have, even if it is slight.
   
   
3. Lease Term. The typical retail lease has a ten year term. This is how lenders manage their risk. Sometimes, however, a lender will accept a shorter term lease for a small tenant. Even for a small space, a ten year term can mean a financial commitment of more than $250,000.00, plus operating expense increases and percentage rent. Seek a five-year term with a five year option. Some landlord's find this approach attractive if coupled with a landlord right to trump the option if certain financial requirements (e.g., minimum annual sales) are not satisfied as of the end of the fourth year.
   
   
4. Cotenancy Requirements. The draw of a large retail center is its anchor tenants. They generate customer traffic the independent retailer cannot. The anchor's traffic also justifies the high rental rates landlord's charge for smaller tenant spaces. So, if the anchor is lost, the tenant loses the benefit of its bargain, right? To hedge, ask for a cotenancy clause which now is commonplace, especially in mall settings. In a perfect world the loss of an anchor would justify termination of the small tenant lease. Realistically, ask for a clause that kicks in only if one or more anchors vacate and the anchor space is not re-tenanted within a year by similar quality traffic generating tenants. The small retailer's remedy rarely is termination. Commonly, rent is reduced to a percentage of total rent (e.g., 50%) for a specific time period (e.g., a year or until the anchor space is operating again). After the time runs, the tenant usually is required to return to previous rent or terminate the lease. Some landlord's require you to show a reduction in gross sales before a remedy kicks in.
   
   
5. Get an Exclusive. Unless you are dealing in retail commodity items like general apparel, shoes or jewelry, an exclusive may be appropriate. This is a hedge against the risk that a direct competitor may locate nearby. Exclusives have become commonplace for mall space and are expected to be available in life style centers. Because of the diversity of building ownership in downtown cores, they are uncommon absent projects like Pioneer Courthouse Square. The clause prevents the landlord from leasing space for the same type uses within the project or part of a project. As was the case with the cotenancy clause, termination is the remedy of last resort. Landlord's usually require you to demonstrate a reduction of anticipated sales and then permit reduced rent for a negotiated period.
   
   
6. The Non-Reconfiguration Clause. Especially in older retail space, there always is the possibility that a landlord will want to retrofit its building to better respond to market demand. The most common means for a landlord to achieve this is to build up. The effect on a base floor retailer may be the addition of structural columns in your space. This kind of physical change can render a small space unusable for its intended use. Make sure the landlord can't do this, and, if the landlord balks, ask what its plans are. There may be better space available in the newly configured space.
   
   
7. Have an Exit Strategy. If your business fails, your lease needs to include a plan for it. Ordinarily you can't just give the space back to the landlord (I can't cover what happens in the event of a bankruptcy in this article). Setting the lease up to make it attractive to a new retailer as an assignee is important. This requires you to focus principally on the use and assignment clauses. First, the described use should be stated as broadly as possible. If it is, you will not need the landlord's approval, at least for the new use. Second, assignment should be permitted to any financially qualified assignee.
   
   
8. Right to Die Clause. Where a tenant is an individual (as opposed to a corporation or some other legal entity), part of any exit strategy should at least seek a "right to die" clause. In the event of the tenant's death, the clause permits the tenant's estate to cancel the lease after a negotiated notice period. A fee probably will be involved.
   
   
9. The Kick Out Clause. A kick out clause permits a tenant to cancel a lease if, after a pre-negotiated period (e.g., three years) the tenant's gross sales projections are not met. Essentially, it's a business failure clause. Very few small tenants succeed in getting such a clause. But, some landlords are willing to consider them if they are reciprocal. In other words, if the tenant fails to meet the negotiated threshold, the landlord can kick the tenant out. Unfortunately, in most cases the landlord's kick out threshold typically is lower than the tenant's (i.e., the landlord can kick the tenant out if gross sales do not exceed $300 per square foot of gross leaseable area but the tenant can cancel only if it fails to attain $400 in sales per square foot).
   
   

Remember that as a small tenant you have a limited opportunity to get your landlord's attention. Don't seek too much if you expect to get anything. At the same time, resist the temptation to simply sign the lease without considering some of the suggestions stated above.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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