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Sep 2003
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September 01, 2003

How to Keep a Roof Over Your Head Without Losing Your Shirt

Restaurant operators face many barriers to success. Start-up costs are significant and competition for patrons is fierce. Even if a restaurant owner can successfully market his/her establishment, the operation may not succeed unless the agreement under which the space is leased has been properly negotiated. The restaurant tenant must make certain that the lease does not contain provisions that will improperly or unexpectedly allocate risk or cost to the tenant. In this article, I will identify thirteen provisions that could slow the progress of an otherwise successful restaurant tenant. With some resolve in negotiating its lease, the restaurant tenant will increase its likelihood of success.

  1. Premises. The premises must be properly described and measured. Rent is often based upon the number of square feet of space within the premises. When comparing lease rates, the restaurant tenant must confirm that the method of measurement is consistent (e.g., rentable vs. rentable, usable vs. usable, etc.). The restaurant tenant must make certain it is comparing apples to apples.

  2. Percentage Rent. If the lease contains a percentage rent clause, the tenant should calculate its full rental obligation under all reasonably foreseeable scenarios. The restaurant tenant should confirm that a particularly weak or strong performance will not lead to an oppressive or above-market rental rate.

  3. Landlord Work. Because start-up costs can be significant, a prompt commencement of operations is essential. The tenant should confirm that the lease contains a firm commencement date with appropriate penalties if the landlord fails to perform.

  4. Pass-Through Expenses. The restaurant tenant must prevent the landlord from "passing through" a number of landlord expenses, including: (i) depreciation; (ii) amortization of debt and financing costs; (iii) costs reimbursed by third parties; (iv) marketing, advertising and renovation costs; (v) legal and accounting expenses; (vi) overhead and administrative costs; (vii) costs to correct defects in the project or because the landlord breaches the lease; (viii) any cost exceeding the fair market cost for the service/good provided; (ix) costs to remediate contamination; and (x) costs not incurred under sound management principles. If taxes and assessments are passed through, the landlord should only pass through currently due installments of taxes and assessments. If the landlord has the opportunity to pay taxes and assessments in installments, the landlord should be required to pay such sums over the longest period of time allowed before delinquency. The tenant should attempt to cap increases in pass-through expenses during the lease term. The tenant should also have the right to audit any pass-through expense calculation.

  5. Tenant Improvements. The restaurant tenant should seek the right, but not the obligation, to remove any improvements to the premises made by or for the tenant prior to or during the lease term. Removal and restoration costs could be significant. In addition, the tenant may require improvements at a new location or in the event of liquidation. The tenant should not allow the landlord to hold a "landlord's lien" on any tenant improvements or other property.

  6. Rent Abatement. Rent and other sums under the lease should abate (proportionately, when appropriate) when: (i) the premises or essential common areas are damaged by a casualty or condemned, (ii) required repairs are not promptly and properly completed, or (iii) essential services are interrupted.

  7. Landlord's Consent. Whenever the landlord's consent is required under the lease, the tenant should insist that it not be unreasonably withheld, delayed or conditioned. The tenant should be wary of landlord fees associated with reviewing any request for consent.

  8. Insurance/Indemnity/Waiver. The landlord should be required to maintain full replacement cost insurance on the premises and waive any claims against tenant covered by such insurance. The landlord must provide tenant a waiver of subrogation rights from landlord's insurance carrier. Any indemnity clause in the lease must be subject to the landlord's waiver and should otherwise be reciprocal. In the event of a casualty, the landlord should be required to promptly restore the premises.

  9. Non-disturbance. The landlord should be required to provide the tenant a non-disturbance agreement from any lender holding a mortgage on the premises.

  10. Representations. The landlord should represent and warrant to tenant that the landlord owns the premises and that the premises (i) are in good condition, (ii) are served by all necessary utilities, (iii) comply with all laws, (iv) are free of contamination, and (v) may be used for tenant's intended use.

  11. Remedies. The lease should provide the tenant at least ten days' written notice and opportunity to cure any breach of the lease before the landlord may exercise any remedies or levy any late charges. The lease should also provide the tenant reasonable remedies in the event of a landlord breach.

  12. Relocation. The lease should not allow the landlord to re-locate the tenant.

  13. Other Tenants. The tenant should consider preventing the landlord from leasing other space in the project to another restaurant and should also consider limiting the other types of businesses allowed in the project. In addition, the tenant may wish to limit the potential uses of any common area of the project.

If a restaurant tenant carefully negotiates its lease, it may be successful in keeping a roof over its head without losing its shirt.

* * *

James J. Rabaut is a partner with Warner Norcross & Judd LLP and he focuses his practice in real estate transactions, including, without limitation: commercial construction projects, commercial lease negotiations, commercial real estate sales and acquisitions and business condominiums. Jim may be reached in the Grand Rapids office at 616.752.2178. Warner Norcross & Judd is a full-service law firm with offices in Grand Rapids, Metro Detroit, Holland, and Muskegon. Because each business situation is different, this information is intended for general information purposes only and is not intended to provide legal advice.

Next Course Magazine

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