Power centre leases: Use – exclusivity

May 2009

Power centre leases: Use – exclusivity

bouton-vers-francaisFredric L. Carsley
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Rental structures address financial control. This topic deals with operational control and exit strategies within the context of long term leases. No party of interest, be it landlord, tenant or Secured Lender, has a crystal ball or can predict the future. But when a Major Tenant or Shadow anchor contractually obliges a landlord to operate and maintain a first class shopping centre, when a Secured Lender says to the landlord "perform your obligations under the leases and the RSOA", and when the landlord obliges its tenants to use their respective premises exclusively for the permitted use and continuously operate for those purposes in a first class manner, each is positioning itself to exert operational control.
 
In exploring these themes, be mindful of the following Civil Code concepts:

  • The obligation upon each of the landlord and tenant not to change the form or destination found in Article 1856 CCQ., a carry over from Articles 1607 and 1618 of the Civil Code of Lower Canada (C.C.L.C.)1
  • The covenant of good faith and fair dealing embodied in Articles 6, 7, 317 and 1375 CCQ2

 Use clauses

The purpose of a use clause in a lease is to determine what kind of business the tenant may or may not operate.

Zoning compliance

Landlords and Secured Lenders need tenants to use their premises in a manner that is lawfully compliant. Tenants need landlords to warrant that their permitted uses comply with law. The wider the permitted use, the more difficult this will be to achieve and without a waiver of the legal warranty on use contained in Article 1854 CCQ3, all the more worrisome. Where the landlord is aware that the permitted use is not permitted, a court will not uphold the disclaimer4.
 
Prudent landlords know the extent of the zoning, or ensure the uses are zoning compliant. Prudent tenants not only insist upon a contractual zoning warranty, but sometimes do their own intensive checking, particularly where their businesses contain many classes of uses. Often exterior building uses such as garden centres are only permitted on an accessory or "usage complémentaire" basis, and are subject to a series of restrictions, such as maximum size, type of fencing off, types of merchandise that may be sold, periods of seasonal operation and so forth. Tenants need to know about these; landlords need to permit these operations only if they are done in compliance with all legal requirements.
 
Where there may be some doubt, title insurance can be of assistance. Title companies operating in Canada provide, as a matter of course and without additional premium, a zoning endorsement which insures the actual zoning as being in full force and effect. This is useful in circumstances where there is reason to believe that the City may have improperly adopted or amended the current zoning, rendering the current zoning open to challenge. This will not protect the landlord from a claim by its tenant if applicable zoning does not allow one or more of the tenant's permitted uses.

Interference with other tenants

Keeping in mind the obligation not to change the form or destination, leases need to be constructed to ensure that all tenant operations are harmonized and non conflictual. Landlords often handle these in Rules and Regulations. Tenants should not object to follow these as they are ostensibly established for the common good, provided they are reasonable, do not conflict with the terms of the particular tenant's lease and are applied to the tenant in a non-discriminatory manner. The landlord should agree to this change, provided the tenant accepts the Rules and Regulations attached to the lease; if it has any objection, better to raise this up front.
 
Be proactive when you look at a site plan, as common sense dictates preventive law is the right way to go. Take the example of two anchors close to one another, and each receiving merchandise by 18 wheeler delivery trucks that need to enter and exit quickly. Deal with these in the Rules and Regulations. Where the power centre has a Shadow anchor owning its own land, address these issues in the RSOA, as once the land is sold, the developer loses control, but still has to answer to its tenants that don't care how the developer may be structuring its affairs.

The Use clause spectrum5

What the landlord and Secured Lender want: precision, narrowness and for "no other purpose".
 
What the tenant wants: as much flexibility as possible to evolve the business and provide a potential exit strategy, if necessary, as due to the obligation not to change the destination, all things being equal, the landlord would be reasonable in refusing approval to a transfer for a change of use, unless the lease permits changes.
 
Retail leases clearly demonstrate these polemics.
 
Landlord's dream use clause: Clear, concise and restrictive

  • "The tenant will use the premises for the sale at retail of lead pencils and for no other purpose."

Tenant's dream use clause: Wide open, not even limited to retail, unless the zoning is limited to retail. In the writer's opinion, even better than "any lawful purpose" or no particular use clause. Why? Because of the rule against changing the destination, which is a "lawful" issue.6

  • "Tenant may use the premises for any purpose not prohibited by the zoning by laws applicable to the property."

What really happens in the power centre lease?

  • For most tenants, the landlord's dream clause is far too restrictive, and for landlords, if it gave every tenant the tenant's dream clause, every shopping centre would turn into anarchy, with everyone duplicating what the others do
  • Retail tenants today bargain for wide flexibility to adapt their businesses over time in a competitive manner, and to change the use when they need an exit strategy
  • Use clauses distinguish between principal and ancillary uses: ladies go to Brown's Shoes principally to buy footwear; if they see a purse that goes well with the shoes or the boots, they may buy it. But nobody would suggest that Browns' principal use is anything but fashion footwear
  • Retailers such as drugstores and dollar stores are difficult to identify principal uses. Power centres are no different when there is overlap. Consider the drug store agreeing to limit the sale of food, in order to accommodate the food store's exclusivity demands. How do you count and qualify? A recent judgment involving Pharmaprix drug stores in two First Capital centres, each anchored by a Metro supermarket7 illustrates the point. In both of these situations, Shoppers, the current tenant of the Pharmaprix Lease, agreed to limit the area [Translation] "devoted to the storage, display and sale of food products" to 6% of its gross leasable area. Pharmaprix furthermore acknowledged and agreed to [Translation] "abide by a restrictive covenant within the current lease of the current grocery store ("Metro") located in the shopping centre which stipulates to such effect." The Court ruled that the expression "food" should be given a wide interpretation to anything which is consumable; this would include candy and confectionary products, often found at cash registers or on displays within the store. The Court also ruled how the percentage should be calculated, referring to the fact that the restrictive covenant, originally from Steinberg leases and then transmitted by assignment to Metro, included storage and display of food products which resulted in 23.09% in Fleury and 21.27% in Wilderton. It is important to note that Metro was seeking a permanent injunction against both the landlords and against Shoppers. Since Shoppers had agreed to the restriction, then the injunction could be imposed directly against Shoppers and if the landlord suffered any adverse consequences, it would have its recourses in breach of contract against Shoppers. This really underlines a very important premise in any negotiation involving conflicting rights: Do not commit more than you have
  • The best approach for power centre landlords is to attach the restrictive covenants to the leases of each of the tenants as they come into the Centre and have each tenant agree that it will not do or cause to be done anything which would result in the landlord being in breach of any of these restrictive covenants. Otherwise, particularly where there is a wide use clause, the landlord risks being the target of an injunction from the tenant with the exclusivity, with no back up to turn around to the tenant creating the problem in the first place and possibly, simply exercising its rights resulting from a wide and uncontrolled use clause
  • Some big box retailers such as Canadian Tire can identify their core areas as principal uses, and insist upon exclusivity protection for these areas. As retailers grow into larger format concepts, such as Winners Homesense which combines apparel with home furnishings, and the supercentres which vastly expand their product lines, "principal use" evolves to "principal uses", with all of the problems that creates

While some exclusivities define what the beneficiary considers to be principal as opposed to ancillary, many if not most do not. Controversy arises both when an existing tenant expands its product line, as well as when the landlord is trying to lease space to a new tenant whose product lines overlap with those of the tenant benefitting from the exclusivity. What guidelines should we look to distinguish principal from ancillary? Percentage of sales and floor space devoted to the item(s) in question were employed recently by Quebec Superior Court Justice William Fraiberg8 to assist in making the distinction. The judgment noted that 3% of gross sales (529,500 out of $13,853,799) and 5% of floor area (1,425 square feet out of 29,090 square feet) devoted to major appliances did not breach an exclusivity which, among other matters was "... principally ... as store selling major appliances...". Three and five percent are quite obvious; suppose the percentages would have been in the 25-30% range. Justice Fraiberg observed (at page 7) "that the "principally" qualifier related more to the relative importance of sales of competing products made by a store rather than the extent of space occupied by such store". In so doing, he applied a qualitative approach. At page 7 of the judgment, he explains:

  • "It is through the products they primarily sell that the stores may be distinguished from each other and attract different clientele, even though they may to a lesser extent carry other kinds of merchandise that is the specialty of other stores."

So when agreeing to ancillary uses:

    1. set limits so that the ancillary does not become the principal9
    2. tie them to what is sold in a majority of the stores operating under the same or similar trade name within a geographic area
    3. when drafting "majorities", put a minimum number to avoid "chain dilution"
    4. if the tenant is being given an exclusive, never give this on the ancillary use or uses
    5. where the tenant is strong enough to obtain change of use rights, make this conditional upon not breaching any exclusives existing at the time of the change, not overlapping any existing uses and the new use or uses being compatible with the tenant mix existing at the time10. Note however that some tenants will accept exclusives existing at the time the lease is entered into, and will expect the landlord to carve them out of future exclusives. Anchors and Shadow anchors will often accept an exclusive for the term of the lease of the tenant with the exclusivity but not beyond. They will reason that the exclusivity is tolerated as long as the landlord has no control of the situation. The computer systems and diary systems need to be programmed to bring this to the attention of the landlord at renewal time, as the renewing tenant will expect its exclusivity to continue forward as a matter of course
  • Be careful with generic terminology. "Apparel" is a very wide term. Is it ladies', men's, children's? Is it outwear, evening wear, casual wear, underwear? Is it high- and medium priced or discount?
  • These concepts have real consequences.
    1. suppose the tenant is leasing space in an area over which the anchor has "mix control". The Bay, that owns Zellers, wants retailers of a higher grade than Zellers would require, as the shopper traffic generated towards The Bay differs from what may be generated to Zellers
    2. conversely, the landlord must guard against The Bay converting itself into a Zellers, as the in line tenants will complain;
    3. if the landlord agrees to limit the number of a certain type of stores (such as no more than 3 of any particular types of stores), without tightly drawn use clauses, this is difficult to monitor.
  • Frequently, there is interplay between the use clause and other clauses such as assignment rights. Following Article 1427 CCQ, each clause in a contract is to be considered in conjunction with one another. For example, suppose a department store agrees to use its store as a department store consistent with the majority of its other stores operating under a particular trade name. Suppose as well that the retailer owns a junior department store chain, has inter corporate assignment and sublet rights, and wants to assign to its junior department store affiliate? To avoid doubt, the landlord should make the assignment right subject to respecting the use clause. The tenant on the other hand should be concerned about Article 1427 CCQ and draft in the right to convert the use

Exclusivities and other restrictive covenants

To the landlord, an exclusivity is something to be avoided as much as possible; to the tenant, it is an asset, without which deals will simply not get approved by senior management.
 
Being exceptions to the general rule favouring the free use of property, they will be restrictively interpreted by the Courts11, but they will be enforced where appropriate12. So if the landlord must give the exclusivity, here are a few tips:

  • limit the exclusive to the principal use, or if the wording of the principal use is not tight enough, refine this further
  • make the rights conditional upon the tenant not being in default and continuously operating all of the premises principally for the exclusive use. While this may seem elementary, retailers with go dark rights will want to preserve their exclusivities despite the fact that they are not operating
  • carve out tenants whose uses cannot be controlled. This ranges from the department store that carries anything it wants, to the drug store where it is larger than the store obtaining the exclusive, to the food store which adds uses at will. An exclusive to a bank for banking purposes should carve out ATMs
  • consider limiting the exclusive to the original tenant and its affiliates, although the astute tenant will want this protection available to future acquirers as the freedom from competition the exclusivity provides constitutes a valuable asset which, if not assignable to a potential buyer, could result in price discounting
  • treat the Shadow anchors as if they were tenants. The court of appeal's position in the Victoriaville Metro Standard Life13 case is showing signs of modification, and in any event, the restrictions certainly apply among the co contractants

Many retail sectors today have chains which compete with one another head on. Each has a liberally drafted standard use clause and frequently, an overlapping exclusivity. Here are three (3) possible reconciliation suggestions:

  1. Snapshot in time – where each recognizes the others' exclusivities, agrees not to breach them, but declares to each other that provided it operates substantially in accordance with the manner in which it is operating at that time, it will not be in breach of the exclusivities of any of the others. This requires all the skills the negotiator can muster to accomplish, but it has been done
  2. Inter tenant waiver letters between the various tenants, which have become popular in the United States
  3. Consider the "give none take none" approach, where a retailer asks no exclusivity protections and agrees not to respect any other exclusivity. This works only if all of the other retailers agree

Prohibited activities

These are usually dictated by the anchor leases or RSOA and are needed to be mirrored in the CRU leases. Many are nuisance related, such as sex shops and other image driven uses. Some are operational, such as no theatres, restaurants, etc. within a certain distance of the anchor due to infrequency of parking turnover. A few are sometimes policy driven. For example, Eaton's leases prohibited catalogue stores. The reason was that the consumer would enquire about the product at Eaton's and then buy it cheaper at the catalogue store.

Continuous operation and go dark clauses

A continuous operating covenant is a contractual undertaking to keep the premises open for business for the permitted use during prescribed business hours and business days. It is designed for retail shopping centres where synergy is critical, and if percentage rent is payable, cannot be realized without the store being open for business. Stronger power centre tenants will resist continuous operations. They may agree to open for one day, which actually has more than just symbolic value, as store operators do not build stores to open and close them. Too much human and financial capital is expended in the process to pull the trigger on new stores.

Co-tenancy

Power centre tenants will often insist upon what is known as a "co tenancy" clause, which makes its obligation to continuously operate conditional upon named majors and often a percentage of the other satellites, by number or by GLA, or both, doing likewise. Obviously not what the landlord would offer, but where given, it should:

  • carve out temporary closures due to force majeure, damage or destruction or labour disruptions resultant from strikes or lock outs
  • provide for a curative period, that is reasonably sufficient to find one or more replacement tenants
  • where the tenant exercises a renewal or extension option at a time when the co tenancy is not being met, the existing facts triggering the co tenancy ought to be waived
  • do not extend this to Shadow anchors, as recapture rights discussed below generally will not be available

Go dark clause

Given the obligation not to change the form or destination14, astute tenants contractually give themselves the right to cease continuously operating, known in the trade as "going dark". Sometimes this applies throughout the term; sometimes it applies after a certain limited period, which varies with the policies of the retailer. For the landlord, this can lead to potential disaster, and while our Quebec courts have been much more amenable to granting mandatory injunctions for breach of continuous operating covenants15 than do the common law courts which focus upon enforcement issues as a reason not to exercise the equitable jurisdiction to grant the mandatory injunction, the writer is unaware of any instance where there is no continuous operating covenant. For the tenant, this is an exit strategy which permits flexibility. In dealing with "Go Dark" scenarios:

  • the landlord should insist that the tenant open for business. The landlord could also push for a limited operating period before the Go Dark first applies; most will, as retail chains don't open stores to close them
  • these decisions to Go Dark are difficult ones, not made on a whim, and not taken lightly. The landlord should insist upon significant prior notice, to have an opportunity to re tenant the space
  • the landlord should then insist upon what is known as a "recapture right", being a right to terminate the lease, or part thereof to which the closure applies
  • where the closure is partial, it should be reasonably re tenantable, considering width, depth, frontage, signage availability and other leasing prerequisites
  • if the landlord does not recapture (or its Secured Lender will not allow it to do so), then landlord should place restrictions on the tenant's sublet rights, such as maximum number of units in which the premises may be sub divided, respect for exclusivities, tenant mix and so forth
  • once the pre closure notice period expires, if the landlord hasn't terminated, it is often a race of the swiftest – who gets the new tenant as to what happens. Tenants will object to this (correctly so) as they will be out looking for tenants for the space as well

Good faith and fair dealing

Suppose a tenant has an exclusivity, goes dark, re locates across the street, continues to pay the rent but refuses to surrender the lease in order to keep the competition out of the trade area?
 
At least two decisions, involving supermarket anchors in strip centres, one from New Jersey16 and one from South Carolina17, implied a covenant of good faith and fair dealing to this situation and cancelled the leases.
 
In the writer's view, this is good law, and given the prominent position our Quebec Civil Code affords to good faith and fair dealing, should be applied in Quebec as well. Delving deeper beyond the words of the clause, the landlord gave the tenant an exclusivity to participate in and strengthen this centre. It did not do so to allow the retailer to close, keep the store dark and thereby weaken the centre, while it competes elsewhere in the trade area.

Secured lender issues

  • Exclusivities are sometimes a concern as they may limit the re tenanting process following realization. No tenant will allow the Secured Lender to destroy its exclusivity
  • The Secured Lender wants to see tight use clauses and even tighter exclusivity clauses. It also would like an opportunity to cure defaults, rather than suffer an interruption in the cash flow. A Secured Lender will generally not accept a lease that permits the tenant to terminate in the event of a breach; so adapt accordingly
  • Loan agreements and hypothecs do not allow the borrower to release the tenant or terminate the leases without the Secured Lender's consent. Sometimes it is not practical to obtain the consents, but there are risks associated with potential default. Even in limited recourse loan situations, this failure to obtain consent may be covered by the recourse carve outs, so the decision should be carefully considered
  • Tenants should insist upon a Secured Lender release, where they have notice, have a non disturbance agreement or have signed an estoppel undertaking not to terminate their leases without the Secured Lender's consent
  • Secured lenders of credit tenant leases do not like clauses giving the tenant any type of clause échappatoire. So in go dark scenarios, the tenant should never be given the right to terminate. Going dark is tough enough on the leasing and renewal program; loss of the income stream is disastrous

 

[1] For a detailed analysis on the concept and case law under the C.C.L.C., see F. Carsley’s 1989 Meredith Memorial Lecture circulated as advance reading.
 
[2] For a detailed analysis of the covenant in commercial transactions generally, see Carsley F., Comparative Law Yearbook of International Business, 1997, pages 233-248; In real estate transactions, see Seidman J., McEvily S., Carsley F., ICSC North American Survey – 1999.
 
[3] “He is also bound to warrant the lessee that the property may be used for the purpose for which it was leased and to maintain the property for that purpose throughout the term of the lease.”
 
[4] See for example Tremblay v. Tremblay J.E. 96. 400, A property was structured in divided co?ownership and the declaration prohibited retail and retail signage. Nevertheless, the landlord leased an exclusive unit for a hairdressing salon and disclaimed liability on zoning. The court held that the zoning disclaimer did not apply, as it controlled the majority of the exclusive units and knew that non?residential was not permitted.
 
[5] For an excellent in?depth discussion of the numerous permutations and combinations of retail use clauses, see E. Harper Shopping Center and Stores Leases.
 
[6] See Steinberg Inc. v. Centre d’achats Duberger Inc., [1987] R.J.Q. 868 (C.A.), where a lease gave the Tenant the right to sublet in whole or in part for “any lawful purposes”. The Tenant, a supermarket, went dark and sublet 30% of its store to La Maisonnée, its dépanneur subsidiary. The Court of Appeal cancelled the lease on the basis of change of destination.
 
[7] Metro Richelieu Inc. vs. Corporation First Capital Wilderton Inc., Corporation First Capital Fleury Inc. and Propriétés Shoppers Inc., 500-17-019795-049, October 26, 2005 Jean?Guy Dubois J.C.S.
 
[8] Compagnie Trust Royal v. Iberville Developments Limited and Future Shop Limited, SCM 500-05-069624-011
 
[9] See Place Desjardins Inc. v. Bokobza, [1980] C.S. 1100
 
[10] In re: Micro Cooking Centres Ltd. [1988] 68 C.B.R. 60 contains an excellent explanation of the theory of Tenant mix in shopping centres, justifying a refusal to permit a bankruptcy trustee to assign a lease for a microwave oven store to a dépanneur. Henry J. concluded that in weighing detrimental effects, the interests of the landlord and its Tenants as a collectivity here took precedence over the interests of the mass of creditors to the bankruptcy.
 
[11] See for example, Russo v. Field [1973] S.C.R. 466 S. & I. Management Limited v. Place St-Tropez Inc., 500-09-001477-785.
 
[12] See Hudson’s Bay Company v. Wise Brothers Limited, [1983] C.A. 501
 
[13] Épiciers Unis Métro?Richelieu Inc. v. Standard Life Assurance Company, [2001] R.J.Q. 58.7 (Q.A.) leave to appeal to the Supreme Court of Canada refused November 11, 2001.
 
[14] See 124298 Québec Inc. v. La Banque d’Épargne de la Cité et District de Montréal, [1986] R.J.Q. 852 (C.S.)
 
[15] See for example Compagnie de Construction Belcourt Ltée v. Golden Griddle Pancakes House Ltd., [1988] R.J.Q. 716.
 
[16] Becorde v. Acme Markets Inc. No. A?2367?97TI (N.J. App, Nov. 19, 1998).
 
[17] Bo?Lo, Inc. 386 S.E. 2d

 

 

 

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.

 

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