Restaurant leases are similar to other retail leases in terms of the challenges they present and the care the restaurant owner must take. When you are leasing premises for your restaurant, you must perform due diligence checks including but not limited to:
- Review the survey
- Thoroughly read the property condition report
- Read all documents that state restrictions
- Review the Phase I environmental report
Given the time and cost involved in leasing premises for your restaurant, due diligence is even more vital than normal. You need to ensure the site is properly set up for the needs of a restaurant, including utilities, parking, sanitation, and compliance with all industry regulations. Even visibility and access to your customer base is a major concern for your business.
Landlords will often want to maintain a high degree of control over who they choose as tenants. They prefer to have a good mix of tenants to ensure there is no competition amongst other tenants and increase the number of customers visiting their development.
In this article, we will address a number of the common issues that restaurant owners will face during the lease and offer negotiation process.
Contractual Issues in Restaurant Leasing
A restaurant lease is a huge commitment and tends to be at least ten years long. Therefore, restauranteurs need to have a plan for how they will run the business for the minimum duration of the lease, not just for the opening. Some common issues during the term of the lease include:
Use Clauses
Landlords like to restrict the use of their premises to avoid competition amongst their tenants and encourage enough variety to attract visitors to their development. A landlord might want to establish the dining style of the restaurant as well as the cuisine you plan to offer. On the other hand, a tenant likes a little bit of flexibility so they can innovate, especially if they are opening a new restaurant. This is why tenants should shy away from providing the landlord with a sample menu with their lease. Depending on the contract wording, it may cause issues if your menu changes at all.
A tenant should negotiate to protect its rights to make periodic changes to the menu, restaurant design, and even small concept changes. Some landlords may permit this by having an expanded use clause once the restaurant has been in operation for a certain length of time. Other landlords prefer to have clauses that limit the amount of square footage or percentage of sales that may be devoted to any new uses of the space. Tenants in response to strict use clauses may negotiate a right to terminate the lease if their restaurant does not make a certain amount of sales. It can be a tricky negotiation to balance the wishes of the landlord and tenant.
Exclusivity
Exclusivity clauses can create similar tension. A restaurant would not open a similar restaurant, either in terms of cuisine or dining style, to operate nearby and poach their profits. Therefore, a restaurant may ask the landlord for an exclusivity clause to ensure they have a corner on a specific market within the development. Such a clause must protect the tenant’s use of the premises but also allow the landlord to find tenants for the rest of their development. You must clearly define the protected items, even so far as describing protected items of food like burgers.
Landlords should be cautious about allowing certain dining styles to be excluded as that may severely restrict their development. They should also pay close attention to the language of their leases and ensure that they carve out exceptions that allow for current tenants and any successors. They should also allow for incidental use so that a current tenant having one or two pasta dishes on their menu would not violate an Italian restaurant’s exclusive use.
The exclusive clause should also address the following issues:
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- In the event of a sublease or assignment, does the exclusive use clause remain in effect?
- If the tenant no longer operates, does the exclusivity remain in place?
- If the tenant extends or renews their lease, does the exclusivity remain in place?
- What are the penalties for the landlord breaching the exclusivity clause?
- If a breach occurs, are there different penalties for an intentional and unintentional breach?
An exclusivity clause can even be limited by geography; you may negotiate exclusivity in your section of the development or in the food court.
If a tenant wishes to prohibit the sale of certain products, it is easier to negotiate a certain percentage of the menu rather than a certain amount of sales. This is because businesses may not accurately report or record their sales of a certain product. The landlord will react more favourably to this, so they are not liable for a rogue tenant who breaches exclusivity clauses without the landlord’s knowledge. A landlord should also include penalties for breaching the exclusivity clauses of other businesses in their contracts with tenants. They should consider the remedies they offer their tenants for breach of exclusivity clause:
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- Right to terminate the lease plus a return on the initial investment
- Liquidated damages
- Reductions in rent in accordance with decreased earnings
- A time period where the tenant may exercise their right to remedy or continue their lease
Operation, Hours, and Maintenance
When negotiating the lease and letter of intent, the landlord and tenant must be clear on the expected condition of the premises. The lease should clearly state a timeline and the responsibilities to meet deadlines, as well as the penalties for missing them. Also, ensure the lease is clear about remedies for the inconvenienced party.
Landlords may want a tenant to complete their construction and open their store within a specific timeframe and a covenant that requires continuous operating for the term of the lease. They may have a lease that gives them the right to recapture the premises if the tenant does not operate for a specific period of time.
On the other hand, the tenant might want to time its grand opening for a specific date or time of year. Or, if it is a new development, the tenant may not wish to open until a certain number of stores are open, and therefore the development is attracting customers. This is called an opening co-tenancy right. If the landlord grants co-tenancy, then they and the tenant may negotiate reduced rent until the required stores are open.
The tenants may also want contingencies in negotiations such as proper zoning, obtaining a liquor license, and sufficient utilities for construction. To do this, the tenant must do their due diligence and find out the expected time frame of things like obtaining a liquor license or the utilities being connected. It will be vital information to the negotiations between tenant and landlord on the matter. If the process will take a long time, the landlord is less likely to permit no rent payments until after the completion. If the tenant can successfully tie rent payments to certain construction or permits, then the lease will have to contain “what if” provisions. For example, what will happen if the tenant delays applying for the necessary permits.
Hours
If the premises are in a mall or another development with strict opening hours, there may be some restrictions to opening hours. Certain types of restaurants will only open for certain times of the day and may require permission to deviate from the regular opening hours. For example, a brunch café may only be open for breakfast through to mid-afternoon, or a wine and tapas bar may only be open for lunch and dinner. Can the landlord force a restaurant that serves alcohol to open on a Sunday if it operates in jurisdictions where they cannot serve alcohol on Sundays?
Landlords will often require a minimum number of opening hours per day or week from their tenants. This is because most landlords make a portion of the tenants’ sales. The tenant must negotiate these minimum operating hours to ensure they work for their business and its peak times. The lease should also address holidays and temporary closures for inventory, remodelling, or repairs. If a tenant wishes to remain open longer than the standard opening hours of the development, then there may be additional costs for security, access, parking, and lighting to consider.
Installation, Maintenance, and Deliveries
Most restaurants will have unique needs for fitting and layout, so even if the previous tenant was a restaurant, some construction is often necessary. Restaurant owners should carefully consider the premises and receive advice from a construction expert as to whether it is possible to customize the premises for their needs. They need to look at things like drainage, heating, cooling, service, and ventilation.
Both the tenant and landlord should ensure the lease is clear on who is responsible for the installation, maintenance, repairs, and cost of equipment on the premises. For example, if the tenant has to install circulation systems or vents, are they responsible for them, or is the landlord responsible for them? Venting provisions in a lease can be rife for conflict, and you need to ensure the lease is clear on how it should be handled. For example, no matter the number of vents and circulation systems, a certain amount of cooking smell is normal for a restaurant, bakery, or café. The lease should allow a reasonable amount of smell without penalty. Also, depending on the layout of the building, venting may be more complex.
Restaurants also have a unique need for grease traps which need regular maintenance to avoid damage to the property. In most cases, a landlord will usually make grease trap installation and maintenance the tenant’s responsibility. However, if it is a food court with a shared grease trap, then the landlord is often responsible for the maintenance and will pass the costs onto the tenants.
Waste disposal is another common issue for restaurants. Landlords with restaurant tenants will want to ensure regular waste pick up and that the bins and trash compactors are kept far away from the main areas of the development to avoid smells and pests. The tenant can consider the costs and prohibitions of the landlord’s trash disposal services and the cost of using their own contractor to handle their waste. Along with waste management, the lease should also address pest control responsibilities for each party.
Restaurants will also require regular and large deliveries, so they will need to have clear provisions on loading zones, access, and delivery times.
Alterations and Improvements
Along with the building systems, a restaurant will want to have a little bit of flexibility and freedom to install and change equipment, furniture, and fixtures as their business needs. They need to install anything from walk-in fridges and freezers to seating for their customers. The lease needs to clearly lay out the process for sending plans to the landlord for approval before any material alterations are carried out.
The lease should also provide clear instructions for signage and take into account the landlord’s wishes as well as the requirements of government agencies. For example, a landlord may find that proposed signage detracts from the desired aesthetic of their development or causes confusion amongst tenants. Careful negotiation needs to occur to ensure the tenant’s need for visibility is weighed against landlord and government restrictions.
Satellite TV or anything else that requires aerials or antennae on the roof can also be a tricky topic. The landlord has to weigh up the visibility of equipment on the roof as well as the noise and weight of the equipment. Even if it is granted, the landlord may require the tenant to use the landlord’s contractors at their own cost to protect their roof warranty.
Liens are common in leases to help the landlord recoup some of the cost for unpaid rent or to help them lease out the premises quicker after terminating the lease. Most restaurants will be reluctant to allow these as they may interfere with lenders’ rights or cause brand confusion amongst their customers. If anything, the value of such furniture and equipment are minimal. Even without a lien, the lease should clearly spell out what will happen with any fixtures or improvements the tenant makes during the term of their lease. This will stop the landlord from trying to force a tenant to leave a particular item they were planning to sell or move into new premises.
Parking and Drive-Throughs
Restaurants will often have greater parking needs than other retail tenants, especially during their peak hours. A lack of adequate parking could reduce the tenant’s business or cause a spillover into other tenants’ parking. To combat this, a landlord might designate certain areas of parking for that restaurant’s customers and employees or short-term parking spots for takeout customers of a business. A restaurant tenant should negotiate to secure as many parking spaces as possible for their business. They may even ask for a clause that gives them the right to approve or deny changes to the parking.
Another remedy for inadequate parking is valet parking, which will reduce congestion in developments with multiple restaurants. This needs to be checked against local permits and be stated in the lease. A landlord will often require a little bit of flexibility as to the location of the valet stand and valet parking to ensure optimal traffic flow.
A landlord should ensure that any agreements they make regarding parking do not encroach on existing leases. They should also consider the lighting in parking areas, especially for restaurant tenants that are open until late at night. Additional lighting can increase the security of an area for employees and customers. Ensuring that parking for both the customers and employees are close to the restaurant is similarly important for safety, especially for late-night restaurants.
The landlord should carefully weigh up the benefits of allowing a restaurant dedicated parking against the reduced parking for other tenants. Is there enough room for overflow parking if necessary or an easement with nearby parking? If they need to build additional parking, the landlord should weigh the cost against the income the restaurant will bring.
The lease should also address the maintenance and upkeep of the parking area and who is in charge of controlling it. There are opposing cases to be made. For example, the tenant may want to tow other customers who park in their parking zone. The landlord may want to tow or fine the tenant if their employees use customer parking instead of dedicated employee parking.
In terms of drive-through, the tenant should conduct due diligence checks to ensure they will be able to receive permits and that the drive-through will not violate any government restrictions. Landlords would be reluctant to perform such checks, so this responsibility falls upon the tenant. The tenant will likely be required in the lease to handle traffic control as well. This may be in the forms of directing traffic or just ensuring the drive-through process is quick and prevents traffic backlogs that interfere with parking.
Patios
Patios benefit both parties. The tenant has additional capacity without paying more rent and offers different seating options for their customers. The landlord will profit from the success of the tenant. In many cases, the tenant will be responsible for the patio in the lease. There will be cleanliness standards, maintenance, and insurance requirements listed in the lease. The landlord should ensure that the Patio is included in the definition of premises in the lease, even if they are not charging additional rent for its use.
The tenant should be prepared to negotiate with the landlord in regards to the appearance of the patio. While the tenant may want to design and brand it in accordance with their business, the landlord wants the patio to fit in with the rest of the development. The lease may give the landlord approval rights over furniture and general design. It is also normal to have noise control requirements in the lease that prohibit the use of outdoor speakers. When negotiating this part of the lease, the tenant must keep in mind their branding and any requirements they may have as part of a franchise or chain. They should also limit the control of the landlord over the staffing levels, food and beverage served, or equipment allowed on the patio. Ensure the language is specific to prevent confusion or disagreements.
Utilities
A restaurant has different needs to other retail tenants in terms of capacity and cost of utilities. Retail stores will often need around 200 amps of electricity to run. But a mid-size restaurant will require 1200 amps on top of any gas needs. This is because they are not only powering lights, they are also powering appliances and large coolers. Drainage also needs to be sufficient to handle not only water, but acid, sugar, and alcoholic beverages.
When sending a letter of intent, a restaurant tenant should conduct due diligence and express their requirements for utility location and capacity. To express utility location needs, the tenant may include a copy of their approved plans. If the utility needs to be brought to the premises, then the lease needs to state who is responsible for the cost and work of bringing that utility. Check that moratoriums do not exist that would prevent this. Some moratoriums may be seasonal to factor in frozen ground or hot weather. The lease should also clarify who is responsible for the costs of deposits, impact fees, or tap-in fees.
The lease also must be clear on who is responsible for maintenance, replacement, and repair of utility. It may be obvious if the tenant’s utility line connects with the city line; however, if the tenant’s utility connects to the landlord’s utility lines, then it may not be as clear. Layout clearly who is responsible for maintenance and the cost of such maintenance and repairs. Also, if the landlord is responsible for the installation and maintenance of utilities, then the tenant should ensure the lease gives them remedies for missed installation deadlines and if the utilities go down. This may be reduced rent or termination rights. The landlord may negotiate these remedies to ensure they have the opportunity to cure and delayed effectiveness. It is important to consider how utilities will be installed and maintained and if easements are needed to accessed, shared parts of the building like the roof or garage.
Alcohol/Ancillary Uses
Most restaurants will seek to serve alcohol if possible because it offers high-profit margins and can increase the number of time customers spend in their restaurant, spending money. However, alcohol does bring extra costs in terms of licensing/permits and liability insurance premiums. These additional costs should be addressed in the lease.
The tenant will need to do their due diligence to check any restrictions that may impede their ability to acquire a liquor license. There may also be local restrictions that apply to the time or days that alcohol may be served. We recommend the tenant performs these due diligence checks while negotiating the letter of intent to ensure they know how long it will take them to obtain the necessary licenses.
In the letter of intent, you should also address what type of liquor license you are considering. For example. There are transferrable licenses which would also include the next tenant to sell alcohol. Would the landlord prefer you apply for such a liquor license and give them the option of purchasing it at the end of your tenancy? The letter of intent should also include provisions that would ensure the landlord promptly cooperates with any efforts by the tenant to obtain the liquor license. This obligation for cooperation includes any renewal efforts.
Transfers
Because most restaurants have leases that are at least ten years long, the risk of opening a restaurant can be extremely high. The tenant’s desire to include exit strategies in the lease will be in conflict with the landlord’s wish to control who occupies their development. Therefore, any transfer or subletting often have clauses to allow the landlord to sign off on any subletting or transfer decisions. The original lease conditions will often stay in play for the subletter or subsequent tenant.
Issues can also occur when the restaurant is part of a franchise, as franchisors will want to have a certain degree of control over the branding and operations of the restaurant. So there are 3 parties involved in lease negotiations. The franchisor may even want the option to take the lease assignment back if the tenant defaults so they can reassign the store to another franchisee.
Financing can be common for new restaurants, especially if the tenant is bearing much of the cost for fitting out the premises. The landlord may want to restrict what the lender may want to do if the tenant defaults on any of their loans. They may want to have the option to sell the equipment to recoup some of their lost costs rather than the lender doing so. Alternatively, they may use the equipment and fixtures to attract new tenants to the premises.
Another option for the landlord is to recapture the premises rather than allowing the tenant to transfer its lease interest. This option will often involve the landlord paying an amount for the enhancement that the tenant made that would make the space more attractive to future restaurant tenants. This should be negotiated and included in the lease, so each party knows its responsibilities.
Casualty and Insurance
The lease should also detail what will happen if a casualty affects the premises or development. Because a restaurant has expensive equipment and fixtures, the cost to repair or rebuild can be huge in comparison to other retail spaces. The lease should define the insurance responsibilities of each party and which party is responsible for the process and cost of repairing or rebuilding which parts of the premises. Landlords and tenants will have differing views on this because while both want to reopen as soon as possible, neither party wants to be on the hook for the costs.
Usually, if a certain amount of the development is affected, the landlord is often responsible for some of the rebuilding obligations and costs. The obligations are dependent on the language and clauses of the lease. Both parties should ensure that the lease has stipulations for different types of scenarios. Some restaurant leases we have negotiated have laid out obligations for the landlord to repair joint utilities. Only once these are repaired do the obligations of the tenant begin.
The tenant should contain sufficient business interruption insurance to cover the rebuilding period. Often, restaurant rebuilding is much more expensive and takes a lot more time than other types of businesses. This should be clearly laid out in the lease. The landlord has just as much interest in the tenant having sufficient business interruption insurance as the tenant does.
Similarly, the tenant should carry insurance that covers the higher risk of casualty that restaurants have due to their high usage of utilities and equipment. The landlord should consider putting clauses in their lease to prevent the tenants from behaving in any way that would negate the landlord’s insurance or otherwise increase premiums. Both parties should do their due diligence to check that the intended use of the tenant would not increase the cost of the landlord’s insurance.
Post-Opening Termination Rights
A lease for a restaurant tenant should also address any termination rights the business may have once it has an opening for business. For example, a tenant might want exit clauses to address revoking any permits or licenses for reasons outside of their control. Also, the lease should address what happens if the tenant dies or is incapacitated.
The lease should also address issues about smells that are difficult to get rid of, force majeure, and even acts of terrorism. Possible remedies and rights to termination should be addressed in these parts of the lease.
ADA Accessibility Issues
Restaurants must comply with federal, state, and local laws regarding accessibility. The ADA has some strict requirements for the removal of communication and architectural barriers, but there may be additional laws that would apply to the premises. The tenant should budget for the additional costs when calculating its construction budget.
When ensuring their restaurant is accessible, the tenant should pay close attention to bathrooms, parking areas, entrances and exits, menus, and signage. The lease should address how costs relating to accessibility should be allocated, especially for access outside the premises. For example, for parking for the development or entry to the development.
Other Costs
Most landlords will require their tenants to contribute to cleaning and maintenance (CAM)costs for the development. If there is not a fixed CAM cost, the tenant should negotiate a cap amount and reduce the landlord’s ability to increase the rate in future years.
Restaurants will often use more trash, water, and electricity services as well as require additional security services for later hours. The leases should address how the CAM costs will be split and whether they will pay higher rates than non-restaurant tenants or if the calculation is based on square footage.
Another important part of the lease will be the rent portion that is based on a percentage of sales. It is in the tenant’s interest to negotiate exclusions and breakpoints into this part of the lease. Most tenants and landlords will agree on exclusions such as:
- Gratuities
- Insurance
- Sales of furniture, fixtures, and equipment
- Employee meals
- House allowances
- Condemnation and refinancing proceeds
But things like gift cards may be a point of dispute. Tenants who are part of a franchise or chain may not want to include these in the gross sales calculations as the gift card may be redeemed elsewhere.
Easements and Licenses
Tenants should conduct due diligence to ensure that easements exist that allow for:
- Signage
- Additional parking
- Access
- Valet parking
- Utilities
- Non-exclusive patio seating in common areas
- Drive-through lanes
If the easements do not already exist, then the lease should require the landlord to grant the appropriate licenses for the tenant during the term of the lease.
Relocation
If the landlord asks a tenant to relocate, then it should be at the landlord’s cost. The tenant should also have a right to termination if they find the new premises unsatisfactory.
The tenant may demand compensation for any and all losses they incur from the move. This can include reasonable lost profits, the dark period costs for their staff, and the cost of obtaining new licenses and permits for space.
The landlord has the right to relocate tenants if they wish so that the development can grow.
Delivery Conditions by Premises Type
The type of premises and development may have an effect on the lease. We will compare outparcel sites or premises that are located outside of the main development and in-line sites or premises inside the development. Each type of site will have different due diligence checks required:
Outside
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- Phase I Environmental Reports
- ALTA surveys
- Geotechnical soil tests
Inside
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- Plumbing plans
- Electrical plans
- Mechanical plans
Also, the landlord will need to bring utilities to tenants inside their development, but exterior premises will need to bring their own utilities.
Interior tenants will need to negotiate the installation and maintenance of utilities and facilities that may be shared amongst tenants. If the landlord does not deliver the premises in the agreed-upon state, then remedies may be termination with reimbursement of costs or liquidated damages.
An exterior tenant may need to install and maintain utilities and facilities themselves. If the landlord does not deliver the premises in the agreed-upon state, then the remedy would more likely be self-help.
In either case, the lease should include good faith obligations of both parties in terms of meeting realistic deadlines for completion of work.
Protection From Interference
Tenants can request clauses in the lease that will protect their premises from anything that may deter customers or inhibit the frequent deliveries their business requires. To do this, they can negotiate terms that prohibit temporary events within a specified distance of their premises or even other businesses of a similar kind. They may also negotiate terms that prohibit obstructions such as maintenance of access points, parking lots, or drive aisles and scaffolding.
Landlords will obviously prefer flexibility in how they manage their developments and what tenants or temporary events they run, so they may not keep negotiating these terms. Any lease disagreements over these terms can be remedied by requiring the landlord to give the tenant prior notice of any temporary interferences. The lease should also state that the landlord will coordinate with the tenant and make reasonable efforts to reduce the impact that any such interference would have on restaurant operations and profits.
Guarantees
Restaurants can be very uncertain businesses, and therefore restaurant owners will operate as an SPE (special purpose entity) to protect themselves from personal liability. An SPE will mean that landlords may not be able to access financial obligations in the event of a lease breach. Therefore, the landlord might require a restaurant tenant who is an SPE to obtain a personal or corporate guarantee. This can be a tricky thing to negotiate as each party will have concerns about the practice. Often the best way to find a fair middle ground is to limit the guarantees to a specific number of years to cover the rocky first few years.
In Conclusion
Restaurant leases can be very challenging because both parties wish to cover their backs can require different clauses and requirements. However, thorough and clear lease negotiation can ensure that both parties know their responsibilities and obligations when certain situations arise.