Thursday, August 20, 2015
Understanding Radius Restrictions in Commercial Leases
Radius restrictions are common in commercial leases that include a percentage rent provision, under which a tenant pays a percentage of the revenue generated from its premises in addition to base rent. Since a landlord does not want the percentage rent generated by the premises diluted by sales originating in one of the tenant’s future locations, a lease will often prohibit a tenant from operating a competing store within a certain radius measured from the location of the premises. Radius restrictions are common in leases for properties that generate income from sales to customers, such as restaurant premises (particularly fast food), retail stores and hotels.
In negotiating a radius restriction, a landlord and tenant will first need to agree on the physical boundary of the restriction. Often, this is done by creating a circular exclusionary zone around the premises with a set radius from a specific point. It can also be done by defining a boundary using specific streets and identifying specific shopping centers, shops or popular sites. An exclusion zone of an entire city may even be appropriate in some circumstances. Ultimately, a landlord will want to ensure that the radius is large enough to protect against a tenant opening a new location so close that it cannibalizes sales from the premises. A tenant, on the other hand, will want to ensure the radius is not so large that it interferes with future expansion—particularly at promising sites.
Second, a landlord and tenant will need to determine to whom the radius restriction applies. A tenant will want to limit the restriction to businesses operated by the tenant using the same trade name or offering the same product. However, a landlord will be uncomfortable with such a narrow scope, since it would allow the tenant to open a competing store within the radius under a different name but the same product. A landlord will want to broaden the restriction to apply to any of the tenant’s affiliates, including its owners and franchisees. But a tenant should be careful to ensure that the definition of “affiliate” is not so broad that it precludes other products operated by the tenant or any of the tenant’s owners or investors.
Third, a landlord and tenant will need to agree on what remedies will apply if the tenant breaches the radius restriction. Along with injunctive relief, a landlord may want to require the tenant to pay a set increase in base rent as liquidated damages. Another remedy would be to include the gross sales (or a portion of the gross sales) from a violating store into the calculation of percentage rent of the premises. The tenant must recognize, however, that the sales used to calculate the amount of percentage rent for the premises would not reduce the amount of gross sales of the store that violates the restriction.
While radius restrictions can appear fairly straight-forward, they may not have their intended effect unless they are carefully crafted. As such, both landlords and tenants can benefit by engaging experienced legal counsel to assist with lease negotiations.
Bruce B. May is Chair of the Jennings, Strouss & Salmon Real Estate practice. He has devoted his entire career to all aspects of the law and practice of real estate and commercial transactions throughout Arizona. Mr. May is named as preeminent in his field in both The Best Lawyers in America® and Southwest Super Lawyers, each since its inception. In 1991 he was elected to membership in The American College of Real Estate Lawyers in honor of his statewide and national accomplishments. Mr. May is also a member of the Georgetown Advanced Commercial Leasing Institute in recognition of his expertise in commercial leasing and keeps current with his corporate clients as a member of the International Association of Attorneys and Executives in Corporate Real Estate.
Alan P. Christenson focuses his practice on all aspects of real estate law, including restaurant, retail and commercial leasing; acquisition, sale and development; and financing.