Commercial Leases: What's the "Use"? 

publication 

Fall 2005 - (Lang Michener LLP InBrief Fall 2005)

Lang Michener LLP InBrief Fall 2005

In any lease of retail premises, whether within a shopping centre or in some other multi-tenant development, the tenant's right to use its premises for its specific business and the landlord's control of the uses within the development are among the most fundamental and important terms. Typically, a use provision will restrict the tenant to using its premises for a specific purpose. The tenant may have also negotiated for an exclusivity right that restricts the landlord from leasing other premises within the development for that purpose.

Over the last number of years the importance of the use clause and its interaction with exclusive rights has escalated as various types of retailers have expanded their product offerings. The examples are numerous: the drugstore has a food aisle, the supermarket has a pharmacy, the video store sells drinks and snacks, the convenience store rents videos, the book store has a gift section, and some drug stores are selling certain consumer electronics. This trend has put pressure on existing use and exclusivity clauses, and provides negotiating and drafting challenges for both landlords and tenants in new deals.

Permitted Uses

A typical use provision in a lease will grant the tenant the right to use the premises for its specific business. The landlord and the tenant approach the negotiation of this provision with different goals. From the tenant's perspective:

  • The tenant will want as broad a use as possible to retain flexibility. This may include a right to change the use or at least to allow for the ongoing evolution of its business; and
  • The tenant will also look to make the right to assign and sublease meaningful. For example, if the tenant is allowed only to sell widgets and it cannot make that use work, limiting assignment and sublease rights to the same use may effectively make the assignment and sublease right meaningless.

On the other hand, the landlord will approach the provision with a different mindset:

  • The landlord will want a very specific use to protect tenant mix within the development. The common perception is that the mix of uses is a major factor in the success of a centre. Success translates into higher rents, which results in increased value. So, control of the uses is important to the landlord;
  • The landlord may need to protect itself from breaches of exclusivity rights granted. If the landlord has given another tenant the exclusive right to sell and rent videos and DVDs, giving a new tenant an unrestricted right to use the premises for any lawful purpose could result in a situation where the exclusive right is breached. The landlord may also want to retain the ability to grant exclusives in the future, and a broad-use clause or a use clause that allows changes might impact that ability. The issue can also go further than simply protecting exclusive rights. Even if a use is not protected by an exclusive right, the landlord may not want to bring in a competing use. One convenience store may be enough and putting in another may preclude either from being economically viable; and
  • Other factors perceived as important to tenant mix (which tend to be more relevant in larger centres) include having an optimal number of tenants for different categories (say no more than 20% fashion, only one convenience store, only one video store etc.); bundling related tenants in certain areas of the centre; having a balance in numbers between recognized national and regional stores and local owner-operators; and having the proper retailers to serve the demographics of the shoppers in the area.

Evolving Uses

Issues arising from the evolving uses of retailers have found their way into the courts. The conflict between the evolving uses of supermarkets and drug stores has been the subject of a number of cases. For instance, in the 1988 case of London Drugs Ltd. v. Truscan Realty, the permitted use was a food supermarket. The court did not accept the supermarket's argument that the wording in the lease should be interpreted in a flexible manner. The supermarket use was to be considered as it existed when the lease was signed, at which time supermarkets did not include pharmacies.

A supermarket pharmacy was permitted, however, in the 1995 case of 947101 Ontario Ltd. v. Barrhaven Town Centre Inc. The Loblaws lease permitted subleasing up to 20 per cent of the store for any use or uses that did not breach any exclusive covenants of others. The pharmacy's exclusive right expressly excluded the food supermarket premises from its operation.

The supermarket and pharmacy issue was most recently considered by the Nova Scotia Court of Appeal in Norsyd Investments Inc. (Receiver of) v. Sobeys Group Inc. In that case, the use provision permitted the premises to be used for "the business of the retail sale of a complete line of food products, as well as general retail merchandising, as carried on by the rest of the majority of its stores." The court found that the professional services offered by a pharmacy were outside the meaning of "general retail merchandising" and determined that, even if the operation of a pharmacy was within that meaning, pharmacies were not yet found in the majority of Sobeys stores.

The reality in the market is that major retailers will now negotiate to protect an evolving use. A landlord may react by trying to limit incidental and ancillary uses outside of the tenant's core business. This may include restricting the floor area, restricting the percentage of sales and requiring the landlord's approval for the sale of any new items.

Exclusive Rights

The granting of exclusives can be a minefield for landlords. It may seem like an easy give that has no cost at the time the deal is made but it can come back to haunt the landlord. Usually it is not the straightforward case of another tenant having the same use, but of components of uses conflicting. For example, does the automated banking machine in the drug store conflict with the bank's exclusive?

Landlords should focus on ensuring that any exclusive granted is for the primary use and not for the products. For example, a landlord could give a convenience store the exclusive right to sell confectionary products and snacks. If this exclusive is granted for these products then the drug store could not sell confectionary, the video store could not sell soft drinks and popcorn and so on. The better alternative for the landlord is to grant an exclusive for the primary use. A convenience store will be protected against another convenience store, but ancillary products of other tenants will be allowed.

From the tenant's perspective, there are a number of drafting issues that should be considered including the following:

  • In the same way a tenant may want to draft a use clause that allows for evolutionary changes, it will want the exclusive clause to have the same effect. If ten years ago a video store exclusive simply prohibited the sale of video cassettes, competing DVD retailers could presumably operate in the face of such an exclusivity. In these type of situations you may see the use and exclusivity provision contemplate products that are a technological evolution of the protected item; and
  • The tenant may negotiate to have the exclusive right applied to expansions and additions to the shopping centre. These could be either through additional buildings on the existing lands or the purchase of further lands by the landlord.

When negotiating an exclusive right, the landlord may require some prerequisites, exclusions and qualifications. For example:

  • It may be that existing leases need to be excluded. The landlord may have granted (or inherited) leases in the past that would allow any retail use and, in such case, the exclusivity could not be enforced should such a tenant change its use to the protected use;
  • The landlord may wish to require that the tenant be in possession and operating (and possibly even being in the position of paying percentage rent); and
  • The landlord may wish to negotiate to limit the operation of the exclusivity to a certain portion of the development.

Conclusion

The use and exclusivity provisions of existing leases are coming under increased scrutiny as retailers continue to expand the products and services offered. While these provisions have always been an important part of any retail lease negotiation, the changing marketplace has increased the importance of such provisions for both landlords and tenants in new deals.

This article appeared in InBrief Fall 2005.