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Take Five - Patrick Wartan, Attorney and Chair, Food & Beverage Group at Taft Law

   

 

Top Five Restaurant Lease Considerations

by Patrick Wartan

After months of searching and touring spaces, you finally decided on the perfect spot for your new concept. This is an exciting time, but if you have never negotiated a restaurant lease before, you will quickly see that it can become an overwhelming and daunting task.

Negotiating restaurant leases typically comes in two phases: (1) the Letter of Intent (or the “LOI” for short); and (2) the lease document itself. The LOI is typically a non-binding document that sets forth the basic business and economic terms of your lease, and is not customarily drafted by attorneys. Instead, attorneys use the terms of the LOI to draft the actual lease document, which is the legally-binding contract between you and your landlord. If possible, you should try to address the following issues during the negotiation of your LOI, and not leave them as “TBD” or “for the attorneys” to address. Experience shows that the earlier you and your landlord can come to agreement on the following business terms, the smoother (and faster) the lease negotiations will be for your attorney later on.

While nothing can ever substitute legal advice* from a seasoned attorney, below is an overview of some main issues you should consider when negotiating your first restaurant lease. Please feel free to contact me anytime at (312) 836-4131 or pwartan@taftlaw.com to talk through any of these issues or additional questions you have regarding restaurant legal matters. 

Condition of the Premises

This is an important lease component, as it details what is included with the rental property and the condition the premises will be in when you ─ the tenant─ take possession. The physical condition of the premises should be considered and documented in writing, so there is no confusion as to the condition of the property when the landlord turns it over to the tenant. What portion of the build-out is required by the landlord? Will you be presented with a turnkey operation with all of the furniture, fixtures, and equipment included? Issues under this provision commonly factor in when the space was previously used by another business or industry, or if the site is newly-developed and never had a previous tenant. For example, the electrical and/or water service at the premises may not be adequate to support a restaurant user. Replacement of either component can be incredibly costly and, unless contemplated prior to the execution of the lease, may fall on the tenant. Further, if black iron pipe for ventilation is required by code but not contemplated in the lease, that cost will likely be absorbed by the tenant.

Additionally, any improvements and non-cosmetic alterations to the premises will likely be subject to the landlord’s approval and must be in compliance with applicable law. Your architect’s formal plans will likely remain subject to the landlord’s approval. Further, you should make sure to detail which aspects of the alterations are your responsibility and which are the landlord’s. Generally, improvements to the premises can be factored into the amount of the fixed rent, when a tenant improvement allowance is granted by the landlord.

Licensing/Permitting; Contingencies; and Termination Rights

When negotiating the LOI for the lease, think through your project timeline. You will first want to review zoning regulations and determine if a liquor moratorium exists to confirm that the license you are seeking can be issued at that address. You will then determine how long it will take to prepare plans and obtain a building permit. After you obtain a building permit, you may apply for the food and, if applicable, the liquor license.

A conservative timeline to obtain a liquor license is approximately three to four months after filing the application. Note, however, that in the City of Chicago, you cannot apply for a food and/or liquor license until after you’ve obtained your building permit. Taking the time to prepare a timeline ahead of the project will help align your process with the landlord’s expectations.

Understanding your timeline is extremely important in the lease negotiations because as the tenant, you could negotiate to push the rent commencement date until the date the food and/or liquor license is issued, or negotiate for a contingency to obtain the licenses which would provide you the ability to terminate the lease in the event that the licenses are not issued. This should be non-negotiable on the part of the tenant. Without a contingency to obtain a license, if you are ultimately unable to secure the requisite license(s), you may be stuck paying rent for the premises without the ability to operate. Some landlords may require a payment of a termination fee in connection with the aforementioned contingency. The termination fee is essentially a specified amount for a tenant’s exercise of the right to terminate, or reimbursement for the landlord’s brokerage and legal fees and funds spent readying the property for you.

Additionally, you may want to consider requesting certain termination rights which will afford you the opportunity to terminate the lease in the event of certain conditions. As an example, a termination right in the event that there is a drop in gross sales. A landlord may be hesitant to agree to such a term, but having an escape hatch will grant you some peace of mind.

Use Clauses and Exclusivity

The permitted-use clause determines the allowable scope of your use of the premises. It often describes the actual concept and style of your restaurant. A tenant’s preference would be a broad use clause such as “Tenant shall use the Premises for a restaurant with liquor sales and any other lawful use.” However, a landlord would prefer a narrow and specific use clause and may often require the tenant to attach an agreed upon menu to the lease as an exhibit. The parties will ultimately need to negotiate and find a balance here but you should be careful not to agree to a use which potentially limits your ability to innovate in the future.

If you’re setting up shop in a building with more than one retail space (i.e. shopping mall, strip center, or mixed-use building), you may get the benefit of increased foot traffic in your restaurant, but you may also want to make sure your landlord won’t rent a space to a competing restaurant next door to your restaurant. Adding an exclusive use clause to the lease agreement protects your business, because the landlord then can’t cause your business to suffer by setting up a competing venue in the same facility.

Guarantees

Restaurateurs will often insulate themselves from personal liability by creating special purpose entities (“SPEs”) to operate the restaurants and serve as the named tenant entities. In the event of a breach of a lease, often times the SPE tenant may not be sufficiently capitalized to provide adequate financial resources to cover the breach. To circumvent this, landlords may require a lease condition that obtains personal or corporate guarantees from you or affiliated parties with deeper financial coffers to cover your obligation in the event of a default.

You and your landlord must seriously consider a fair balance that protects both of your interests. Solutions can include limiting guarantees to a specific number of lease term years or to a maximum dollar amount to ensure the viability of your business and lease obligations.

Permitted Transfers / Assignability

Transferability of your lease is important for a variety of reasons, as it can be viewed as a potential exit strategy. In the event the business fails, you may be able to sell the furniture, fixtures, and equipment and assign the lease to a new operator. Landlords will typically require that you obtain the landlord’s consent prior to assigning, subletting, or licensing the premises – even in the event of a sale of your company to a third party. If the landlord withholds consent to a proposed transfer, you will be bound under the lease to continue meeting your rent obligations and subject to any guarantees you have provided. Therefore, you will want to carve out situations where you can transfer/assign the lease to a third-party without obtaining the landlord’s consent, also known as ‘permissible transfers.’ Some examples of permissible transfers include assigning to a prospective party who has a certain level of experience and net worth. 

 

*Please note: The above information is provided as a membership service for restaurant operators, and is not intended as legal or professional advice or counsel. Any local, state, or federal rules, regulations, or laws summarized are subject to change. The Illinois Restaurant Association strongly encourages readers to consult with their attorney or competent professional prior to taking action based on the above information.

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