United States: Negotiating The Use Provision In A Commercial Lease

One of the most overlooked but vital provisions when negotiating a commercial lease is the "use" provision.

The "use" provision should be carefully negotiated at the letter of intent stage to avoid any subsequent negotiation problems down the line. Specifically, the landlord and tenant must understand the differences in the legal impact between (1) the permitted use clause, (2) the exclusive use clause, and (3) the prohibited use clause.

As I will show you in the details below, it is critical that these provisions be carefully reviewed and negotiated by lawyers for both sides that have specific expertise in this particular area.

Permitted Use Clause

The permitted use clause enumerates how a tenant will be allowed to use the lease premises and, by implication, suggests that all other uses are not permitted. The use clause can be as wide as "any use permitted by law" and as narrow as describing the how, where, and when of the specific services and/or products a tenant will be allowed to provide from the lease premises. If not carefully negotiated, the use provision can have a number of negative implications for a tenant's business success down the road, as well as harm the landlord's other tenants and uses at the same property.

Landlords strive for a robust tenant mix by drafting narrow permitted use provisions; whereas tenants want a broad permitted use provision. The landlord's objective is to drive traffic to the property while avoiding same site tenant use conflicts. Conversely, tenants prefer broad use provisions because a broader use provision allows for (1) the expansion of uses over time; and (2) the tenant to more easily assign or sublease the space to a third party in the event that the tenant's business is not successful or, on the contrary, it is so successful that it outgrows the leased premises.

For example, I recently represented a fitness company. My client gave me the fully-executed letter of intent, which had a very narrowly-tailored use provision. The fitness industry, in particular, has experienced sharp growth in the number and types of specialty gyms, including spinning, aerial silk yoga, rock climbing, Pilates®, yoga, rowing and more. In my recent transaction, the permitted use was described narrowly in the letter of intent as "a studio for spinning classes and for no other use."

A narrow use provision, like the one just described, significantly constricts the tenant's freedom to expand, assign, or sublease the space because the potential pool of other fitness companies wanting to accept an assignment or sublease under the same limitations will be very challenging to find. That type of narrowly drafted use provision also leaves it open to the landlord to lease remaining space on its property to a competing full fitness gym with weights and classes as long as spinning classes are not offered.

These details are important, and the expectant tenant (and its counsel) must consider whether the landlord should be able to undermine the tenant's plans for other business ventures.

On the flip side, I represented a full-service gym as the proposed tenant in another lease transaction. In that matter, it was vital to specifically discuss with the Landlord (a) all the various types of fitness classes that the tenant would or could be offering and (b) which uses, if any, the landlord had already assigned to other tenants at the same shopping center. Disclosure of that competitive information before executing the long-term lease ultimately caused my client to determine that the particular shopping center was not suitable for their short and long-term business plans.

The Exclusive Use Clause

An exclusive use clause in a lease is the landlord's covenant to the tenant that no other tenants on that property will be permitted to engage in the same type of business, carry the same type of merchandise, and essentially engage in any type of direct competition in the same market segment.

The importance and relevance of the exclusive use provision also arose in the lease negotiation where I was representing the tenant who was a specialty spinning class. The proposed lease included a provision that said that during the lease term the landlord would not enter into another lease at the property where the primary use was described as a spinning/cycling fitness studio. The unexecuted lease document also clearly indicated that the use limitation would not be applicable to uses by preexisting tenants. This type of "exclusive use" provision was not really exclusive and left open the possibility for any existing tenant at the property to engage in a directly competing use.

An exclusive use clause with exceptions also leaves open the question of whether the landlord's consent to an assignment or sublease, which effectively violates the exclusive use provision, is permitted or is considered a violation of the use provision. It was critical in the lease negotiation, described above, to overcome and close the 'not really exclusive use' loophole in order for my gym client to commit to and invest in that particular location.

Exclusive use clauses that work require the landlord to (1) accept the duty to enforce it on other property tenants; and (2) provide for specific remedies for both the tenant and landlord if breaches occur. For example, when representing the tenant, if the landlord violates the exclusive use (for example, by allowing another new or existing tenant to violate the exclusive use, or by failing to insert the exclusive use in a future lease), then the harmed tenant must have the flexibility to sue the landlord for the landlord's breach of exclusive use covenant in the lease and to recover attorney and court costs from the landlord.

Prohibited Use/Restricted Use Clause

Finally, a "prohibited use" provision is a covenant clause that prohibits or limits certain uses at the property by the tenant. For example, a typical prohibited use clause restricts uses such as restaurants, entertainment venues, 'sin' businesses (i.e., adult novelty stores and marijuana dispensaries), check-cashing and pay-day loan providers, video and music stores, and certain types of massage providers. It is also common to see a tenant-imposed prohibition on a landlord barring the landlord from leasing to certain classes of governmental entities, such as welfare offices, state-owned liquor stores, or probation department offices. Given that it is unlikely that a tenant is even aware of there being a prohibited use provision in another tenant's lease, it is critical for the potential tenant (and/or their attorney) to ask these questions and negotiate these restrictions at the letter of intent stage and, even more importantly, obtain a copy of all prohibited uses whether they are in another tenant's lease or are a restriction on the property itself such as a CC&R.

As is the case in a number of contract negotiations, "the devil is in the details." But, as most attorneys would advise, it is better to meet and defeat the devil at the LOI stage than during the lease negotiations, or even worse, after the lease has been signed.

Originally published in Commercial Real Estate Insight Newsletter

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.