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Location, location, location: Issues that arise with leases in unique places

By Jennifer S. Romano, jromano@crowell.com

Anyone who works with retail leases knows that leases are not all the same, and the parties cannot assume that cookie-cutter language will meet all needs. However, if you work with leases in unusual locations, such as airports, military bases or theme parks, the differences are even more significant and the impact on profitability can be staggering.

In these unique locations, the landlords may impose far more control over a retailer’s business, from setting pricing guidelines, to imposing strict use restrictions, to requiring detailed audits. In addition, when a retailer seeks to operate on property that is not open to the general public, a violation of lease obligations can lead to stricter penalties.

While leasing at unusual locations may come with more burdens and higher costs, it can still be a profitable part of the business, as long the additional obligations are reviewed and evaluated before the retailer signs the lease.

Airport leases

A retailer operating at an airport typically secures the retail space by responding to a Request for Proposal from the applicable airport authority. If the retailer’s bid is chosen by the airport, the retailer signs a “Concession Agreement” with the airport. The retailer is the Concessionaire and is subject to unique obligations under the Concession Agreement.

For example, the Concession Agreement often sets forth security obligations of the retailer, including extensive security checks that must be conducted for all employees of the retailer at the airport location. In addition, the airport may impose restrictions on who can deliver materials to the retailer and how the deliveries are made. The retailer may be required to engage a security escort for all deliveries to the retailer, which can substantially add to the costs of the retail business at the airport.
 
Despite these additional costs, many airports impose restrictions on what airport retailers can charge for their merchandise. Customers want to see name brands at the airport, but they do not want to pay more for the same product than they would pay on the street. Airports sometimes require that retailers offer their merchandise at similar prices offered by that retailer in the geographic area, or airports limit the additional mark-up on merchandise. Many airports require that their Concessionaires track and submit to the airport on a regular basis information regarding pricing at the airport as compared to pricing at other locations in the geographic area.

One other consideration for retailers at airports is the Department of Transportation’s participation goals for businesses who qualify as a Disadvantaged Business Enterprise (“DBE”). DBE’s are for-profit small businesses, which are at least 51% owned and controlled by socially or economically disadvantaged individuals. The objective is to create a "level playing field" on which all firms can compete. If a retailer is majority-owned by persons who are African American, Hispanic, Native American, Asian-Pacific, Subcontinent American or female, it may be advantaged in obtaining an opportunity to become a Concessionaire at an airport.

However, because of the additional obligations associated with operating a retail store in an airport, many retailers have decided to enter into exclusive franchise relationships with franchisees who specialize in airport operations. While retail stores in airports look and feel like their namesakes on the street, many are now owned and operated by franchisees focused solely on airport concessions.

Military base leases
What distinguishes a lease on a military base from a typical shopping center lease is the landlord at the military base is a branch of the United States government. A retailer becomes a “government contractor” when it enters into a lease to operate on a military base. With this designation, comes a number of obligations and risks.

A retailer who operates on a military base must comply with specified affirmative action obligations. Under Executive Order and applicable regulations, all operations of the contracting entity (including retail stores operated by that entity at locations other than the military base) are required to prepare an affirmative action plan and establish tracking mechanisms to capture data regarding applicants and employees.

In addition, military leases may include best pricing provisions, price reduction triggers and commercial practices requirements. These terms often take discretion to make business decisions away from the retailer. They also require the retailer to be vigilant about compliance, sometimes imposing an obligation on the retailer to track detailed information about commercial sales beyond the base location.

The burden can be substantial, and the exposure for non-compliance is heightened when the landlord is the government. While a retailer ordinarily faces allegations of contract breach when it is non-compliant with lease terms, a government contractor also is exposed to a government audit and fraud risk for false claims and false statements. A study some years ago found that it costs a commercial entity at least 16% more to perform a government contract due to these additional requirements and administrative burdens. Evaluating these costs is critical in deciding whether to lease on a military base.

One way companies try to ameliorate these costs and risks is to enter into a franchise agreement with the military, such that the military operates the retail store as a franchisee. This strategy can reduce the burdens associated with operating on a military base, but they are not eliminated entirely. With a franchise relationship, the retailer remains a government contractor. Affirmative action requirements may still apply and the retailer faces a risk of fraud for false statements. However, if the franchise agreement is carefully drafted, the landlord can limit exposure for fraud, and avoid many of the administrative burdens, such as monitoring pricing and best practices compliance. 

Theme park leases
It is not uncommon for theme park owners to lease out retail space in their parks pursuant to leases or concession agreements. Theme park visitors view retailers and vendors selling goods and services within a theme park (particularly retailers with outdoor carts and merchandising) as being associated with the theme park owner.  Because the key demographic for theme parks is kids and families, park owners are concerned about damaging their brand with retail merchandise that is of poor quality or of questionable nature. Therefore, theme park leases often include narrowly tailored use provisions, such as restrictions on the types and quality of products that can be sold, and limitations on the sale of alcohol, which are strictly enforced. In addition, theme park leases and concession agreements typically include specific remedies that the theme park can invoke to prevent and mitigate against any damages caused by a breach -- or potential breach -- of use restrictions, without having to resort to formal litigation.

Further, with respect to theme park retail leases and concession agreements, there is an inherent conflict between the business purposes driving the retailer and theme park owner when negotiating the rights and conditions for the length of the term and right to relocate the retail space. Unlike many venues, theme park owners desire the contractual right to relocate retailers and vendors because they often move rides, attractions and other concessions around or in and out of the theme park to keep the park “fresh” for the public. In contrast, retailers and vendors want to ensure they are located where they believe their business will do best, whether in high profile gate areas, near popular rides or adjacent to complimentary retailers. Additionally, theme parks want to maximize their flexibility to eliminate those retail operations that are not profitable, become obsolete or stale, or are otherwise inconsistent with new park “themeing.” Therefore, the theme park owner wants complete control over who is operating in its theme park, and there are generally strict prohibitions on assignment or subletting, which are usually non-negotiable. This can lead to a lease term that is far shorter than what is found in a more typical retail lease, and far greater flexibility for the theme park owner to relocate its tenants.

Finally, for many theme parks, the business is seasonal, compressing a year’s worth of operating costs and revenues into a few months. As such, a retailer must be prepared for rent provisions designed to maximize revenues or profits during the operating season of the park. Among those provisions are continuous operation provisions that require the retailer to be open during park operating hours, which may not be typical shopping center hours. Additionally, the basis for calculating percentage or revenue-based rent is typically a far greater proportion of rent than at other more standard venues.
 
Conclusion
These unique lease provisions and obligations are just an example of the issues that can arise when a retailer seeks to open a retail store in a unique location that is not open to the general public. The burdens may be steep, and in some circumstances, insurmountable. But, in some cases, it may be well worth the effort and risks to open a retail store in a unique location where the merchandise will be exposed to an entirely different group of consumers.
 
Jennifer S. Romano is a litigation partner in the Los Angeles office of Crowell & Moring and an Esq. National Retail Tenants Association Conference presenter (Retailtenants.org). She can be reached at jromano@crowell.com.

© 2014