Normally an operating covenant or continuous operation provision is not the most noteworthy or “sexy” provision in a retail lease. However, this seemingly unremarkable provision can have remarkable consequences to an unsuspecting tenant.
An operating covenant is an agreement by a tenant to operate its store for a designated number of hours and/or days each week (i.e., continuous operation). Such a provision may be desirable to both tenants and landlords because open stores bring in customers. Operating covenants help landlords keep their shopping centers open and operating, maximize revenue and make their properties appeal to prospective tenants. Such provisions are most common in leases containing a percentage rent clause. The more hours a tenant is open, the higher the likelihood that a tenant’s gross sales will reach their full potential. Makes sense, right?
Similarly, an operating covenant may help to maximize cross traffic in a shopping center or strip mall increasing potential business for the other tenants. The interdependence of stores and synergy in a shopping center is adversely affected if a store is closed.
This year dozens of retailers like Costco, Crate & Barrel, Ikea and Lowes are closing on Thanksgiving to allow employees to spend time with their families. However, even if a tenant is trying to set a good example by closing on Thanksgiving, if its lease contains an operating covenant that does not contain an exception for the Thanksgiving holiday, the tenant could be breaching its lease by refusing to remain open.
The “good deed” of closing on Thanksgiving could give a landlord access to its panoply of remedies under the lease. The usual remedy is damages as courts are hard pressed to force a tenant to continue to operate, often citing the hardship of monitoring a tenant’s compliance. As a result, many leases simply stipulate to a liquidated damages provision, such as double rent during the period of non-compliance.
Tenants need to review the required period of operation in their leases before closing for any period of time. Those tenants entering into new leases may insist upon limiting the operation of the covenant such that it only applies if a certain percentage of the tenants in the shopping center are similarly obligated. Excused periods may also be negotiated when the provision does not apply, like Thanksgiving, events of casualty or condemnation, and time the tenant will need to renovate or remodel.
Tenants with significant negotiating leverage may go one-step further than negotiating for exceptions to an operating covenant. Many anchor tenants insist on a right to “go dark.” The go dark provision allows a tenant to cease operating as long as it continues to pay rent. This may be desirable for a number of reasons including, avoiding labor costs for an unprofitable store, or closing on a given day like Thanksgiving.
Whatever your plans are this year, we wish you a Happy Thanksgiving!
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