COVER STORY, MAY 2004

SERVING UP A RESTAURANT LEASE
Tenants and their attorneys should know what’s on their plates before bringing a new restaurant to town.
Gregory Otto

Just as the typical retail lease addresses a host of issues that are unique to the realm of retail leasing, the typical restaurant lease, while being a retail lease at heart, should address a broad range of additional development and operational issues that are not the focus of a generic retail lease.

In addition to negotiating traditional retail concepts, such as operating covenants, use clauses, exclusive uses, percentage rent and common area maintenance costs, the landlord and tenant should also focus on specific matters to negotiating a restaurant lease, such as what land use approvals might be necessary; the availability of appropriate liquor licenses; the availability, location and capacity of necessary utilities; and the challenges that may be faced in venting kitchen equipment. Each of these matters can have a significant impact on the operations and costs of a new restaurant.

Land Use Approvals

In entering the typical retail lease, a tenant or its attorney rarely give much time and attention to zoning and other land use approvals. The assumption is that if the landlord and its lender each invested the dollars necessary to develop the center and the landlord obtained the permits necessary to build the center, certainly the center is properly zoned for retail use. In most cases, this is a fairly safe assumption, both with respect to a generic retail use and to a base restaurant use. However, it would be a mistake to assume that such zoning also permits many of the ancillary operational aspects critical to running a successful restaurant.

For instance, in many jurisdictions, obtaining a liquor license, serving food or beverages in outdoor seating areas and operating the restaurant beyond normal retail hours all require the issuance of a conditional use or similar permit. While obtaining a conditional use permit is a mere formality in most jurisdictions and circumstances, sometimes it is not so easy. Therefore, a tenant and its attorney should keep at least two things in mind.

First, from time to time, there is public opposition to the issuance of a conditional use permit. Residents may object to the noise generated by outdoor seating or may blame a number of other perceived ills on the alcohol served or the late hours kept by the restaurant. In this case, the conditional use permit may be rejected outright or its issuance may be subject to conditions that are just not workable from a tenant’s perspective.

Second, even if issuance of the conditional use permit is a “slam dunk,” issuance of the permit almost always requires action by one or more governmental commissions and/or boards, many of which meet only once a month. A tenant and its attorney need to carefully coordinate the local jurisdiction’s schedule with the tenant’s construction schedule and the opening/rent commencement date. From the tenant’s perspective, it would be nice for the lease to be contingent on its ability to obtain an acceptable conditional use permit and for the rent commencement date to be tied to so many days after issuance of the permit. However, as is often the case, if the landlord is not willing to give the tenant latitude in the lease, the tenant and its attorney really need to do their homework before executing a binding lease.

Liquor Licenses

In negotiating the generic retail lease, a tenant’s ability to obtain a liquor license is a non-issue. But, in negotiating a restaurant lease, a tenant’s ability to obtain all necessary liquor licenses should be of utmost concern to both the tenant and the landlord. If the tenant cannot serve alcoholic beverages in its sit-down restaurant, the restaurant will not likely survive, and the landlord will not have a viable, rent-paying tenant. Thus, very early on in the lease negotiation, it would behoove the parties to spend the time and effort necessary to familiarize themselves with the process and potential pitfalls in obtaining all liquor licenses appropriate to the tenant’s operations.

The requirements and procedures for obtaining appropriate liquor licenses vary widely from state to state and can vary widely from local jurisdiction to local jurisdiction within the same state. In many states, in order to serve alcoholic beverages, the tenant must obtain appropriate liquor licenses at each of the municipal, county and states levels. Usually, such licenses must be applied for in succession (i.e., after the tenant obtains the municipal licenses, the tenant moves on to the state and then on to the county), and thus the entire process can take a number of months.

Almost all jurisdictions tend to focus on the identity and background of the equity owners of the restaurant, as well as the person in charge of day-to-day operations (often called the “managing officer”). Usually, the liquor license application delves into the criminal histories, including prior liquor license violations, of the equity owners and managing officer and requires that the managing officer be a taxpaying resident of the state in which the restaurant is located. One should keep in mind that restaurant owners and operators who, by all appearances are upstanding, model citizens, frequently have colorful pasts.

At the local level, the tenant and its counsel should be wary of municipalities that cap the total number of liquor licenses that it will issue or that condition issuance of liquor licenses on the signature of a petition by a certain percentage of residents and/or business owners within a certain radius of the restaurant. At the state, county and local levels, other potential pitfalls in obtaining appropriate liquor licenses include:

w prohibitions on the issuance of licenses to establishments located within a certain distance from a school or church;

w prohibitions on the issuance of licenses to persons employed by or having an ownership or other financial interest in a manufacturer, distiller or distributor of alcoholic beverages;

w requirements calling for the finger printing of all officers and directors of the ultimate owner of the restaurant (when the restaurant is ultimately owned by a Fortune 500 company, good luck explaining that requirement to the board of directors); and

w limitations on the total number of licenses that may be held at one time by an entity and its affiliates.

In the realm of liquor licensing, state, county and local jurisdictions across the country have lots of quirky, and often arcane, procedures and requirements on the books. The parties to a restaurant lease would be well advised to do their due diligence thoroughly and to do so early in the lease negotiation. Nobody wants to be under construction and then discover that the tenant will be unable to obtain liquor licenses necessary to the successful operation of the restaurant.

Utilities

All retail premises require basic utility services (electric, telephone, water and sewer). The concern with restaurant premises is that they almost always require more than basic service. Restaurants need natural gas to properly and efficiently operate kitchen equipment, and they often require cable or satellite service for clear reception for televisions located within the bar area or elsewhere throughout the restaurant. In addition, the operation of commercial refrigerators, freezers and other kitchen equipment requires greater electrical capacities than are provided to the typical retail space. Also, kitchen operations, combined with additional restrooms, often exceed the capacities of water and sewer lines provided to the typical retail space.

Because virtually all retail leases contain a clause imposing the cost of upgrading utility services upon the tenant, the tenant and its attorney need to focus on the availability, existing location, and existing and required capacities of utility service to the proposed premises. In terms of availability of service, from time to time, tenants find that natural gas service has not been extended to the shopping center or to anywhere within the vicinity of the shopping center. Every once in a while, shopping centers simply do not have enough electrical capacity to serve the needs of all of their tenants.

In terms of location of service, in some cases (frequently in regional shopping centers), gas service is available to the center, but the closest point of connection may be hundreds of yards from the premises. In this case, extending the gas line to the premises can add tens of thousands of dollars to the tenant’s anticipated construction costs. In terms of capacity of service, even if all applicable utilities are stubbed to the premises, often the capacity of electrical, water and sewer service is not sufficient for a restaurant use.

In order to keep construction costs under control and to avoid unpleasant surprises, in negotiating the utility provisions in a restaurant lease, the tenant and its attorney should always do three things. First, they should work in close consultation with the tenant’s architect/engineer. Most attorneys and their clients do not have a technical background and are completely lost when it comes to establishing, describing or even understanding appropriate utility requirements. Second, they should have the tenant’s architect or other qualified professional do an on-site inspection of the proposed premises to confirm current conditions. More often than not, the tenant will get burned when relying on the landlord’s oral representations regarding existing utility capacities and conditions. Finally, once the tenant’s utility requirements have been established by the architect and/or engineer, the tenant and its attorney should make sure the specific requirements are clearly set forth in the lease. This is tenant’s “get-out-of-jail-free card” if and when issues regarding insufficient utility capacities arise.

Venting Kitchen Equipment

Venting can become a significant logistical and cost issue for restaurants. Cooking equipment located in the kitchen of a restaurant requires venting, usually to the roof of the building where the restaurant is located. If the restaurant is located in a single-level shopping center or on the top floor of a multi-level center, venting to the roof is relatively simple. However, if, for example, the restaurant is located on the first floor of a three-level regional shopping center, venting to the roof can be challenging and extremely expensive. Often a direct, vertical route to the roof is prohibited by the location of other tenants directly above the kitchen of the restaurant.

Logistically, whether there is a direct, vertical route to the roof or an indirect route must be taken, the installation of such venting can be a nightmare; it will almost certainly involve performing work in the premises of other tenants and may even require the removal and subsequent re-installation of portions of the walls or ceilings of other tenants. From a cost perspective, if the tenant is forced to take an indirect route to the roof, the additional cost for venting can easily exceed six figures.

So, what are the tenant and its attorney to do? First, as is the case with utilities, get the landlord’s and the tenant’s architects involved early in the process. The landlord and the tenant need to have a clear understanding of what practical challenges may have to be faced. Once the parties have an idea of the scope of any potential problems, the landlord and the tenant (and their attorneys) can make an informed decision in addressing an appropriate allocation of costs between the parties. Second, if the installation of the tenant’s venting will require work within the premises of other tenants, the obligation to perform such installation work should be imposed on the landlord, regardless of who ultimately pays for the cost of such work. The landlord’s leases with other tenants should grant landlord access to the premises of these tenants and should contain appropriate exculpation provisions. Therefore, the landlord is the party best suited to perform this type of work.

While a restaurant lease is a retail lease at heart, restaurants operate in ways that are very different from the generic retail use. Thus, in negotiating a restaurant lease, the landlord, the tenant and their attorneys need to recognize these differences and adequately address these issues. In addition, they should address a range of other differences between restaurants and generic retail. For example, restaurants generally have different operating hours than typical retail uses; restaurants create more and different types of trash than other retailers; and drive-through facilities create all sorts of regulatory and development issues. These factors impact the way that a restaurant is developed and operated.

Gregory Otto is a partner in the St. Louis office of Chicago-based Sonnenschein Nath & Rosenthal.



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