Should I Consider a Non-Compete Clause?

Your profitable bakery sells light and airy whipped cream cakes, melt-in-your mouth cupcakes, freshly baked bread, and every kind of cookie imaginable. Business is so good that you are branching out and opening another store. After investing time and effort researching trade markets, you have found what seems to be the perfect place to expand your business.

As you begin negotiations with the shopping center landlord, you will want to protect your sales from being eroded by other bakeries that may lease space in the shopping center. You wonder: “Should I consider a non-compete clause?”

A non-compete clause is also referred to as an exclusive use clause, and refers to a lease provision that prevents the landlord from leasing the development premises to a direct competitor of yours, or to a tenant operating the same kind of business.

The short answer, without having to skip to the end, is “yes.” Why compete with your own shopping center mates? There is plenty of competition on the other side of the parking lot to keep you on your toes.

Non-Compete Clauses Can Benefit both Tenants and Landlords

Non-compete clauses protect tenants from unnecessary competition and help maximize sales. A publication by the American Bar Association notes four reasons that tenants seek exclusive use or non-compete clauses.

  1. The trade market can support one but not two similar businesses.
  2. Two similar concepts might be successful, but sales of each will necessarily be less than if only one was in operation.
  3. Tenants invest significantly in researching trade markets, and don’t want piggy-back competitors undercutting this investment.
  4. Tenants themselves may want to open that second restaurant when the trade market is strong enough.

Non-compete clauses can also maximize landlord’s profits, especially where landlords collect a percentage of sales as part of tenants’ rent. When exclusivity clauses apply in a development, there is no cannibalizing of sales from similar businesses; for example, a yogurt shop’s sales aren’t eroded due to an ice cream parlor or smoothie establishment on the premises. Both the yogurt shop tenant and the landlord can maximize profit due to the non-compete clause.

Other benefits for landlords come as landlords respond to non-compete clauses by leasing development space to many different kinds of businesses. Each tenant will show greater profit in its own industry, and the center will enjoy more traffic with an ideal mix of businesses, thereby improving sales.

Scope

As a bakery owner, you will want to negotiate a non-compete clause to prevent other independent bakeries from leasing space in your shopping center. But what about a grocery store that operates a bakery? What about a donut shop or cupcake shop or a coffee shop that includes baked goods? All of these businesses will detract from your sales. Your goal is to make the non-compete clause as broad as you can.

Landlords, on the other hand, will prefer to limit the scope of the exclusivity clause, as a broader scope restricts his or her pool of potential tenants. For example, the landlord may not want to limit all bakery offerings on his or her premises, as this may undercut big grocery chains. He may be willing to include language to permit “incidental” sale of baked goods, or sales that represent less than X% of other tenants’ gross sales. This would allow the landlord to lease to grocery stores, coffee shops, and other organizations whose primary business is not baked goods, without violating your non-compete clause.

Depending on their bargaining power, tenants may negotiate to extend the radius of their non-compete clause to all of the landlord’s nearby properties. If the tenant is profitable, the landlord may be happy to extend the non-compete clause’s reach. Or he or she may simply demand higher rent in exchange for this concession.

The landlord may also seek a non-compete clause that prevents the tenant from opening a similar store in a competing nearby development. In the case of your bakery, the landlord doesn’t want your sales in his establishment to decrease due to your sales in another shopping center two miles away.

Remedies

Historically, non-compete clauses are not well-received in the courts when litigation becomes necessary. Not only is it difficult to prove harm, but anti-competition activity is frowned upon and rarely rewarded. Therefore, in order for the non-compete to be at all useful, remedies that provide incentives for the landlord should be included. This includes the threat of litigation, as no one wants to be sued.

Tenants will want to have remedy provisions in spades. They should endeavor to include language that covers the following:

  1. Landlord is required to take all actions to terminate violation or threatened violation
  2. The ability to seek injunctive relief
  3. The ability to act to enforce the restriction on behalf of the landlord if the landlord fails to do so
  4. The right to collect costs, expenses, damages incurred as a result of the breach
  5. The tenant has the right to reduce or terminate rent
  6. The tenant has the right to terminate the lease and seek damages

The landlord will want fewer remedies, to be sure. In the case of a rogue tenant, the landlord may want the tenant to take whatever action they deem necessary, and leave the landlord out of it. In the case of wrongdoing by landlord, such as not providing a rider to new tenants explaining the non-compete clause, or simply leasing to a tenant that violates the non-compete provision, the tenant will want to exercise every remedy possible to compensate for damages and lost income.

Rent abatement and right to terminate if the violation is not addressed are the most easily enforceable and common of the remedies. These may be the sharpest “teeth” in the enforcement provision for the non-compete clause, as landlords will suffer from reduced rent income and possibly the loss of a good tenant.

The Answer is “Yes”

Non-compete clauses give tenants a competitive edge and help them to maximize sales. They can be a boon for landlords as well, as they refine the ideal mix of tenants in their developments and rake in cash from maximized profits. Both parties should bargain hard for provisions that protect their own interests in the non-compete clause. This will result in a exclusivity provision that represents a win-win, thereby ensuring that both landlord and tenant will be motivated to protect and uphold it.

Sources:

http://commercialrealestateorlando.net/exclusive-use-and-non-compete-clauses-in-commercial-leases/
http://www.nolo.com/legal-encyclopedia/clb-pros-cons-use-exclusive-commercial-lease-clause.html
http://www.sba.gov/community/blogs/community-blogs/business-law-advisor/10-commercial-real-estate-terms-you-need-know
http://www.meislik.com/articles/exclusive_use_clauses/
http://www.tuckerellis.com/files/exclusive_use_clauses.pdf
http://www.crainscleveland.com/article/20131216/BLOGS05/131219865/making-the-most-of-exclusive-use-provisions-in-leases-for-landlords
http://apps.americanbar.org/rppt/meetings_cle/2008/spring/programmaterial/RPmaterial/rp32Myers.pdf