Food Halls Hold Special Legal Considerations for Landlords

January 6, 2020Articles Law360

There’s no doubt that while online shopping is growing in popularity, primarily because of convenience, many consumers are increasingly seeking unique and shared food and entertainment experiences that a phone or laptop simply can’t fulfill. In other words, the convenience of ordering a pizza online from the couch and binge-watching the latest TV show is a very different consumer need than visiting a public place for a meal, celebration or concert that provides a memorable and fun experience with friends or family.

Consequently, landlords across the country are more frequently developing food hall projects to attract the growing number of people looking to visit a venue with quality food and/or entertainment options.

But the food hall is frequently misunderstood. It is not a food court with a little stage tucked in the corner, or some food trucks scattered randomly in a parking lot with a Saturday farmer’s market.

Instead, a successful food hall is a thoughtfully designed space where the landlord has taken the time to understand the local community’s food and entertainment preferences, habits and trends. It’s a diverse mix of food, beverage and often entertainment options under one roof, with pop-up and seasonal venues rotating frequently to create a dynamic space that encourages repeat visits. Most profitable food halls combine a variety of ideas such as trending food or entertainment concepts, celebrity chefs, themes targeted to a specific demographic or a combination thereof.

Below are a few legal issues from the landlord’s perspective when structuring and documenting a food hall project. It’s certainly not an exhaustive list, but introduces some key issues for landlord’s team to consider at the beginning. The issues below assume that the food hall has an experienced hospitality manager frequently on-site to help resolve disputes among tenants with different experience levels of commercial real estate projects, such as how tenants use and pay for common areas, menu development that fits the particular project, or costs and rules related to tenants’ maintenance obligations.

Lease and License Structures

A food hall’s success largely depends on a skillful balance of providing long-term and typically well-established tenants with repeat customers, while being nimble enough to quickly capture trending but unproven food or entertainment concepts by tenants that may have little experience with a traditional restaurant lease. Accordingly, it’s not uncommon for a landlord to negotiate standard restaurant leases with well-established anchor-type tenants, and utilize short-term licenses for trending, pop-up or seasonal tenants.

A license can be very useful for temporary tenants because the arrangement provides significant flexibility. Unlike a tenant’s right to exclusive possession in a lease, a licensee’s rights is a limited and specifically tailored permission to use a certain area in the food hall that is generally nontransferable and revocable by landlord upon very short notice. The term can be month to month, or perhaps a short period between six to eight months subject to the landlord’s termination rights upon prior notice.

Significantly, if the landlord needs to terminate the license, given a licensee’s limited rights by operation of law, in most jurisdictions a well-drafted license allows the landlord to recover the terminated space within days and avoid the time, expense and statutorily required notices and court proceedings of an eviction action required in a traditional restaurant lease.

Similar to how a successful food hall requires careful planning and design, a license should also be carefully drafted to reflect the project’s goals and a variety of uses from a diverse mix of tenants. Carelessly deleting entire pages from a traditional restaurant lease form, adding a month-to-month term and calling it a license is unwise because if the document has enough characteristics of a lease, a court or tenant could interpret it as creating a leasehold interest.

Thus, commercially reasonable language ideally clarifies, among other project-specific issues, the parties’ intent to enter into a license, the licensee’s limited and specific use in the food hall, the licensee’s inability to assign its rights and clear timelines regarding the landlord’s right to revoke the license and the licensee’s obligations when leaving the project.

Ultimately, a license’s flexibility can benefit both parties by allowing the landlord to take more risks with less experienced but trending tenants and concepts to help increase interest and customers to the food hall, while also providing such tenants an opportunity to test a new food or entertainment idea in a new venue or market without the significant costs of entry required in a more traditional retail lease.

Regarding a traditional restaurant lease for more long-term tenants, the negotiation and provisions are similar as in any multitenant shopping center with some exceptions unique to food halls. For example, typical clauses allowing a tenant’s assignment or a subletting of the premises upon landlord’s reasonable consent is problematic in a food hall because of the landlord’s need to control a diverse mix of tenants. Thus, the landlord’s ability to decide an assignment or sublease request in its sole and arbitrary discretion is valuable in helping maintain a vibrant food hall.

The project’s rules exhibit also needs reworking beyond the standard grease trap maintenance and similar restaurant issues given the frequent use of shared common areas by some tenants that are constantly rotating and have different experience levels with commercial real estate projects. Some examples of such food hall specific rules are set out in the last section of this article.

Regardless of how a food hall tenant is documented, the landlord should carefully draft each tenant’s permitted-use clause. The landlord needs to provide a variety of food choices that fit within a common theme but do not materially compete with each other, while also maintaining its sole discretion to deny a tenant’s change of use. The landlord may also want to add financial or related termination remedies if a tenant unilaterally changes its use without first obtaining the landlord’s approval.

Options Regarding Rent and Operating Costs

A food hall’s rent structure can also be unique. Whether a license or lease, a tenant paying percentage rent only is common. Typically, the percentage rent is substantially higher than a traditional restaurant lease in order to absorb common area operating costs and lower the cost of participating in the food hall to encourage less experienced and trending food or entertainment concepts while also providing a share of the profits to the landlord.

The standard definitions of gross sales for percentage rent should be revised in the food hall context. For example, the landlord should consider additional sources of revenue such as: (1) the tenant’s sponsorship funds, (2) marketing funds from third parties, and (3) ticket sales for special events.

And certain carve-outs to gross sales specific to a food hall can include: (1) employee meals where no charge was made or which were discounted, (2) third-party payment services, such as Apple Pay, and (3) amounts collected for food delivery charges and fees that are paid to unaffiliated third parties (e.g. DoorDash Inc. or Uber Eats).

Given the challenge of estimating operating costs for food halls, another rent structure is a higher-than-usual percentage rent coupled with a monthly food hall-specific operating costs fee (which flat fee could have a reasonable annual increase to absorb increased operating costs for longer-term leases). This hybrid rent structure may be more profitable and accurate for some food halls than a traditional gross lease with a base rent estimating operating costs.

In addition, some food hall contracts provide a minimum sales threshold as an additional basis to trigger termination. Depending on each parties’ leverage and risk tolerance, such a kick out clause may be viable and benefit both tenant and landlord. And with respect to a license, such a minimum sales threshold can encourage the landlord to take a thoughtful risk on a trending concept, knowing it can quickly terminate the license if necessary.

Some Rules Unique to Food Halls

Detailed and clear rules and regulations specific to the food hall’s operations and code of conduct are also key to a successful project. Examples of rules unique to food halls include:

  • Expanded hours of operation, especially if the food hall is part of a project with tenants operating during traditional business hours;
  • Additional security requirements for uses with large crowds, such as concerts;
  • Adequate parking close to tenants with evening hours that also has quality lighting so that it’s safe and convenient for customers and employees to leave at night;
  • Clear notice procedures, expectations and responsibilities of tenants with uses that can be very loud from live or recorded music or a large special event, especially if the food hall is part of a mixed-use project;
  • Use and maintenance obligations of shared commissary facilities, beverage stations, kitchen equipment, tables, chairs and patio furniture used by all tenants; and
  • Anti-employee poaching policies given a large mix of restaurant tenants under one roof where staff turnover is frequent.

In addition, clear rules addressing alcohol sales and tenants’ compliance with related governmental regulations are very important because such sales are often a key driver of the food hall’s success. Such rules in food halls typically require tenants to carry dram shop/liquor liability insurance at a higher than normal limit, may limit glass barware depending on the food hall’s design and set forth clear expectations regarding customers’ on-site alcohol consumption.

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