San Diego Business Lawyer Blog

August 10, 2015

Percentage Rent in Commercial Leasing

Percentage rent allows a retail landlord to benefit from a tenant’s success. In addition to the base rent, tenants will pay an additional rent based on some percentage of the tenant’s gross sales typically triggered by what is termed a “breakpoint”. New tenants asked to pay percentage rent are typically troubled by the idea mostly because they see it as a way of being penalized for success. Clearly, landlords benefit significantly from percentage rent reaping additional profits in times of economic boom while losing nothing during downturns. However, there is a synergistic effect that can benefit tenants. Most landlords aggressively seek to maximize profits and creating the right tenant mix and shopping center atmosphere aids in increasing the revenue stream for all tenants thereby increasing the landlords rent. In such cases, the landlord at least arguably is creating something of value for tenants. The value of a landlord’s labors in this scenario is of course difficult to measure, but with an earnest effort it can unquestionably have a dramatic impact on shopping center sales.

Percentage rent is typically set at five percent (5%) of gross revenue but usually doesn’t trigger until some “breakpoint”. The breakpoint can be arbitrarily set by the parties as a stipulated breakpoint (for instance at $1,000,000). In this case, a tenant would be obligated to pay 5% of all gross sales in excess of $1,000,000. If gross sales were $1,500,000, the tenant would owe as additional rent of $25,000 (5% of $500,000). Many retail leases set the breakpoint at what is termed the “natural breakpoint”. For the natural breakpoint, you divide the base rent by the set percentage (the typical 5%). The natural breakpoint results in a percentage rent applicable to sales over and above the point in which the base rent would equal 5% of gross revenue. In other words, the tenant is paying 5% of gross sales or the base rent whichever is higher. If the breakpoint is not reached, the base rent is higher than 5% of gross sales. If the base rent in the above example was $120,000 ($10,000 a month), the breakpoint would be $2,400,000 resulting in no additional rent due. The landlord is then guaranteed a minimum rent no matter how bad sales are, but benefits when sales are good. Tenants benefit if the stipulated breakpoint is above the natural breakpoint but not if it is below the natural breakpoint. In the above example, if the stipulated breakpoint is $4,000,000, the additional rent would be zero. If the stipulated breakpoint is $500,000, the tenant would pay the base rent ($120,000) plus a percentage rent of $50,000 (5% of $1,000,000).

August 6, 2015

Stock Purchase Agreements

by Donald Oder

Because of the inherent risk of fraudulent activity, the sale of stock is a highly regulated transaction by both state and federal authorities. Unfortunately, many corporate shareholders erroneously believe that privately held corporations do not have to worry about securities regulations because of the limited number of people involved and the relatively limited share worth. They often sell shares of stock either via oral contracts or hastily thrown together written agreements without consulting a corporate attorney. While it is true that smaller privately held corporations benefit from a number of exemptions to securities registrations, the directors, officers and shareholders of these corporations must still comply with numerous state and federal regulations when it comes to selling shares of stock. In fact, it can be argued that in the smaller more intimate setting of a closely held private corporation, the risk of fraudulent activity is particularly troubling. For more on exemptions to registration requirements, see “Exemptions to Registering Federal Securities with the SEC“. Given the inherent risk and associated governmental requirements, it is important that corporate officers consult with an experienced corporate attorney before issuing shares of stock.

A well drafted stock purchase agreement not only protects both the seller and purchaser of stock, it ensures that the corporation is in compliance with securities regulations. It should evidence a transparent transaction. Full disclosure (offering complete access to corporate transactional and financial records) is the key to complying with securities regulations. The idea of course is to ensure that the purchaser is fully informed as to the risk associated with the investment. The stock purchase agreement will also set forth the price per share, the number of shares, whose shares are being sold, the class of shares being sold, the effective date of the transfer and other terms and conditions governing the sale. The stock purchase agreement should clearly define each party’s rights and obligations going forward.

August 3, 2015

Radius Restrictions in Commercial Leasing

by Donald Oder

Landlords desire radius restrictions in commercial leases for two main reasons: where the landlord is entitled to percentage rent, a competing business within the restricted radius may dilute the landlord’s income; and more generally a competing business within the restricted radius can have a negative impact on the exclusive nature of the shopping center. For example, a national fashion chain with a significant lure draws shoppers to the center – shoppers attracted to that particular chain. Opening the same chain too close to the center threatens to dilute the landlord’s traffic. Retail landlords take great care to manage the shopping center’s mix to maximize foot traffic. For either reason, reasonable radius restrictions are legitimate in San Diego commercial leasing. However, tenants should take care to ensure that these clauses are carefully worded to limit the restrictions. Particularly, it’s important that the “radius” of the restriction, the term of the restriction and the scope of the restriction are all specifically defined.

Defining the Radius: Most commercial leases tend to broadly define the distance covered by a radius restriction – usually to about a five mile radius. In such cases, the parties may have different understandings as to how the radius is measured. A five mile radius might mean five miles as the crow flies in any direction from the store’s precise location or it could mean five miles in any direction from the boundaries of the shopping center. In addition, five miles as the crow flies in a specific direction could fall on the edge of a competing shopping mall. In that case, opening up shop just feet away from the maximum distance would still have the negative impact the landlord was attempting to avoid in the first place. Landlords and tenants can avoid this type of confusion by clearly defining how the radius is determined. Stating where the radius is measured from is a good start. Defining the area more specifically on a street-by-street basis or using particular landmarks is even better.

The Term of the Restriction: The term of a radius restriction typically coincides with the term of the lease. However, problems can arise when a lease is terminated prematurely. If the tenant has an early termination right, it’s important that the radius restriction terminate simultaneously. It’s also common for tenants to start developing new opportunities in anticipation of the end of a lease term. This would be a problem if the radius restriction broadly defines the restricted activity as “running, operating, investing in or developing” a competing business.

July 27, 2015

Business Litigation – Proving Your Claims

by Donald Oder

One of the most misunderstood concepts in litigation is the concept of proof. San Diego business owners know when someone or some other business has committed a wrong. They know if a business partner has stolen from them, when a deal has been broken or when someone fraudulently induced them into a bad deal. Because of this confidence, business owners often walk into an attorney’s office expecting an unqualified validation of their claims. In some rare cases, it may be true that a party has a virtually guaranteed win. Unfortunately, in most cases, prospective litigants face numerous hurdles involving significant litigation fees and costs, legal hurdles (including defenses), damages and amassing admissible evidence (proof) all of which vary the risk of loss. This article provides a brief summary of issues of proof in California litigation.

It’s the attorney’s job to evaluate the case and give the client a frank assessment of what lies ahead. A good attorney will be careful to qualify her assessment pointing out various problems that may lie ahead including potential problems with proof. The client tells his story and while the attorney is listening, she is picturing how admissible evidence will be gathered and presented at trial. This often creates a disconnect between attorney and client leaving the client feeling flat. However the business owner might feel, it is important that he accept his attorney’s frank assessment especially when he has talked with several attorneys who are all providing similar evaluations. In fact, an attorney giving different advice might be blowing smoke to do whatever it takes to engage the client. It’s extremely important for prospective litigants to understand that what they personally know and what they can actually prove with admissible evidence are not always the same. Accepting these realities is often complicated because of the client’s personal and emotional connection to the dispute.

There are two key types of evidence presented at trial: witness testimony and documentary evidence. Both types of evidence come with a host of evidentiary and foundational requirements that in their entirety are beyond the scope of this article. However, there are some important evidentiary issues that assist the lay person in better understanding what their attorneys are trying to accomplish:

July 24, 2015

Exclusive Use Clauses in Commercial Leasing

by Donald Oder

Exclusive use clauses in commercial leasing are important to both landlords and tenants, especially in the retail context. Landlords need to focus on the right tenant mixture, ensure that obligations to existing tenants are met and maintain the ability to attract new tenants. Prospective tenants need to know that a direct competitor won’t be setting up shop in the same shopping center or worse right next door. In every new lease, exclusive use clauses come into play in two ways: exclusive use clauses applicable to existing tenants and the new tenant’s desire to obtain its own exclusive use. With respect to existing exclusive use clauses, new tenants are simply excluded from using the premises for such uses. Language in the lease will typically refer to an exhibit itemizing the unpermitted uses based on exclusive uses already granted to existing tenants. Whether an exclusive use is granted to a new tenant will depend on a host of factors including but not limited to the size of the new tenant in relation to the shopping center, the new tenant’s negotiating power, the current mixture of existing tenants in the shopping center and potential conflicts with existing leases (particularly with respect to anchor tenants (national chains) who maintain significant control over their operations).

All commercial tenants are subject to “use” restrictions. Before even entering into a lease, the parties generally have a firm understanding of just what is a tenant will be permitted to sell or serve on the premises (“Permitted Use”). Whether this Permitted Use will be exclusive is a separate matter (but of no less importance to both landlords and tenants). While it might seem intuitive that landlords would prefer not to be bound by exclusive use clauses, Landlords in fact benefit from a diverse tenant mixture. First, the shopping center is generally more attractive to customers looking for the mall experience. Second, it would be hard to attract new tenants if the landlord has a reputation of installing competitors right next door. Finally, a significant number of prospective tenants will look elsewhere if they cannot be reasonably certain that the landlord will not lease space to competitors. Moreover, in cases where the landlord receives a percentage of a tenant’s sales, exclusive use clauses become even more important. Because of these factors, most landlords will entertain the idea of granting an exclusive use to even the smallest tenant. The real issue then becomes the scope of the exclusive use.

June 17, 2015

Why Damages Are So Important in Litigation

by Donald Oder

It may seem obvious that damages are important to litigation but it’s surprising how misunderstood the concept is amongst business owners and the general public. The misconception is understandable of course given the natural inclination to focus on wrong doing. Nonetheless, without damages (significant damages in most cases) the cost of litigation can be prohibitive even where the most egregious conduct exists. There are two very important practical reasons damages are a critical consideration in deciding whether or not to sue: 1) the costs of winning may exceed the value of the case; and 2) even if you win an amount greater than your costs, the chances of collection may be minimal.

If the damages are less than what it will cost to litigate the case, there is very little benefit in suing. Aside from the moral vindication, risking $50,000.00 to fight a court battle where the damages are $50,000.00 is effectively a useless exercise no matter how low the risk of losing is. Moreover, it’s difficult to place a value on the emotional cost that comes with litigation. The battle itself takes a toll. Determining whether the damages are outweighed by the costs requires careful evaluation of numerous factors including the risk of losing and whether or not attorney fees are recoverable. The risk of losing is not always clear. The first step in analyzing risk is analyzing the merits of the case, something that should be analyzed with the assistance of an experienced litigator.

Attorney fees for litigating a case through trial can easily reach $100,000.00. In more complicated cases, the fees can be far higher. Even in the most simplest cases with extraordinarily efficient litigation counsel, attorney fees through trial can exceed $50,000.00. This all of course presumes that attorney fees are recoverable in the first place either pursuant to a contract or some statute. Moreover, it’s possible that if you are awarded $5,000.00 in damages where you originally sought damages of $50,000.00, the court may not consider you a prevailing party for the purposes of awarding attorney fees. In such cases, your attorney fees will not be recoverable (you will have spent $50,000.00 in attorney fees plus costs while only recovering $5,000.00). In addition to attorney fees, actual costs are incurred. Copying fees, court filing fees, service of process fees, court reporter and transcript fees for depositions and trial and expert fees are just some of the actual costs incurred during litigation. These fees can double the cost of litigation. While most of these actual costs are recoverable to the prevailing party, the determination of who is the prevailing party is often unpredictable. In the worst case, your opponent may be determined to be the prevailing party in which case you will have to pay their costs and attorney fees along with your own (while collecting nothing in damages).

June 16, 2015

Buy-Sell Agreements

by Donald Oder

Starting a new company with business partners requires a careful understanding of each partner’s expectations and goals. Lengthy and detailed discussions amongst the prospective partners are common. Unfortunately, these expectations and goals aren’t always adequately memorialized in writing. Too often, partners rely on oral agreements – sometimes with respect to the entire partnership. See “Why Oral Partnerships Are a Bad Idea.” Seasoned business men and women understand that oral agreements are problematic. They understand the importance of a formal written agreement and in today’s climate usually opt to form a business entity such as a corporation or limited liability company (“LLC”). However, even with well drafted corporate by-laws or LLC operating agreements, the partners are sometimes still surprised by the result when one of the partners dies, goes bankrupt or merely decides that he or she wants out (perhaps because the sale price for the exiting partner’s share in the business was based on a set value which is now too low given a change in the fair market value of the business). For whatever reason, the owners neglected to ensure that a buy-sell agreement was included, or, if one was included, that it embodied the expectations they had originally discussed. A well drafted buy-sell agreement addressing every contingency will govern precisely how shares of the business will be transferred upon the occurrence of triggering events and how the price of the shares will be determined. This article briefly discusses important issues with respect to buy-sell agreements. It is not a comprehensive analysis however. Given the complexities of buy-sell agreements, it is best to work with an experienced corporate attorney.

Triggering events include the death, incapacitation, bankruptcy, divorce or retirement of a partner or the desire of a partner to sell his ownership interest. A good buy-sell agreement will clearly define precisely what happens upon the occurrence of any of these triggering events. It may call for the immediate purchase of a deceased, incapacitated or bankrupt partner’s ownership interest by the company itself (Redemption Agreements), or it may grant the remaining partners a right of first refusal before the company itself is required to purchase the interest. It might also call for the remaining owners to purchase the ownership interest (Cross Purchase Agreements). In cases of divorce, the buy-sell agreement might require that any claimed interest of the non-partner spouse automatically transfer to the partner (the non-partner spouse will have signed a spousal consent when the buy-sell agreement was originally executed). When one partner wishes to sell his interest in the company, the buy-sell language will usually require that the remaining partners approve of the sale or at least maintain a first right of refusal in which case the buy-sell agreement will detail the mechanism by which this right will be exercised.

May 15, 2015

When Commercial Tenants File for Bankruptcy

by Donald Oder

Because federal bankruptcy law preempts California landlord/tenant law, it’s important that commercial landlords and tenants alike understand the process when a tenant has filed for (or is considering filing for) bankruptcy. The timing of a tenant’s bankruptcy is critical because once a tenant files for bankruptcy an automatic stay immediately stops any state court action against the tenant including pending unlawful detainer actions (evictions). Once the bankruptcy stay is in force, the tenant can maintain possession of the premises for up to seven months so long as it pays rent post bankruptcy filing. Landlords’ recourse depends entirely on the timing of the landlord’s pre-bankruptcy actions. If a judgment is obtained prior to the bankruptcy filing, the landlord will be able to recover possession. If an unlawful detainer action is filed but a judgment is not yet obtained, the landlord can file a motion with the bankruptcy court seeking to lift the stay so that the landlord can proceed with the unlawful detainer action. This can be accomplished in relative short order. If the bankruptcy action is filed before the landlord filed an unlawful detainer action, then the landlord is bound by the bankruptcy procedures which give tenants 120 days time to consider their options (90 days longer with a court approved extension).

Due to the bankruptcy risk, it’s advisable for landlords to move quickly where they suspect a tenant is heading for bankruptcy and is behind in rent. Of course, there is a cost (especially for large retail centers) to serving three day notices and filing unlawful detainers on the drop of a hat. Long time tenants with proven track records are known entities. There is a benefit to working with these known entities to see if the problem is a short term one or, if not, whether a compromise can be reached. Either way, open lines of communication allow landlords to get a better sense of the tenant’s current position while simultaneously letting the tenant know that the landlord is willing to talk. However, if there is any hint that bankruptcy is on the horizon, the sound business decision is to file an unlawful detainer action as soon as possible (after a three day notice to pay rent or quit is served) and to pursue the action to judgment as quickly as possible.

The decision for tenants on the verge of bankruptcy on the other hand is much simpler. They want to file for bankruptcy as soon as possible. However, it’s important that they are not filing bankruptcy for the sole purpose of avoiding eviction. First, at best the eviction proceedings are merely delayed (and rent for the post bankruptcy filing will still be due). Second, there are consequences to filing frivolous bankruptcies. For a tenant that truly qualifies, bankruptcy is certainly worth considering and back due rental obligations should be a factor in that decision. Because of the negative consequences attached to bankruptcy, it’s important to consult with a bankruptcy attorney to fully understand whether it is right for your business.

May 13, 2015

Selling Shares of Stock in Your Privately Held Corporation

by Donald Oder

Whether or not to sell shares in a privately held corporation is often hotly debated among shareholders. In most cases, the shareholders are seeking a necessary cash infusion either because initial funding has run out before the company could reach its full potential or because the shareholders desire expansion. The shareholders, however, are simultaneously reluctant to share equity, profit and control. After investing significant personal time and resources in development, they feel as though they have poured their heart and soul into the company. With so much invested and so much at stake, it’s not surprising that shareholders have disagreements about funding and expansion. Funding and expansion aren’t the only reasons shareholders may want to issue new stock. In smaller closely held corporations, it may be that the shareholders (typically fewer in number) desire to issue new stock to someone with a particular expertise even if that person has no money to invest. In other cases, issuing new stock is a way to ease into a full transfer of ownership over time so that tax liabilities are spread out.

In addition, there are important practical considerations not the least of which is whether or not those wishing to sell corporate stock have the authority to do so under the corporate by-laws. If the by-laws require a unanimous decision of the shareholders for the issuance of new stock, then even a one-percent owner with little involvement in the company’s operations can veto the sale. If the total authorized shares under the Articles of Incorporation are already outstanding, then either the Articles need amending or the shareholders will have to relinquish some of their existing shares.

Finding Investors: Once the corporation’s directors decide to issue new corporate stock, the first step becomes the difficult task of finding an investor. In some cases, the call for issuing new stock in the corporation arises because the board of directors has already found (or been approached by) a prospective investor. In such cases, the investor has already been vetted and the directors go straight to a vote. In other cases, the directors consult with the shareholders about the need for investment and after satisfying themselves that the shareholders are on board, seek out investors.

April 28, 2015

What is Gross Negligence in Indemnification Clauses?

by Donald Oder

Commercial tenants are often perplexed when they realize that under the terms of their lease, they are responsible for damages that occur on the leased premises even if caused by the landlord’s own negligence. In most cases, the landlord’s liability for just about any scenario is limited to gross negligence and willful misconduct. Landlords typically insist that all liability shift to tenants because tenants have control over the leased premises. Tenants are then required to adequately insure against all liabilities whether or not it’s the landlord’s fault. The idea that tenants should be responsible for a landlord’s negligence seems counter intuitive. Landlord’s simply argue that they do not want to get caught up in battles over who may or may not be negligent. In their view, the simpler solution is for tenant’s to indemnify landlords for all liabilities while maintaining adequate insurance coverage (including insurance covering the landlord’s negligence). Whether or not one buys into the argument, the practical reality is that most landlords in California will insist on indemnification clauses requiring tenants to defend, indemnify and hold landlords harmless except in cases of the landlord’s gross negligence or willful misconduct. As a practical matter, excepting gross negligence and willful misconduct from indemnification clauses is not problematic for landlords because under California law they are already unable to contractually shift liability for their own gross negligence or willful misconduct. Willful misconduct is intentional misconduct. But what is “gross negligence”?

In layman’s terms, negligence is often referred to as carelessness. In legal terms it refers to the failure to meet an accepted standard of conduct. For example, a surgeon that accidentally leaves a sponge in a patient would clearly be careless thereby breaching the “standard of care” expected from surgeons generally. Gross negligence refers to a level of negligence that is greater than standard negligence but falls short of an intentional act to harm. Leaving the sponge in the patient on purpose because the surgeon didn’t like the patient’s constant complaining would be an intentional act. In California, gross negligence is defined as misconduct that demonstrates either a want of even scant care or an extreme departure from the ordinary standard of conduct. Gross negligence falls somewhere between a careless accident and an intentional act. Perhaps a nurse reminded the surgeon twice that the sponge was still in the patient but the surgeon decided to respond to a text message. Being warned about the sponge and texting while operating reflects a more careless act and in this case arguably rises to the level of gross negligence. Defining the contours of what is and what isn’t gross negligence however is easier said than done. Proving gross negligence then, at least in California, depends on making a factual determination as to what is scant care and/or an extreme departure. This is a highly subjective standard. The finder of fact (the jury in most cases) is tasked with determining what the standard of care is and then what level beyond this standard rises to gross negligence. In short, proving gross negligence is difficult in almost any circumstance.

To learn more about landlord liability and indemnification clauses, contact a San Diego commercial lease lawyer today.