Radius Restrictions: The Circumference of Issues to Consider

April 2016

Commercial landlords of retail shopping centers often try to protect the profitability of their property through so-called “radius restrictions.” A radius restriction prohibits a tenant from opening additional locations within a certain distance from the shopping center and helps retail landlords increase and maintain the appeal of their shopping centers. For example, if a tenant is prevented from opening other locations in the vicinity of the landlord’s shopping center, customers from the surrounding area will have to visit the landlord’s property if they want to shop at that particular tenant’s store. By limiting the number of options available to customers searching for particular tenants, the landlord increases its foot traffic, which ultimately translates into more sales for all tenants of the shopping center.

Radius restrictions are particularly important to landlords in leases that include a percentage rent provision, which requires the tenant to pay a percentage of the sales from its premises to the landlord as a form of rent. A radius restriction helps protect a landlord’s prospect of receiving percentage rent by preventing a tenant’s sales from being cannibalized or diluted by another store located in the surrounding area.

Tenants often resist radius restrictions in an effort to maintain control over the growth, development, and operation of their businesses. From a tenant’s perspective, the tenant is in the best position to determine how many locations it can and should successfully operate in any given area to maximize sales for the overall business. Tenants generally contend that by limiting their ability to enter or control certain areas, landlords inhibit the tenant’s ability to gain market share, challenge competitors, and increase brand recognition.

Specific Points of Negotiation

The particular details of a radius restriction determine its effectiveness in protecting each party’s competing interest. Below are a few common issues that arise when landlords and tenants negotiate the specific aspects of a radius provision.

  • Size and Delineation: The size of a radius restriction determines the specific area where a tenant is prevented from opening an additional store. A typical radius provision defines this area by describing a line that begins at any boundary line of the applicable shopping center and extends for a certain distance in every direction (e.g., 5 miles). Other times, landlords and tenants may agree to use a distinct restricted area delineated by specific streets, other shopping centers, or other relevant landmarks. Regardless of the method used to determine the restricted area, it is important to clearly describe and define the area where the tenant is not allowed to open additional locations. The parties can avoid potential ambiguities by using both a written description of the restricted area as well as a map identifying the same area.
  • Scope: Generally, a radius restriction not only prevents the tenant entity under the lease from opening another store within the radius, but it also prohibits the tenant’s affiliates, subsidiaries, parent entities, any entity under common control with the tenant, and any officer, shareholder, partner, or employee of any of the foregoing entities from opening, operating, or having any interest in another store within the radius area. Tenants often want to reduce the scope of a radius provision by limiting the stores affected by the restriction. For example, tenants may require that the restriction only apply to additional stores operating under the same trade name and for the same use as the tenant’s premises subject to the restriction. This type of limitation provides the tenant flexibility and assures the tenant that it will not be prevented from buying, operating, or investing in additional businesses (that operate under a different trade name or for a different use) within the radius area. Landlords and tenants are usually able to reach a reasonable agreement on the scope of a radius restriction based on the specific details of each party’s business and the location of the shopping center.
  • Remedies: There are generally three categories of remedies to consider when deciding what remedies will be available to a landlord in the event a tenant breaches a radius restriction: injunctive relief, termination of the entire lease or specific tenant rights under the lease, and damages. Although an injunction can sometimes prevent a tenant from opening, operating, or having an interest in (as the case may be) another store in the radius area, injunctive relief is an equitable remedy that is typically unavailable to landlords in the event of a radius violation because damages are sufficient to compensate landlords for the harm they suffer. A landlord may request the right to terminate the entire lease if a tenant breaches a radius restriction, but tenants may resist such a harsh penalty and offer some sort of monetary damages as a remedy.

Damages are difficult to calculate for a violation of a radius provision because the violation involves both the loss of sales and the loss of goodwill at the landlord’s shopping center. Therefore, the parties typically avoid trying to calculate an exact amount of damages and instead agree to either an “effective rent” concept or an “artificial sales” concept. If the parties agree to an effective rent concept, the tenant’s base rent is increased to an amount equal to the base rent that the tenant was previously paying the landlord, plus the amount of percentage rent the tenant was paying prior to the breach, and the percentage rent breakpoint is adjusted accordingly. Tenants often argue that using an effective rent concept puts the landlord in the same position it would have been in without tenant’s breach of the radius provision. If the parties agree to an artificial sales concept, a specific percentage, often one hundred percent, of the sales from the tenant’s violating store will be included in the sales from the tenant’s store located at the landlord’s shopping center for the purposes of calculating percentage rent. Another common remedy that landlords and tenants agree to use for a radius violation is the loss of the tenant’s so-called “kick-out” right, which would otherwise allow the tenant to terminate its lease early for failing to achieve a certain amount of sales from the premises in a given time period. Landlords often assert that a tenant should not be allowed to “kick-out” of a lease due to lack of sales if the tenant has diluted its sales and violated a radius restriction by opening an additional store. Finally, the parties may agree to simply consider a radius violation a default under the terms of the lease, which entitles the landlord to all of the remedies specified therein.

A well-negotiated radius restriction can increase the appeal of a shopping center and protect a landlord’s percentage rent without placing an onerous burden on retail tenants. However, it is essential for tenants to consider the long-term effects of a radius restriction on all aspects of the tenant’s business before agreeing to be bound by the restriction for the entire term of a commercial lease.