The Importance of the Operating Covenant in Commercial Leases: What You Need to Know

Are you a commercial tenant looking to sign a retail lease? Then you must understand what an operating covenant is, and how it impacts your business operations. An operating covenant is a clause in a retail lease that requires you to operate and remain open during the lease term. This clause is crucial to the landlord as it ensures that the tenant’s sales are maximized, and the shopping center’s appearance and value are maintained. If you don’t operate and remain open, it can lead to co-tenancy clause violations, difficulty leasing spaces, and negatively impact the overall appearance of the center.

If you have a retail lease with a percentage rent component, you are more likely to have an operating covenant. A tenant with negotiating leverage, such as an anchor tenant, can insist on maintaining the right to go dark. However, even if you go dark, you are still obligated to pay for your monetary obligations under the lease. In some cases, the tenant may find it financially preferable to go dark and continue paying rent rather than maintain operations at a financially unsuccessful store.

As a tenant, it’s important to consider negotiating limitations on the operating covenant, such as exclusions from the operating covenant, specified hours of operation, inadvertent closures, and the landlord’s right to recapture. You should try to tailor the operating covenant to your specific type of business and have it apply only if a certain percentage of the other tenants in the shopping center are similarly obligated.

When negotiating the operating covenant, the landlord can include protective mechanisms to hedge against the risk of the tenant going dark. These include a right of recapture, exceptions based on the operations of other tenants, and an opening for business operating covenant.

A recapture right is necessary when the tenant is not obligated to remain open and operating. With a recapture right, the landlord may terminate the lease and recapture the space if the tenant goes dark. However, if the tenant is required to be open and operating, but goes dark, the landlord’s remedy is to declare a breach of the operating covenant.

If the landlord has a recapture right, the most important matter to negotiate is the payment obligation on termination of the lease. Each party is affected differently depending on the circumstances of the lease transaction. As a tenant, you should try to negotiate for the right to nullify the landlord’s termination notice if you agree to reopen by a certain date. This way, you have the opportunity to reopen or assign your lease and realize a return on your investment.

In conclusion, as a commercial tenant, it’s crucial to understand the operating covenant and its impact on your business. Negotiating limitations on the operating covenant and understanding the landlord’s protective mechanisms can ensure a successful and profitable business operation.