Rethinking the Landlord/Tenant Relationship in Retail

As a result of the COVID-19 pandemic, landlords/owners have frequently been forced to renegotiate leases with, or take back space from, restaurant, gym, movie theater and other retail tenants that have little to no credit and that built out their space at the landlord's cost.

As an alternative to either granting significant rent abatement to a nonperforming tenant or terminating the lease and living with dark space while attempting to relet the premises, some have been successful in introducing a management structure. Under that scenario, the owner identifies a qualified user such as a chef, an experienced restaurant operator, movie theater operator or gym operator who can take over the space as is and operate the facility for the owner under a "Management Agreement" that is similar to the structure of a hotel operating agreement. If appropriate, the user could be the nonperforming tenant, in which case it would be necessary to memorialize the tenant's transfer to the owner of its furniture, fixtures and equipment (FF&E) rights on the premises. Under this structure, the owner provides the space and funds required for the build-out process, and the manager hires personnel, orders equipment/food/inventory and operates the business. The manager and the owner split the "profits" based on a formula that allocates returns to each party. Typically, the manager gets a larger percentage of profits as profits increase. If the manager fails to achieve specified minimum returns, the owner can terminate the agreement or readjust the economics of the transaction.

When structured properly, one benefit of a management agreement is that it is a personal services contract that does not transfer a real property interest to the manager and, therefore, it can typically be terminated by owner without an eviction proceeding. Think of the Management Agreement as a cross between a lease and a joint venture agreement – it typically addresses the owner's commitment to fund certain startup costs, manager's reimbursement of such costs, use and ownership of personal and intellectual property (including the name of the business), and the quality and pricing of the products sold.

Holland & Knight attorneys have used this structure with restaurants, gyms and theater operations. Rather than allowing a retail space to remain dark, such a structure can provide an owner with the opportunity to operate the space at little cost or risk and potentially develop a profitable operation that benefits the entire project.  

In some cases, Management Agreements are being used in lieu of leases at project inception, especially in connection with mixed-use projects where there are very few credit-worthy users capable of funding the build-out of restaurants or entertainment venues that are critical to the success of the project. Under this structure, the owner would be responsible for delivery of a turnkey facility to the selected operator. Holland & Knight recently structured such a deal for an entertainment venue in Washington, D.C. The key to that agreement was strict control by the owner over build-out costs and the operation of the facility, coupled with financial incentives for successful operation and the ability to quickly terminate the agreement in the event of poor performance.

Of course, there is no one size fits all, and each Management Agreement must be carefully crafted to address the particular situation and jurisdiction, but this structure can provide distinctive opportunities and benefits to retail owners.