Watch Your Language with Percentage Rent Clauses in Commercial Leases

(“Say what you mean, precisely, or a judge will decide what you meant #5”)
“Typically, courts will uphold commercial lease provisions unless they are contrary to public policy or statutory law. Consequently, commercial landlords and tenants have a lot of leeway in allocating the risk and responsibility of issues inherent in commercial leases. For example, a commercial landlord in Ohio could draft provisions calling for non-judicial, self-help evictions (provided there is no breach of the peace); a one-year security deposit versus a one-month security deposit; and a default interest rate of 15%. Courts traditionally presume that commercial landlords and tenants are on more of an equal playing field and are more sophisticated concerning these transactions, since both will usually have attorneys to review their leases. This is not the case in residential leases in Ohio which are subject to the Ohio Landlord Tenant Act (See Ohio Revised Code Section 5321.01 et seq.).

Because courts often defer to the specific language of a commercial lease, (and refuse to consider extrinsic evidence of a party’s intent if the language is clear and unambiguous), unintended results are often norm for landlords and tenants who do not review the language in their leases carefully prior to signing the same. This is especially true regarding interpretations of “gross sales” under "Percentage Rent Leases".

In today’s economic climate, many retail landlords and tenants are agreeing to lower base rental rates, and adding rent in terms of a percentage of "gross sales", above a minimum amount (also known as the “break point”). With Percentage Rent Leases, both landlord and tenant share the proceeds if the tenant is fortunate enough to incur sale volume above the breakpoint. The problem occurs when the lease does not adequately define the formula for percentage rent, in particular, the meaning of “gross sales.”

From the landlord’s standpoint, the Percentage Rent Lease should include the following items in the definition of gross sales or gross receipts:

1) The entire amount of the gross sales price for cash, check and/or credit received from the sale or lease or otherwise of all goods, merchandise, and services provided or performed at, in, on or from the leased premises;

2) All sales by any subtenant, assignee, licensee, concessionaire, or other occupant of the premises;

3) Revenues from internet sales;

4) All telephone, mail-order, facsimile, catalog and email orders originating from or filled at the premises, or filled at other stores or locations;

5) Un-refunded and forfeited deposits and other amounts received from customers;

6) Related services such as delivery, installation and servicing paid for by customers who ordered merchandise at or from the premises;

7) The fair market value of trade-ins;

8) The sales price of gift and merchandise certificates;

9) Lottery ticket revenue;

10) Interest and finance charges in connection with sales;

11) Vending machine, video and amusement game, pay telephone, postal service and newspaper revenue.

It is certainly arguable that lottery sales, or liquor sales whose revenue goes to the state of Ohio should not be included in the definition of gross sales, and the tenant or tenant’s attorney would be wise to have same excluded from the definition. Certainly, commissions are earned from those sales, and those commission amounts should be included. However, the landlord in the case of Midtown Foods, Inc. v. Mid-America Management Corp. 2007 OHIO App. Lexis 2556 (8th District) disagreed with this reasoning. The Midtown-Mid-America lease called for percentage rent on gross sales of all merchandise, services and other items of value, and the landlord argued that liquor was certainly merchandise as well as an item of value. The Court in Mapletown Foods disagreed with the landlord. It held that the gross sales definition and language was ambiguous because it did not include the phrase “liquor sales”. The Court further pointed out that the revenue from the sales actually went to the state of Ohio, and only commissions on sales stayed with the owner. Courts across the country have generally treated lottery tickets sales in the same manner. Courts have also, effectively prevented landlords from securing percentage rent from concessionaires, program advertising, and service-related labor when these items were not specifically included in the definition of gross sales. The moral of the story for landlords is, “say what you mean precisely, or a judge will decide what you meant.”

Tenants who fail to specifically call for exclusions from their gross sales definitions are equally disappointed. Among the items that tenants seek to be excluded from gross sales are:

1) Cash or credit refunds;

2) Transfers or exchanges of merchandise between a tenant’s stores that do not involve a sale;

3) Sales and use taxes;

4) Interest, finance and carrying charges;

5) Returns of merchandise to manufacturers;

6) Licensee, sub-tenant or concessionaire fees;

7) Employee discounts;

8) Vending machine sales to employees;

9) Unredeemed gift certificates;

10) Insurance proceeds;

11) Employee and/or senior discounts; and

12) “Lost leader” sales that generate no profit.

The morale of the story is the same for tenants, as it is for landlords: "say what you mean precisely, or a judge will decide what you meant".

One particular vexing issue in gross sales definitions is whether or not to include internet sales. Because sales are technically made in “cyberspace” rather than at a leased premises, general provisions such as “gross sales of all merchandise at the premises” will not suffice. The ultimate resolution of whether or not internet sales will be included in a lease definition of "gross sales" will depend primarily on the relative bargaining strength of the parties. However, if it is agreed that internet sales are in fact to be included, careful drafting is in order so that the following questions are answered within the language of the lease itself: 1) How are you defining the location of the applicable internet sales? (e.g., all sales made within the zip code in which the store is located, or within a certain radius of the store, or just sales that are fulfilled from the particular shopping center location); 2) In the case of a national tenant, should a portion of national sales be allocated to each region or store; 3) How will you treat internet returns in order to determine what to exclude from the new definition?; (4) Is a separate breakpoint for calculating internet sales in order?

However you define gross sales, say what you mean precisely, or a judge will decide what you meant.

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