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Restaurant Leasing: Part 2 of 5

What Do You Mean I Can’t Change My Restaurant?

You have a great idea for a restaurant concept in an emerging area of the city, let’s say fast-casual barbecue, focusing on pork using your grandfather’s secret rub to give the meat an out of this world flavor. Six months after opening, sales are less than stellar. You’ve received rave reviews from local food critics, but unbeknownst to you when you signed the lease, the immediately surrounding neighborhood is comprised middle eastern families who abhor pork. Realizing the concept is probably best used elsewhere, you inform the landlord that you’re reinventing yourself as a Mediterranean grill, refocusing your barbecue skills on grilling kebabs and meats (other than pork of course). The landlord is sympathetic to your unfortunate situation, but informs you the lease only permits a barbecue restaurant and any other use violates the lease. What is a food entrepreneur to do?

This scenario is quite common; however, the risk can be minimized by proper planning. Restaurants by nature require periodic re-imaging. Whether it’s a complete change of concept or some minor updates and sprucing up, tenants should make sure the lease provides flexibility and an exit plan. This is important in order for restaurants to remain profitable and adaptable to continually shifting market trends. If the restaurant is part of a franchise it will be subject to a variety of image and use requirements imposed by the franchisor and franchise agreement, so these factors must be taken into consideration during lease negotiations.

To protect its flexibility, tenants should attempt to negotiate a broad use clause to permit a “restaurant or any lawful use.” Similar concepts should be addressed in the alterations and signage provisions of the lease in order to permit tenant to reimage or rebrand as necessary. Since the lease term for restaurants are generally longer than most other retail businesses, such broad use clauses will protect a tenant from future changes in the market.

Landlords may not be willing to provide such flexibility out of fear that a restaurant may become a nightclub, bar or coffee shop. Some landlords may not be flexible at all and may insist upon attaching a menu as an exhibit to the lease to establish the parameters of a potential tenant’s use. However, having an agreed menu can limit innovation, even when a tenant is not looking to drastically change its use of the premises. It is important to point out that many landlords are concerned with maintaining a mix of tenants at the property in order not to duplicate certain cuisines or themes. To further protect this tenant mix, landlords may include language in the lease that requires approval or recapture rights for a change of use.

While initially in the lease negotiations parties may appear to be at an impasse when it comes to defining permitted use, there is still room to reach a mutually acceptable compromise. If the landlord rejects including a general restaurant use provision, the tenant may suggest an expanded use clause. This would permit the tenant to modify its use of the premises after operating for a period of time under the initial permitted use, so long as not in conflict with any prohibited or exclusive uses granted by the landlord. Another option is to limit the percentage of sales or square footage of the premises which are devoted to the new use. If the landlord is unwilling to consider any of the suggestions above to provide tenant with sufficient flexibility in the use clause, tenant may try to include a right to terminate the lease if the restaurant does not generate a certain amount of sales.

When negotiating a restaurant lease for a franchise particular attention should be paid to the requirements under the franchise agreement. Too often tenants overlook the terms and conditions of the franchise agreement in regards to reimaging and rebranding, which may conflict with the permitted use provision in the lease. In such event, the tenant may be in a position of having to choose between defaulting under the lease or franchise agreement, neither of which results in a desirable outcome. In order to prevent this from happening, the parties may want to include a provision that permits the tenant to change the use and/or name of the business under which tenant is operating if the change is made across the franchisor’s franchise system. Usually, if the qualification is that such changes are done in the majority of the franchisor’s locations, the landlord will permit this.

RESTAURANT LEASING: PART 1 OF 5

Landlords May Have the Right to Keep Your Restaurant Equipment

When a restaurant lease expires it is fairly common for disputes to occur between landlords and tenants over what is the landlord’s property and what belongs to the tenant. Disputes may also occur upon a tenant default, where the landlord sues to terminate the lease and recover possession of the premises. However, what constitutes the “premises” is not always clear. For tenants, who spend significant amounts of money on equipment and trade fixtures to build out a space, this can be a major issue.

Property is divided into two distinct classes: real property and personal property. Real property consists of the land and building, whereas personal property is removable and includes the furniture, fixtures and equipment (“FF&E”) the tenant uses to operate its business. FF&E is usually defined as a “trade fixture,” which means the tenant may remove it at the end of the lease. Examples of common restaurant trade fixtures include coffee makers, soda machines, tables and chairs, and certain kitchen equipment.

However, certain fixtures that are affixed to walls that cannot be removed without causing damage or injury to the premises or building are not considered trade fixtures and therefore remain with the premises at the end term, regardless if they were paid for by the tenant. Items that may be considered “affixed” to the property include stoves, ovens, walk-in coolers and exhaust vents. During the lease negotiation period tenants should take steps to identify the equipment considered “trade fixtures” in order to avoid costly lease end disputes with landlords.

So what can tenants do to protect themselves? The following are some suggestions to include in restaurant leases:

  • Listing FF&E in the Lease.  Tenants may want to identify their trade fixtures at the execution of the lease in an attached schedule, including items that may be installed at a later date. During the term of the lease tenants may replace items that are not considered FF&E, but could be considered affixed to the premises and therefore landlord’s property. The lease should address who owns the replaced item and whether tenant has the right (or obligation) to remove it at the expiration of the lease. For example, if a tenant is operating an upscale restaurant and intends to install expensive fixtures in the restrooms or lighting in the dinning area, the lease should include language that permits removal of these fixtures. These fixtures are considered leasehold improvements that remain landlord’s property, but the landlord may agree to their removal so long as they are replaced with lesser quality fixtures.
  • Improvements and Alterations.  Leases typically provide for landlord’s prior consent to the installation of fixtures and trade fixtures on the premises. While tenants may want unlimited rights to install equipment and improve the premises, including such language in the lease may not be in their best interest. Even if the lease provides tenant with substantial discretion to alter the premises, the landlord should get notice of tenant’s work in order to establish a paper trail of what was installed. At the expiration of the lease the parties can rely on such documentation to determine ownership should a dispute arise. Alternatively, if the landlord won’t agree to provide a tenant with broad alteration rights, the tenant may try to negotiate the right to remove all improvements at any time.
  • Catch-All Provision.  Regardless of how FF&E is defined in the lease, it is important to include a provision that protects a tenant from breaching its other legal obligations.  For example, restaurants frequently lease major equipment used in the kitchen from third-party lessors.  If, at the expiration of the lease, the tenant is prohibited from removing equipment affixed to the premises (e.g., stove, dishwasher, refrigerator), then tenant would be in breach of the equipment lease by conveying ownership to the landlord.  The risk of this occurring can be reduced by including language that permits removal of any equipment leased to the tenant by third parties.

Restaurant leases are unique and contain provisions specific to the industry. Although there are obvious similarities between many lease transactions, each transaction is different and accordingly so is each lease. There is no “standard form” lease that is appropriate for all situations. Having a lawyer who is familiar with the restaurant leasing process, lease documents and their hidden traps is the best way of ensuring that your transaction will go as smoothly as possible and that the lease accurately represents your understanding and expectations, and protects your interests.

President Signs Mandatory GMO Labeling Law: What You Need to Know

Last week President Obama signed the National Bioengineered Food Disclosure Standard into federal law. The law mandates disclosure of genetically modified organisms (“GMO”) on food labels. The law directs the U.S. Department of Agriculture (“USDA”) to establish, within two years, a nationwide mandatory disclosure standard for bioengineered foods and the labeling procedures. This means that the law itself does not define the standard, but instead gives the USDA significant discretion to define and implement the required disclosure.

Below are some things manufacturers should know about the law:

  • Preemption of State Laws. The new law specifically preempts all state and local labeling requirements applicable to genetically engineered (“GE”) foods that do not mirror the language in the law. This would even apply to state laws already passed, including Vermont where mandatory GMO labeling went into effect in July. 
  • Defining Bioengineered Food. The law defines bioengineered food as food that contains genetic material “that has been modified through in vitro recombinant deoxyribonucleic acid (DNA) techniques” and “for which the modification could not otherwise be obtained through conventional breeding or found in nature.” This definition could be interpreted as quite restrictive, so it will be important to watch the rule-making process to see how the law is interpreted.
  • Labeling Requirements. The law does not specify GMO labeling standards, this is left up to the USDA to determine. However, the law does state the methods to disclose GMOs in food, such as text on the packaging, a USDA-created symbol, or an electronic or digital link (such as a QR code) selected by the manufacturer. Small food manufacturers are provided the additional flexibility to disclose GMO ingredients either by listing a toll free number or link to website containing the disclosure on their labels. The purpose of the law was to disclose GMO ingredients on food labels so consumers searching grocery store aisles could make informed decisions, but law effectively fails to achieve its purpose because “disclosure” can be a link to somewhere else, not on the label itself.
  • You Aren’t What You Eat. Meat from animals that consume bioengineered food are exempt from disclosure. Specifically, the law prohibits the USDA from considering any food primarily derived from an animal because “the animal consumed feed produced from, containing, or consisting of a bioengineered substance.” So, for example, you go into a store to buy some beef for a family barbecue and, because of your concern about the safety of GE foods, you want to purchase a GMO free product. You’re aware that most cows slated for consumption are fed a diet containing mostly corn, a majority of which is bioengineered. The label doesn’t disclose GMO ingredients, so you think you’re safe. Think again. Even if the cow eats nothing else but bioengineered corn its entire life, the meat is not considered GE under the new law. Thus, Congress is betting that consumers will be uniformed about the provisions in the law and think their meat is non-GMO, even if its arguably not.

Food Recalls: Does Your Insurance Policy Cover “Reasonable Probability” of Contamination?

Many food businesses, after conducting a risk assessment, will purchase some form of recall insurance (commonly referred to as product contamination insurance). These recall policies typically provide coverage for “actual” contamination, meaning for coverage to kick in the consumption or use of the product must have resulted in bodily injury and/or property damage. To date, recalls were voluntary and initiated by the company. However, earlier this year the final rules were issued under the Food Safety Modernization Act (“FSMA”), which provide FDA with the authority to mandate recalls for food products if there is a “reasonable probability” that the food product is adulterated or misbranded and the use and/or exposure to the product would cause serious health consequences or death.

The FDA’s mandatory recall authority under FSMA may put food businesses at risk because many insurance policies don’t provide coverage for government recalls without an “actual” contamination. The direct and indirect costs associated with these recalls can be substantial. It is important to know if your damages are covered by your policy and, if so, to what extent. 

While many insurers have yet to address FSMA, some insurers have altered their basic form or issue an endorsement for “government recall”.  However, not all “government recall” clauses are created equal, so careful attention should be spent when reviewing or negotiating the policy to ensure proper coverage, especially since every business is different and are faced with different risks. 

In order to better understand their insurance requirements, businesses should perform a comprehensive risk analysis. The risk analysis should not only include the business’s products and operations, but also the operations of their suppliers’ and an analysis of the quality of the ingredients included in the business’s final products. Often overlooked in the analysis process is the risks assumed in purchase and sale agreements and vendor contracts. Businesses should review these agreements to identify and determine which risks can and/or should be insured. Many contracts in the food industry are written in favor of the buyer, so in the event of a recall, the seller (policyholder) is responsible for associated costs. The effects of a recall to a seller without proper coverage could be devastating.

When discussing recall coverage with your broker, the following are a list ofitems you may want to address:

  • Direct Product Damage – Many policies cover the contaminated product in the field or warehouse, but some only cover product in the field. 
  • Publicity – Publicity coverage is not always included in a basic policy, but when it is the most important feature of this coverage is that it can result from “an actual or alleged contamination, where the Named Insured’s Product(s) and the Named Insured must be specifically named.” If a business supplies an ingredient used by a buyer in a finished product and the buyer’s product is recalled (in most cases only the finished product is identified in the recall), then is this scenario the policy won’t provide coverage.
  • Lost Gross Profit/Extra Expense (“LGP”) – If the policyholder loses an account due to a recall event, this pays for a year or more of LGP. For many food businesses, a large account could represent a significant portion of their total revenue. Extra Expenses may arise when it is necessary to engage another processor and new processing costs exceed the businesses normal processing costs.
  • Rehabilitation Expenses – This coverage pays for the rehabilitation of the brand in the marketplace. Many businesses overlook the importance of obtaining this coverage because one food safety incident can destroy a brand that a business has spent years building.
  • Crisis Response/Consultant Expenses – Coverage for these expenses can be very important and largely address the costs involving specialized attorneys and public relations/crisis response specialists.

Entrepreneurs Beware: Violating Food Safety Laws Can Land You in Jail

I frequently receive calls from food startups who want to know the best way to protect their business from their competition. Specifically they’re concerned about theft of their recipes, intellectual property and key employees. After listening to their concerns, I then pose a question to them: what steps have you taken to protect your business from a food safety incident? More often than not there is silence on the other end of the phone. What I attempt to explain to them is that, regardless of all their other legal concerns, without a comprehensive food safety program in place their business will be worthless. Some listen, others don’t. But many of these entrepreneurs don’t realize is that, while they may think they’re in the food business, they’re actually in the food safety business.  

The food industry is unlike any other. When a software company’s product is defective or a financial services company provides poor advice the worst thing that may happen is customers lose money. But unlike these industries, when a food business introduces an adulterated product into commerce consumers may become seriously ill, possibly resulting in death. Now I get many startups are “bootstrapping” their business and capital is tight, so careful decisions must be made where to spend and where to cut corners. While you may want everyone of your witty and artfully crafted slogans trademarked, if by doing so you’re foregoing having your product labels reviewed for FDA compliance or engaging a food safety professional to assist in designing and implementing good manufacturing principals, then you’re setting yourself up for failure.

If you don’t believe me, let’s take a look at a few recent examples. A licensed maple syrup producer decided to expand his business by using the apples picked from his farm to make and sell cider. This all seemed harmless until the cider was linked to an E.coli outbreak that sickened four people, including two children. The court found that the owner failed to follow good manufacturing processes and he was convicted of selling adulterated food, sentencing him to 14 to 48 months in prison.

In another incident, a woman plead no-contest to charges that she sold adulterated and misbranded food at several Michigan farmers markets. She sold various pickled products directly to consumers, which under Michigan law requires certain processes to take place during the production cycle to prevent the risk of botulism. Additionally, under federal law all food processors who make low acid and acidified foods must register their establishment. Here, the woman produced the products out of her home kitchen, not a registered facility, and she apparently didn’t even know there are laws regarding the manufacturing of food products which are intended to protect consumer health. These mistakes cost her not only $3,100 in fines and 11 months of probation, but her business.  

For food startup businesses, making sure your products and food safety procedures are in compliance up front will save you countless headaches, and potentially money, down the road.  If there is on piece of parting advice I can give food entrepreneurs out there it’s this: you will make many mistakes running your business, but most likely the business will continue to survive and you’ll learn from these mistakes; however, it only takes one food safety incident to destroy a business. If you don’t believe me, take a look at Blue Bell ice cream and Chipotle. Whether their businesses will survive these outbreaks or not remains unclear.