Category Archives: Business Law

Commercial Lease Tips for the Business Owner (the unrequited lease)

Here is an overview of some common issues that arise when a small (or any) business owner negotiates with a landlord over a lease agreement.  Routinely, landlords write leases and tenants sign them without negotiating, changing language, or having their attorneys read over them.  Having an attorney spend a half hour reading a lease can save you tens of thousands of dollars in losses down the road.  Keep in mind as you read that this is a negotiation and some landlords may not be willing to budge on some of these issues.  The idea is not to have the upper hand, but for things to be fair between the parties.  Most leases are written by landlords and are pretty slanted in their favor.  Here are some common commercial lease snafus and how to deal with them.

  1. Exclusivity
Almost every commercial lease has an exclusivity clause.  However, these clauses are rarely, if ever, mutual.  You move into a retail shopping center.  You operate a smoothie business.  There is a CVS drug store in the center.  You sign a covenant “Not to compete with, sell, display, or sublease to any business selling or displaying health, beauty, vitamins, dietary supplements, prescription drugs, or over the counter drugs.”  Sounds fair, right?  The problem is that most exclusivity clauses protect the “Anchor” tenant, but fail to give you protection. 
An acquaintance recently ran into this problem.  He agreed not to compete with any retail business currently in place at the date of his lease agreement.  However, the covenant was not mutual.  The landlord never promised not to lease space to another tenant competing with him.  A competing smoothie business moved in two doors down from him.  Did he have any recourse?  Probably not.  He may have a breach of good faith and fair dealing claim, but that’s tenuous as best.
Make the feeling mutual.  Something like:
“Tenant, and any successor, assignee, or sublessor covenants not to compete with any other business occupying the premises, while Landlord covenants not to allow the operation of any business that would compete with tenant, successor, assignee or sublessor operating a _______ business.”
  1. Commencement Date
So many leases set commencement upon, “Substantial completion of tenant improvements.”  What does that mean?  What are substantial?  Which tenant improvements?  Avoid ambiguous language.  Set guide-posts that are concrete and in yourcontrol.  Lease commences upon grant of certificate of occupancy?  Lease commences upon clearance with Department of Health?  Lease commences upon completion of flooring, signage, and certificate of occupancy?  Give the commencement date clause something to hang a hat on.  Make sure that you don’t pay rent until improvements are complete—or that rent is reduced at a calculable rate.
  1. Operating Expenses
Most commercial leases require tenants to pay a percentage of operating expenses.  Many times this is called “Additional Rent.”  Review the expenses that the landlord will pass on and make sure that they are reasonable and directly related to the building’s operations.  Certain costs should not be passed on to the tenant.  Determine whether the allocation of expenses is based upon a fully occupied building or, if not, that they are properly adjusted.  You may want to negotiate a cap on “Additional Rent/Operating Expenses.”
  1. Common Area Maintenance Charges
Yes, there is rent, additional rent, and now common area maintenance fees.  Sure you want to be a tenant?  Common area maintenance charges (CAM) are similar to “Additional Rent” except it commonly covers items such as security costs, painting, maintenance of common areas, etc.  You need to review records to determine what CAM charges are been historically and whether or not they are based on full occupation or adjusted.  If a number of tenants move out, you don’t want to be stuck with the whole CAM bill.  Similar to operating expenses, it’s advisable to negotiate a cap on CAM charges.
  1. Attorney Fees
Almost any lease contract is going to mention attorney fees.  Don’t get too hung up on it.  California Civil Code 1717 ensures that any contract provision about attorney fees has to be reciprocal even if it doesn’t say so.  That’s great.  However, lawyers have become savvy and write clauses like, “Any attorney fees or costs incurred in collecting rent or commissions are payable by the losing party.”  Uh oh.  Even if § 1717 demands reciprocal fees, the clause only applies to actions regarding the collection of rent or commissions.  Tenants are not going to be collecting rent or commissions, landlords are.  So, although § 1717 demands that if a tenant sues the landlord in an action regarding commissions, they can also get attorneys fees—the chances are they would sue about something other than the collection of commissions or rent.  Make sure that any attorney fee provision is as broad or narrow as you want it to be.  Like, “Any costs or attorney fees that arise from this contractor its enforcement are payable by the losing party.”
  1. Use Restrictions (and subleases)
Use restrictions are common and are another means of creating exclusivity.  That’s well and good, but they may be extremely restrictive and prevent subleasing.  Common use restrictions sound like, “the premises may be used for the operation of a retail shoe store and for no other purpose without the prior written consent of the landlord.”  You may want to negotiate a broader clause like, “the premises may only be used for operations of any lawful retail business,” or “any lawful professional business practice.”  The less restrictive, the greater chance you will have of subleasing if you have to in the future.
  1. Recapture/Relocation
Most tenants have trouble understanding recapture.  That’s because its economically ludicrous.  Here you have promised to pay rent, completed improvements on the lease space, for some reason you inquire about assignment or subleasing and the landlord comes and pulls the rug out from underneath you, kicking you out.  Permitted?  Yes, if there is a recapture provision.  Common recapture provisions sound like:
“Landlord retains the right of termination and recapture upon tenant’s inquiry into assignment or sublease or any other event that gives Landlord reason to believe that due performance will be impaired.”
The point is that they don’t want you subleasing for a rate lower than the lease amount.  Having a below-par tenant brings down the value of the property or makes the anchor-tenant nervous.  That makes sense.  That’s why there is probably a clause that requires any sublease to be commercially reasonable.  But, holy cow.  Under the language above, if you simply ask whether or not you can assign the lease to an affiliate– they can terminate the lease.  Make sure there is no recapture provision.
  1. Exit Strategies: Vacancies, Retail Mix, and More
Have an exit strategy.  What happens when operating expenses and/or common area maintenance charges exceed what is reasonable for your bottom line?  What happens with the anchor-tenant leaves and you are leasing space in a dead retail shopping center?  We have all seen those shopping centers where there is one lonely video rental store and ten empty units with weeds growing in the parking lot.  Have a clause that allows termination electable by tenant upon certain events.  It can sound something like the following:
“Landlord agrees that tenant and any successors in interest may terminate this lease without penalty if any one of the following events occur:
                                 i.            Retail occupancy falls below 65%;
                               ii.            The Anchor-tenant Ralphs Supermarket terminates or otherwise fails to occupy retail space within the complex;
                              iii.            Combined monthly Common Area Maintenance fees and monthly Additional Rent equate more that 33% of monthly lease rental payments;
                             iv.            Landlord fails to accept a commercially reasonable assignment or sublease;
                               v.            Landlord leases space to another business who competes with tenant named on this lease or any successor in interest in a similar line of business.
                             vi.            The Retail Mix of the complex is significantly altered from the Mix at the commencement of the lease.  Significant alteration is defined as a change of more than 25% in any given business category.  At the date of this agreement, the Retail Mix of the complex is 50% professional, 40% consumer retail, 10% industrial.”

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California non-compete and non-solicit agreements: when they matter and when they don’t

You’re a consultant and you sign a non-compete agreement or non-solicit with a company that demands you sign it.  Do they matter?  Do you need to keep track of who you can solicit and who you can’t?  The long answer is:  it depends. 
The short answer is that if you are an employee or contractor (not a partner or owner) and the employer is headquartered in California, then such agreements are unenforceable.
Most non-compete and non-solicit agreements in California are illegal, as against public policy, due to California Business & Professions Code § 16600:
Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.
Three situations where such agreements are valid and enforceable:
  1. Business Ownership exception: sales of stock, mergers, LLC membership
  2. Partnerships
  3. Federal Court Boogaloo
Business Ownership Exception
Some of what the California legislature took away from businesses in CA Bus. & Prof. Code § 16600, they gave back in § 16601, 16602, and 16602.5.  Most non-compete and non-solicit agreements coupled with the sale of stock are considered enforceable under § 16601.  Let’s say you are a CEO of a corporation and you own 3% of the company in stock.  As a part of a corporate merger, you sell your stock and sign a non-compete agreement.  The non-compete agreement is valid and enforceable.
The Business Ownership exception also applies to members of an LLC under § 16602.5.  If a member of an LLC signs a non-compete or non-solicit agreement, it is enforceable.
Business owners, I know what you are thinking.  Can’t you just have every employee sign a non-compete agreement, have them buy a small amount of stock, and force the stock’s sale upon leaving the company?  The buy/sell provision will be valid, but you can’t use such measures to circumvent § 16600.  A company tried this technique and lost in Bosley Medical Group v. Abramson (1984) 161 Cal.App.3d 284, where the Bosley court state that a “substantial” sale of all shares must take place, so that it can be said that goodwill of the company is being transferred.  So how much stock must an employee for it to be valid?  No one knows.  However, employers can’t have employees buy a small amount of stock just to validate their non-compete agreements.
A partnership is “two or more persons associated together in a business for profit.”  Also note, no partnership agreement is required in order to be a partner.  So be warned, you may be a partner and not know it.  If you are a partner, non-compete and non-solicit agreements are valid under § 16602.  They are subject to a “rule of reason,” meaning they must be geographically and temporally reasonable.  Generally something like a few years and radius of 40-60 miles are considered reasonable.  Such agreements have been upheld in the context of accountants (Swenson v. File (1970) 3 Cal.3d 389), attorneys (Howard v. Babcock (1993) 6 Cal.4th 409), and physicians (South Bay Radiology Medical Associates v. W.M. Asher, M.D., Inc. (1990) 220 Cal.App.3d 1073, Farthing v. San Mateo Clinic (1956) 143 Cal.App.2d 385).  Consultants beware!   If you sign any consulting agreement make sure that it makes very clear that you are not working “in association,” are not partners, and are not embarking on a joint venture.  Also, contractual denials of partnership formation will be of no avail if all of your conduct indicates otherwise.  Make sure you are consulting and not becoming a partner, or else a non-compete agreement might become valid.
Federal Court Boogaloo
When an employer wants to sue a former employee for violating a non-compete agreement, the employer may try and “remove” the action to Federal Court.  The employer may be able to do so if certain jurisdictional requirements are met, but generally will be able to do so if $75,000+ is at stake and the employer and employee are residents of different states.  (Courts apply many tests when determining where corporations “reside,” but generally look to the corporate headquarters and where they do most of their business.)  The 9th Circuit (Federal Court) is supposed to respect California law and follow § 16600, but guess what, they don’t like it.  In IBM v. Bajorek (9th Cir. 1998) 191 F.3d 1033, the 9th Circuit upheld a non-compete agreement in spite of § 16600.
Edwards and Employer Demands

Demand After Employment
Let’s say your employer comes to you and demands you sign a non-compete or non-solicit agreement or they are going to fire you.  You refuse and they fire you.  There may be a valid cause of action for wrongful termination.  In Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, the court found that an employer cannot lawfully make the signing of an employment agreement, which contains an unenforceable covenant not to compete, a condition of continued employment.
Employment Contingent Upon Agreement
If an employer demands you sign a non-compete or non-solicit agreement in order to get a job, each individual will need to analyze the prospective benefit of employment against the detriment from signing such an agreement (taking its enforceability into account).  However, there is not yet a case on point whether Edwards applies to prospective employment.  An employee would not yet have an action for wrongful termination.  An employer would probably not be intentionally interfering with prospective economic advantage, because usually in such instances a third party is involved.  It is questionable whether or not such an employee would have any claim.  As a result, prospective employees will need to analyze the risk/benefit and enforceability of such agreements before they decide whether to sign them.

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Divorce-proof your business

So you have a business with your spouse and business is going well, but marital bliss is fleeting.  Have you thought about the fact that post-dissolution; your business may have to be sold to raise cash?  Anything you can do to divorce-proof your business?  Here are some thoughts:

  1. Keep good records
Be sure to maintain records and keep business and personal assets separate.  
  1. Pay yourself a salary (maybe)
A salary can be a double-edged sword.  Pay yourself a lower salary than your spouse and his attorney may argue he is entitled to a larger share of the business post-marriage.  Pay yourself a higher salary, and you may provide great evidence for his lawyer to come after you for spousal support.  The best bet is to have the same salary level as your spouse.
  1. Regularly value your business (conservatively)
The value of someone’s business changes drastically depending on whom is asking.  Applying for an SBA loan?  Then you’ll claim you have great cash flow and low current ratio.  During divorce proceedings, the respondent will always claim that the business is hemorrhaging cash and has a negative net worth.  Annually valuating your business in a conservative manner may help provide a fairer divorce settlement.  If you receive very aggressive valuations from a generous analyst and your spouse sues you for divorce the next day, you may be kicking yourself all the way to the courthouse.  If you have your business valuated, make sure it is conservative and accurate.
  1. Realize that your business is probably a partnership
Unless you have another business association (LLC, Corporation, etc.) your business with your spouse is probably a partnership.  Even if you never signed a partnership agreement, you have a partnership.  If you never signed an agreement, surprise! The state of California has written a partnership agreement for you.  It’s something very much like the Uniform Partnership Act.  Under the UPA, any partner can force dissolution of the partnership.  So, if you have a partnership and you haven’t agreed to other terms, your spouse can force the destruction and sale of assets of the business.  If you sign a buy/sell agreement, you can agree in advance to buy the other spouse’s share for a set (or floating) amount and prevent the destruction of your business.
  1. Buy/Sell agreement
Any buy/sell agreement should take fiduciary duties (discussed below) into account, but a buy/sell agreement can be a useful planning tool.  Who gets to keep operating the business after dissolution?  Is one party ousted?  Does the type of business require that one spouse stay in the business to ensure its viability?  Is the ousted party the one who files for dissolution?  Is it the one who commits adultery?  Is the departing spouse paid in installments?  Will the dissolution force the sale of the business?  What about goodwill? 
One popular buy/sell provision requires that one partner divide the assets of the partnership.  The other partner is assigned the task of dividing up the debts.  The partner who divided the assets gets to choose one of the piles of debt.  The partner who divided the debts gets to choose one of the piles of assets.  This gives a strong incentive for each to divide the piles equally.
  1. Be ready to buy him out
So you want to keep the business, but where are you going to come up with the funds to buy out your ex-spouse?  Talk to your friends about investing in the business in order to shore up the funds.  Talk to a business consultant about leveraging business loans to shore up the cash.
  1. Don’t let it burn to the ground
You may want to burn the marriage and sift through the ashes, but don’t let the split do the same to the business.  If money is starting to disappear, someone has acquired a substance abuse problem, or one spouse is grossly mismanaging the business, be prepared to dissolve the business as soon as possible before they squander anything its worth.  Even if that means dissolving the business, that may be better than losing everything.
  1. Special options with abuse, harassment, or violence
If your spouse has been abusive, you may be able to get a domestic violence protective order that also restrains him from the home or your business.  In the alternative you may pursue a civil harassment order or a workplace violence order.  Note: the standard for a civil harassment order is much lower.  In addition, you don’t need to be married to seek protection under the Domestic Violence Protection Act (commencing at Family Code § 6200).
Also, under Family Code § 6324, as a part of a domestic violence protective order, a court can order the “temporary use, possession, and control of real or personal property of the parties and the payment of any liens or encumbrances coming due during the period the order is in effect.”  Not only might you be able to keep him away from the business, the judge may order he pay the mortgage and rent in the meantime.
  1. Act in good faith
Marriage creates a fiduciary relationship just like a business partnership.  California Family Code § 721 states, “This confidential relationship imposes a duty of the highest good faith and fair dealing on each spouse, and neither shall take any unfair advantage of the other.”  Firing your spouse, concealing assets, and signing really one-sided contracts are probably going to back-fire in the long run.
  1. Talk to an attorney
You want your husband out of the business, but how do you avoid liability for his future actions?  What type of buyout provision works best for you and won’t be thrown out of court?  If I pay myself a salary, will that protect me or reduce my prospective spousal support award?  Running a business and ending a marriage is stressful enough, get some accurate answers to your concerns in advance to make sure you are setting yourself up for a smooth transition.

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