By Cassandra Da Re, Partner, Dale & Lessmann LLP

Lease negotiations in the context of franchised restaurants present a distinctive set of challenges, requiring a nuanced understanding of both leasing dynamics and the intricacies of the franchise relationship. This article aims to provide legal insights tailored to restaurant tenants, shedding light on key clauses found in commercial leases, with a particular focus on considerations unique to those operating under a franchise model.

I. Unique Considerations for Restaurant Tenants

Running a restaurant entails specific physical and tangible requirements, distinguishing it from other retail tenants. Unlike many retail establishments that can work within a standard shell space, restaurants have distinct needs concerning plumbing, electricity, ventilation, security, and waste disposal. Consequently, restaurant tenants often seek higher tenant allowances from landlords to accommodate necessary upgrades.

It is imperative that a franchisee have a full and comprehensive understanding of the franchisor’s standards and specifications as it relates to the development of the premises, so that such standards and specifications are adequately and accurately described and addressed in the landlord’s work and the tenant’s work schedules in the lease.

Restaurant tenants should also give due consideration to areas outside of the premises, such as:

1. patio space, terrace, rooftop, and/or outdoor seating;
2. grease and oil disposal equipment and/or facilities;
3. availability and accessibility of parking for patrons as well as pick-up and delivery;
4. access and vicinity to waste disposal;
5. access and vicinity to delivery dock or alternative ingress point for deliveries; and
6. drive-thru construction.

II. Unique Considerations for Franchisee Tenants

Franchise agreements typically grant franchisors a “franchisor approval” right over the site and lease. Franchisee-tenants should request any minimum site specifications as soon as possible to ensure that the franchisee-tenant does not pursue a location which does not meet these criteria. Maintaining brand uniformity is paramount in franchising, and this extends to the selection of the site itself. By way of example, a franchisor’s site specifications may include (a) minimum or maximum square footage for the area of the leased premises, (b) whether the unit must be an end-cap unit or an in-line unit, (c) drive-thru or patio requirements, (d) height clearance, or (e) capacity for special equipment of high utility usage (i.e. built in refrigeration, heavy restaurant equipment, etc.). 

The hallmark of franchising is brand consistency. Naturally, in order to maintain such brand consistency, the franchisor will have established brand standards, and those brand standards typically extend to the build-out of the franchised business. These brand standards and site specifications can be extremely specific, and may require the use of the franchisor’s prescribed supplier for both goods and materials. As a result, the lease must be revised to allow the tenant to unconditionally engage the franchisor’s chosen contractors, rather than the landlord’s designated personnel.

It is standard in a commercial lease for the landlord to reserve approval rights over the tenant’s drawings as it relates to the tenant’s work, and understandably so, the landlord would like to ensure that the tenant is not building out a space that is inconsistent with the building or complex’s image or incompatible with the building system. However, the landlord’s ability to disapprove or require changes to the design and the infrastructural requirements which are set by the franchisor is problematic to a franchisee-tenant, who may be inadvertently offside the lease if it complies with its franchise agreement or offside the franchise agreement if it complies with its lease. Franchisee-tenants must ensure (a) all parties involved understand the scope of work and standards and specifications which are prescribed by the franchise agreement and the franchisor, and (b) that the lease addresses any potential conflict between its obligations to the landlord and its obligations to the franchisor.

Beyond the initial tenant’s work, landlords will seek control and final approval over the type of work being completed, the contractors, the materials, and the signs that will be erected in or on the leased premises. This level of control may sometimes conflict with franchisee obligations under franchise agreements. As a result, the lease must be drafted in a manner that aligns with the requirements of the franchisor’s system while balancing the landlord’s approval rights. Additionally, the lease should be drafted in a manner that would allow for future franchise system changes, which may require the alteration of trade fixtures, the installation of additional leasehold improvements and different layout and sign specifications. If possible, these changes should be accomplished without having to obtain the landlord’s prior approval.

Upon the termination or expiration of the lease, franchisors will likely seek to have included in the lease a provision which will permit the franchisor to deidentify the premises by removing the brand’s trade dress, any items bearing the franchisor’s trademarks, propriety layout or design elements, and to repaint the premises to remove the visual appearance of a branded restaurant. 

III. Relocation

A relocation clause provides the landlord with a contractual right to move the tenant from one premises to another. Such clauses are often found in commercial leases in malls, plazas, and strip-plazas. A landlord may seek to relocate a tenant to allow for certain renovations, demolition or redevelopment plans, to accommodate an existing tenant that wishes to expand, or to attract a new, desirable tenant.  A forced relocation can be incredibly disruptive for tenants as they will be required to build-out an entirely new premises (with limited or no financial help) from the landlord. Expectedly, relocation provisions are often heavily negotiated. On the one hand, the landlord will seek to have as much freedom as possible to exercise its relocation right and on the other hand, the tenant will seek to have as many conditions, qualifications and protections that will circumscribe how and when such relocation right may be exercised.

1. Tenant’s Consent

A standard relocation clause will be unilateral in favour of the landlord and in order to relocate the premises, the landlord will not require the tenant’s consent. A restaurant tenant should seek to negotiate that the relocation is subject to the tenant’s consent, and if the tenant does not consent, the landlord may present an alternate premises or the tenant may terminate the lease.

In the franchise context, the tenant’s franchise agreement will likely provide that the franchisor must approve any relocated premises, and if the franchisor does not approve the relocated premises, then the tenant will not be permitted to operate the franchised business from such premises. Any relocation clause in the lease must account for the franchisor’s approval right, by either providing a tenant consent right or providing that the relocation is conditional on the franchisor’s prior approval.

2. Similar Premises

Similarly, and as discussed above, a franchisor will likely have minimum site specifications. The relocated premises should be required to meet such minimum site specifications, and generally reflect similar premises characteristics such as visibility, accessibility to parking, vehicular and foot traffic, in-line or end-cap position, patio or other outdoor area, and size of leasable area.

3. Term and Extensions

When a landlord exercises a relocation right, it may offer or the tenant may negotiate an extension of the current term. From the landlord’s perspective, it can secure a revenue stream from a tenant with a newly built out premises at the same or higher rental rates. From the tenant’s perspective, it will have expended a significant amount of capital in the relocated premises, and an extended term will ensure that its costs are adequately amortized over the balance of the term. Any changes to the term of the lease should align with the term of the franchise agreement, which will not be correspondingly extended unless the franchisor and the franchisee enter into a franchise amending agreement.

IV. Term, Extensions, and Renewals

Aligning lease and franchise agreement terms is critical for a seamless relationship between the landlord, tenant, and franchisor. In particular, special attention should be made to potential mismatches, as well as commencement, expiration, renewal, extension, and notice dates. Once such mismatches have been identified, amending agreements to harmonize lease and franchise agreement provisions should be requested.

If the lease is entered into prior to the franchise agreement, then the tenant should negotiate an automatic extension of the initial term, or other mechanism, to provide that the leased premises are available and in the possession of the tenant during the whole of the initial term of the franchise agreement. Similarly, it is often a condition of renewal of the franchise agreement that the tenant has the right to remain in possession of the premises. Both the length of the renewal and the timeline to provide notice under both the lease and the franchise agreement should mirror each other, to avoid the tenant being in a situation where it has committed to extend the lease, but has not obtained the right to operate the franchised business during such extension term.

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Successfully navigating lease negotiations in the franchised restaurant landscape requires an understanding of the interconnected relationships between landlords, tenants, and franchisors. Striking a balance that addresses the unique needs of restaurant operations and franchise agreements is essential for the longevity and success of such leasing arrangements. Restaurant tenants must be vigilant in ensuring that leases effectively reconcile their roles as both restaurateurs and franchisees, avoiding internal conflicts and ensuring a harmonious business operation.