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Clarify Which Tenants Are Not Restricted by Non-Compete Covenants

Your decision to allow a tenant that has extended its lease at your center to sell the same or a similar type of product as a new tenant with a non-compete covenant could end in complaints from the new tenant that you’re violating its lease. However, whether there is a violation depends on whether the prior tenant had that right before the new tenant moved in, and, if so, it was was included in the lease extension. In some circumstances, when a prior tenant renews its lease it retains rights that conflict with what a new tenant wants or needs for its business to do well. That was the case in a dispute resolved by a New York appeals court this year, when it decided that a new restaurant tenant non-compete covenant didn’t apply to prior tenants - even if they renewed their leases after the new tenant had moved in.

There, a tenant and a property manager signed a lease extension for shopping center restaurant space that the tenant had been renting to run its pizza parlor. The extended lease term was from June 1, 2010 to May 31, 2026. The lease extension provided a restrictive non-compete covenant: “Owner shall not rent [certain specified nearby premises] to any tenant who offers for sale the same type of food sold by Tenant and if a tenant occupying one of these premises commences the sale of prohibited foodstuffs, Owner shall take steps necessary to have the tenant cease and desist from those sales.”

The tenant later sued the owner and the property manager of the center, claiming that another tenant occupying an area of the center that was specified in the lease extension was selling pizza. The owner and the property manager asked the court for a judgment in their favor without a trial, arguing that their right to allow the competing tenant to sell food similar to the tenant’s preexisted the tenant’s lease extension. The court ruled in the owner’s and property manager’s favor, and the tenant appealed.
The appeals court upheld the lower court’s judgment in favor of the owner and the property manager. It agreed with their argument that the restrictive covenant in the lease extension could not be enforced against a “prior tenant,” such as the competing tenant, which had rented space for several years before the lease extension was negotiated.

The court stated that the restrictive non-compete covenant in the lease extension could not be enforced against a competing tenant whose lease predated the covenant’s execution in June 2010 - absent evidence that the competing tenant, before it had entered into its lease several years before, had notice of the owner’s intention to enter into a restrictive non-compete covenant later with another tenant.
The tenant alleged that the competing tenant was a “subsequent lessee” that signed its lease with “full knowledge” of the restrictive covenant. However, it couldn’t produce any evidence proving that the competing tenant had any idea that, when it originally signed its lease, the owner intended to sign future leases containing restrictive non-compete covenants that would apply to tenants with preexisting leases, such as itself.

You can avoid an argument like this one by clarifying with new tenants that prior tenants who renew their leases will be entitled to begin or continue selling competing products if they originally had the right to do so - despite the new tenants’ non-compete rights. Specify that only new tenants will be subject to restrictions [Fratelli's Pizza and Restaurant Corp. v. Kayzee Realty Corp., et al.].

Issue Date: CPMI Online Exclusive, Posted On: 12/3/2010 

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