Restaurant Start-Ups: The Lease Part 1

Restaurant lease

The legal issues of a start up restaurant can be daunting, here are five insights to be aware of.

 

Editor’s note this is part one of a two part article. 

For Hispanic entrepreneurs, investing in restaurant corporations is an important area of engagement. In 2016, Hispanic owned food services enterprises generating upward of $87 billion dollars of revenue.[1]But for persons starting a restaurant establishment face legal issues which can be daunting, starting with the negotiation of a lease. 

There are, of course, a range of business issues that need to be considered beforehand, such as how the restaurant can be financed and where the establishment should be located, but once these issues are addressed, the make or break issue is whether a workable lease can be negotiated with the prospective landlord.

Here are five items that restauranteurs should be aware of:

1. Form of Restaurant Corporation

To begin with, restauranteurs, generally, do not execute leases on their own behalf but as authorized representatives of a restaurant corporation.

One should consider whether the restaurant corporation should be structured as a limited liability company (LLC), a Subchapter S Corporation, or a standard C Corporation, or as a partnership. As discussed in previous articles, each form has its advantages and disadvantages.

At least in New York, shareholders of Subchapter S corporations may be less exposed to personal liability on state sales tax claims than members of an LLC. 

2. The Use Clause

The restauranteur should review carefully the provision of the lease that defines what the purpose of the leasehold will be.  

Will the restaurant be allowed to use outside space to serve patrons; will it be allowed to serve liquor, etc.? In general, the landlord will attempt to restrict the usage while the restauranteur will want to broaden it.

3. The Rent Clause  

Rent provisions, generally, provide for the payment of a security deposit, and a rent schedule indicating the monthly amount of rent due.

The restauranteur should, at minimum, ascertain how the rent is calculated on a per square-foot basis. Restauranteurs would be wise to understand the framework for rent escalations; the extent to which and the circumstances under which rents can be increased and the amount of the escalation that can be anticipated.

So-called “Triple Net Leases” should be considered with care.  A Triple Net Lease allows the restaurant to pay a lower base rent in consideration for its paying the allocable percentage of property taxes, building insurance, and maintenance and repair costs—costs that ordinarily must be paid by the landlord. 

Triple Net Leases can be attractive from the stand point of lowering initial rental costs, but the downside is that if there is a structural problem with the building that can balloon maintenance, repair and/or insurance costs, such a lease may not be worth it at the end of the day. 

Related to the risks associated with a Triple Net Lease is the concept of assuming responsibility for the rental property “As Is.”  

As construed in many legal jurisdictions, when a tenant assumes the premises “as is,” it is assuming all the risks associated with the property, including potentially hidden maintenance and repair risks. What this means from the standpoint of the restauranteur is that architects and/or engineers should be engaged to ascertain the risks of confronting serious maintenance and repair issues down the line.

To the extent negotiation is possible, the restauranteur should try to make the landlord responsible for the repair of structural defects which may not be readily ascertainable by way of a due diligence review by a competent professional. 

Next page- #4 Transfers and Sublets and #5 Access to Adjacent Properties

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