Think Twice Before Agreeing to Radius Restriction
Including a radius clause—that is, a clause barring you from opening another store within a certain distance, or radius, of your existing location—in a percentage rent retail lease is common. Owners typically include a radius clause in percentage rent leases so that you can’t divert sales to a new store, in effect competing with yourself and depriving the owner of percentage rent. If you violate the radius clause, the owner can use the special remedies set out in the clause against you. That’s why it’s important to really take into account whether a restriction on your opening additional stores is practical or advisable before you agree to a radius clause.
Don’t make the same mistake that a Washington tenant recently did—thinking that outside factors would excuse its opening a store in violation of its radius clause. A court disagreed with the tenant and held it to its agreement with the developer of the mall where it had set up shop.
In that case, a commercial developer sought an anchor tenant for the mall it was building. As an inducement to attract a certain national big-box retailer, the developer signed a purchase and sale agreement with the tenant. Under the agreement, the developer agreed to sell 27 acres to the tenant for $10 and pay the company $5 million in cash. In return, the tenant would build and open a store, operate it for at least 12 years, and refrain from building a competing store in western Washington for five years. The contract provided, however, that if the tenant opened a new store early, it would have to pay back the $5 million and the developer would have the “right to terminate and repossess” the property.
The tenant later determined that opening a new store early was more profitable than adhering to the contract, and its new store opened on a nearby Indian reservation four years and six months later (six months early).
The developer sued the tenant, demanding that it return the $5 million payment. The tenant argued that the restriction is an invalid restraint of trade, that repayment is an unlawful penalty, and that in any event, it didn’t really breach the contract “all that much,” considering that the developer went bankrupt before the tenant allegedly breached the contract, and that the new store was on an Indian reservation that was considered to be its own territory and not part of western Washington. The tenant also claimed that the new store was of a slightly different nature than its current, traditional sporting goods-type stores. The developer asked a trial court for a judgment in its favor without a trial. A Washington trial court ruled in favor of the developer.
In its decision, the trial court noted that the radius restriction in the contract barred the tenant from opening a competing store for five years after the opening of its store at the developer’s mall. It noted that the contract defined the tenant’s store as a “retail outdoor/sporting goods” store but also noted that the agreement applied to any store started by the tenant that “evolved” from that business plan. In other words, the tenant couldn’t open a store that sold additional items from its store at the developer’s mall and then claim that its new store was so different that it didn’t qualify as the same store at the developer’s mall and therefore wasn’t subject to the radius restriction. The contract also specified the counties in which a competing store was barred and didn’t make an exception for any Indian reservations.
The tenant also argued that the radius restriction “does not protect a legitimate business interest, harms the public interest, and is unenforceable as a matter of law.” According to the tenant, the developer never fully built out the mall and, therefore, had no retail spillover traffic to protect from a competing store opened by the tenant. It also asserted that the radius restriction would harm the public by depriving the area of “substantial job opportunities” that its new store would provide.
But the trial court determined that the radius restriction was an enforceable restrictive covenant and was neither unreasonable nor against public policy. That was because the restriction was limited in time—only one-fifth as long as some restrictions upheld in similar lawsuits. And the restriction here was limited in place: The tenant was free to open a store in a part of the state east of a certain area at any time.
Further, the radius restriction was a reasonable restraint on trade and wasn’t counter to public policy. The tenant cited no statute or case law to support its contention, providing only vague notions of harming “substantial job opportunities in a depressed area.” But that was not a legal test, said the court. In determining whether an agreement not to compete is enforceable, courts ask whether an agreement unreasonably restrains trade, not whether it harms “job opportunities,” the court pointed out. While public policy “forbids unreasonable restraint of trade,” it does not “prohibit contracts which reasonably protect a business of either buyer or seller without tending to affect the public injuriously by monopoly or enhancement of prices,” it added.
The district court concluded that it was clear the tenant made a financial decision: It would make more money by breaching the radius restriction than it was likely to pay in damages—a “classic efficient breach” [Cabela’s Retail, Inc. v. Hawks Prairie Inv., June 2013].
Not a subscriber? Click here for a free trial issue!