Turnover Rent Considerations in Leasing
Commercial Leases, whether retail or otherwise, can be overwhelming for even seasoned tenants due to the quantity and complexity of clauses. One such clause that tenants should be aware of is a provision relating to Turnover Rent, also referred to as Percentage Rent.
Whilst most often seen in retail leases and especially in shopping centres, the provision can also be included in other types of commercial leases. It refers to additional consideration that a landlord may be entitled to in the event that a tenant’s sales reach and surpass a certain threshold. The exact terms are always up for negotiation, and it is imperative that a tenant is aware of its obligations under such a clause.
Percentage
This clause can take a number of different variations depending on the drafting of the lease, but it will always be a certain percentage of the tenant’s gross sales and it will only come into effect once a certain threshold, or ‘breakpoint’ has been met as agreed between the parties. For example, a percentage lease might require a tenant to pay 10% of any and all sales that exceed more than $100,000.00 for the lease year.
It is important to note that percentages can be fixed or can increase on a tiered basis as the gross sales increase.
Artificial Threshold
An artificial threshold is a defined monetary amount which, after exceeded, is the basis for turnover rent. The example above uses an artificial threshold of $100,000.00.
Natural Threshold
In contrast, the natural threshold is slightly more complex and arises from the relationship between the base rent and the percentage. To ascertain the threshold, the base rent is divided by the percentage. For example, if the base rent is $100,000 and turnover rent is 10% of gross sales, then the natural threshold is $1,000,000.00:
Base Rent ÷ Turnover Rent Percentage = Turnover Threshold
$100,000.00 ÷ 10% = $1,000,000.00
Turnover rent is then payable at 10% of any gross sales exceeding the $1 million threshold. If the tenant’s gross sales equal $1,100,000.00, the tenant will pay $10,000.00 as turnover rent.
The structure of the threshold can be negotiated between the parties depending on the circumstances.
Gross Sales
In considering Turnover Rent, the definition of gross sales in a lease should be thoroughly analysed. The landlord will always request as broad a possible definition, but the tenant should consider whether there are any circumstances that should be excluded. For example, if the tenant operates online and in-store without direct connection, it will be disadvantageous to the tenant to include online sales in the definition of gross sales.
It should be noted that for retail leases, there are legislative restrictions as to what can be included in gross sales[1]. In some states, for example New South Wales, legislation prohibits the landlord of retail leases from requiring information from the tenant concerning turnover from online transactions unless the goods or services are delivered or provided from or at the shop or the transaction occurs while the customer is in the shop.[2] No such mirroring provision exists in Queensland but that does not mean that the exclusions cannot be negotiated with the landlord.
Reporting
As with the nature of the provision, it follows that the tenant has an added burden to report and audit its business turnover. Tenants are obligated to provide accurate gross sales figures and a failure to do so can be seen as a breach of the lease.
Landlords of retail leases in Queensland are required by law to maintain confidentiality of these records except under certain circumstances.[3] Tenants of other commercial leases should ensure that appropriate confidentiality provisions are included.
In practice, tenants should keep up to date records and accounts of gross sales on a month-to-month basis. Disorganised tenants may reach the end of a lease year and find themselves in receipt of a hefty invoice for turnover rent.
Termination for Inadequate Sales
Although rare, a landlord or tenant may seek to include a clause allowing for it to terminate in the event that certain gross sales are not achieved. In Queensland, there are currently no legislative restrictions on these clauses for commercial leases (unlike some other states which prohibit these clauses in retail leases[4]) and they may be beneficial for a tenant who is a new retail brand as a risk management tool. If the clause benefits one party only the other party may seek an equal termination right. These clauses should be carefully considered and advised upon.
Conclusion
Arguably, these provisions can benefit both the landlord and the tenant, with the tenant being able to avoid high upfront costs while paying the price at a later stage with the landlord benefiting from the tenant’s success. The landlord is also inclined to continually improve the premises and centre (if applicable) to increase traffic flow and sales.
In any case, careful consideration should be given to the drafting of turnover rent provisions in commercial leases. We endeavour to assist our clients, as both landlords and tenants, in negotiating the most favourable lease drafting possible and we always ensure our landlords and tenants are aware of their obligations under any lease.
If you require advice or assistance with your lease, contact the experienced team at Miller Sockhill Lawyers on 07 5444 4750 and one of our friendly team members can answer any questions you might have.
[1] Retail Shop Leases Act 1994 (Qld) s 9(2)
[2] Retail Shop Leases Act 1994 No 46 (NSW) s 47
[3] Retail Shop Leases Act 1994 (Qld) s 26
[4] Retail Shop Leases Act 1994 No 46 (NSW) s 58