A Guide to Negotiating a Permitted Use Clause in a Commercial Lease

A permitted use clause in a commercial lease defines and limits the type of business a tenant can operate within a leased premises. This clause serves as a critical point of negotiation between landlords and tenants, with significant implications for tenant mix, competition, business flexibility, and property value.

For landlords, the permitted use clause helps maintain control over the use over the property and ensure a balanced tenant mix in multi-tenant properties such as shopping centers, office complexes, or mixed-use developments. It ensures that businesses complement rather than compete with each other and prevents uses that might lower the property’s value or cause nuisances. Landlords may also need to align permitted uses with existing exclusivity clauses granted to other tenants.

For tenants, the clause must be sufficiently broad to accommodate their current business operations and potential future growth. A restrictive permitted use clause could limit business expansion, adaptation to market trends, or the ability to assign or sublet the lease. By defining permitted uses carefully, landlords and tenants can avoid future disputes over business modifications or new services.

I. Landlord Considerations

Landlords typically prefer narrowly defined permitted use provisions to control the use of the property and the tenant mix in a multitenant property. Key considerations for landlords include:

• Tenant Mix and Optimization: In multitenant properties such as retail centers and office buildings, landlords seek to ensure a complementary mix of tenants. Conflicting or overlapping uses can create disputes among tenants and reduce overall property appeal.  While complementary uses are accretive for all tenants and lead to the success of the property.
• Exclusive & Prohibited Use Clauses: Many tenants negotiate for exclusivity within a property. Landlords may also seek to prohibit certain uses from the property generally.  Landlords must ensure that permitted use clauses are appropriately tailored to address existing (and future) exclusive use agreements with other tenants & prohibited used provisions included elsewhere in the lease.

II. Tenant Considerations

From a tenant’s perspective, a broad permitted use clause allows flexibility to expand, change product offerings, or assign the lease in the future. Important considerations for tenants include:

• Future Business Expansion: A permitted use clause should anticipate potential business growth. For example, a coffee shop might later want to add a bakery component.
• Compliance with Planning Laws: Even if the lease allows a certain use, tenants must ensure that their intended business operations comply with local zoning laws and regulations.
• Avoiding Unnecessary Restrictions: Tenants should negotiate against prohibitive language that could limit their ability to adjust to market changes.
• Assignment and Subletting: A broader permitted use clause can make it easier to transfer the lease if the tenant wants to sell their business or relocate.  A broad permitted use clause will expand the universe of potential assignees or subletters that could take over use of the space.
• Impact on Rent Reviews: While a broader clause provides flexibility, it may lead to increased rental valuations during rent reviews where fair market rent is based the potential or highest and best use of the property rather than the existing use, so tenants should balance breadth with cost considerations.

III. Interaction with Exclusive Use Clauses

A permitted use clause interacts closely with exclusive use clauses, which grant a tenant the sole right to conduct a certain type of business within a property. Key points include:

• Tenant Protections: Exclusive use clauses prevent direct competition within the same property, benefiting tenants who rely on a unique market position.
• Landlord Caution: Landlords should be careful when granting exclusivity, as it can limit future leasing options and reduce potential rental income.
• Enforcement Responsibilities: If a landlord grants an exclusive use right, they must actively enforce it against future tenants to avoid legal disputes.  This means that landlords will need to tailor permitted use provisions in other leases to avoid interference with an exclusive use right that has been granted to another tenant.

IV. Interaction with Prohibited/Restricted Use Clauses

Leases often contain prohibited or restricted use clauses, which limit certain activities on the property. These clauses may:

• Prohibit Specific Business Types: Landlords may ban certain businesses (e.g., bars, pawn shops, cannabis dispensaries) to maintain the property’s character.
• Address Community Concerns: Some restrictions align with municipal regulations or neighborhood preferences.
• Ensure Compliance with Other Tenants’ Rights: Restrictions may be necessary to comply with existing tenant agreements.

Tenants should carefully review these clauses to ensure they do not inadvertently restrict their ability to operate effectively or expand their business in the future.

V. Change of Use During the Lease Term

Leases may include provisions allowing tenants to apply for a change in permitted use, subject to landlord approval. Important factors include:

• Landlord Consent Requirements: The lease may require landlord approval for any change in use, with varying degrees of discretion.
• Reasonableness Standard: Tenants may seek to ensure that the landlord’s consent “shall not be unreasonably withheld or delayed,” while a landlord may seek to have its consent to a change in use be made in the landlords “sole and absolute discretion”
• Legal and Zoning Compliance: Any requested change must comply with applicable zoning laws and municipal approvals.

VI. Key Takeaways and Best Practices

• Clarity and Specificity: Both landlords and tenants must ensure the permitted use clause is clearly and specifically drafted to avoid future disputes.
• Due Diligence: Landlords should ask questions and fully understand the scope of the tenant’s business before agreeing on the permitted use language. Tenants need to research and ensure their intended use is permitted by law and has necessary approvals.
• Flexibility vs. Control: Landlords need to balance their desire to control the tenant mix with the tenant’s need for flexibility for business growth and transferability. Tenants need to balance a broad use clause for flexibility with potential rent increases at review.
• Professional Advice: Due to the complex legal implications, both landlords and tenants should seek legal counsel with expertise in commercial leasing to negotiate and review permitted use clauses.
• Understand Related Clauses: The permitted use clause should be considered in conjunction with exclusive use and prohibited use clauses to fully understand the rights and restrictions within the lease.

Conclusion

The permitted use clause is a fundamental element of a commercial lease that requires careful negotiation and foresight. A well-drafted clause can help landlords maintain property value and tenant mix while providing tenants with the flexibility they need to grow their businesses. By addressing potential issues upfront, both parties can minimize conflicts and create a lease agreement that serves their long-term interests.