Negotiating the definition of “Gross Sales” for Purposes of Calculating Percentage Rent in a Retail Lease

Negotiating the definition of sales, often referred to as “gross sales,” is an important consideration for retail tenants who are subject to percentage rent provisions. Percentage rent is a form of additional rent calculated based on a percentage of the tenant’s sales, making the definition of “gross sales” directly impact the amount of rent payable to the landlord. A clearly defined and negotiated “gross sales” provision can help avoid ambiguities and potential disputes between landlords and tenants.

Here’s a guide to negotiating this critical definition:

• Importance of a Clear Definition: The definition of “gross sales” should be explicitly stated in the lease to prevent future misunderstandings and disagreements. Ambiguous language can lead to disputes over what revenue is subject to percentage rent.
• Landlord’s Perspective: Landlords typically prefer a broad definition of “gross sales” to maximize their potential rental income from successful tenants. A typical landlord-oriented definition includes the “entire amount of the sales price” for all sales and services conducted at or from the premises, regardless of whether the payment is in cash, credit, or other forms. This can also include orders taken at the premises but filled elsewhere, catalogue sales, and sales to employees.
• Tenant’s Perspective: Tenants, on the other hand, aim to narrow the definition of “gross sales” to minimize the amount of percentage rent they have to pay. They want the calculation to be based on an accurate and agreed-upon revenue figure, typically the actual sales price received.
• Common Exclusions to Negotiate: Tenants should actively negotiate for certain exclusions from the definition of “gross sales”. These often include:
  • Sales or excise taxes collected from customers and paid to the government. The lease should clarify whether these are exclusions (never included in gross sales) or deductions (subtracted after initial inclusion).
  • The value of merchandise exchanged between the tenant’s other stores or transferred to a warehouse. Exchanges by customers may also be excluded, potentially limited to the value of the returned merchandise.
  • Refunds or returns made by customers.
  • Proceeds from the sale of trade fixtures or equipment not part of the tenant’s ordinary course of business.
  • Sales to employees, potentially with a cap on the percentage of gross sales.
  • Bad debts, provided they are later added back if collected.
  • Credit card and other merchant fees.
  • Insurance and condemnation proceeds.
  • Bulk sales of obsolete, discontinued, or damaged merchandise to non-consumer purchasers.
  • Receipts from public telephones, stamp machines, or vending machines for employee use.
  • Charges for minor auxiliary services like gift wrapping or delivery, where no gross profit is realized and they are separately stated, often with a cap.
  • Certain internet or mail order sales where the order is not placed, filled, or picked up at the premises. The rise of omnichannel retail requires careful consideration of how online and in-store interactions are attributed to gross sales. The lease should specify which customer interactions with the physical store will and will not result in a transaction being included in gross sales.
  • Sums received as partial payments for “lay-away” or “will call” sales, until the merchandise is delivered, forfeited, or after a certain period.
  • The value of gift cards until they are redeemed.
• Exclusions vs. Deductions: It’s important to distinguish between exclusions and deductions. Exclusions are revenue items never included in the initial calculation of gross sales, while deductions are subtracted from total gross sales after they have been included.
• Reporting Frequency and Format: The lease should specify how often (monthly, quarterly, annually) and in what format the tenant must report gross sales to the landlord. Landlords often require a written statement, sometimes certified, along with supporting documentation like sales tax returns. Tenants should ensure these reporting requirements are achievable by their accounting teams.
• Audit Rights: Landlords typically negotiate for the right to audit the tenant’s sales records to verify the accuracy of reported figures. The lease should outline the terms of these audits, including who bears the cost if discrepancies are found. Tenants should understand the scope of these audit rights and the record-keeping requirements.
• Confidentiality: Tenants should seek confidentiality provisions to protect their sensitive sales data. While landlords need access to this information for rent calculation, tenants may want assurances that it won’t be disclosed to third parties except for necessary purposes like sharing with lenders or potential buyers of the property.

By carefully considering these points and negotiating a clear and fair definition of “gross sales” with appropriate exclusions, both landlords and tenants can establish a transparent and mutually agreeable percentage rent arrangement.