While certainly not a new phenomenon, the proportion of leases with rents based on turnover has increased significantly in recent years. There are pros and cons to such arrangements for both landlord and tenant and there are a number of things that tenants in particular need to be aware of and consider in the drafting of such arrangements. Here we consider some of those.
Turnover rent model
There are two primary ways to structure turnover rent:-
- A turnover only model - where the rent is exclusively based on the turnover; and
- A base + turnover model - where there is an agreed base rent (a fixed figure which is payable irrespective of the level of turnover) which is then "topped up" by the turnover rent portion.
A key landlord concern has always been certainty of income and a base rent is a method of ensuring that the rent does not fall below a certain minimum amount.
There can also be situations where turnover rent is only payable above a certain threshold as a way of the landlord getting the benefit of better than expected trading performance.
What should Turnover include?
This has become one of the major points of negotiation, as shopping habits and the retail landscape have evolved, and needs careful consideration.
Online Shopping
“Internet sales” present a complex situation and each retailer’s model is likely to be slightly different depending on their trading style and product range. The terms of the lease therefore need to be very carefully negotiated and tailored to the particular situation.
For example, if a customer visits the premises to view potential purchases and then orders the product online, is that a sale that should be included in Turnover? Landlords will probably say yes but how can it be ascertained that a customer went to the shop first and didn’t just see the product online and buy it? Online sales will not all be generated following customer store visits and while it is reasonably easy to identify and include orders placed in the store itself (whether fulfilled in store or delivered direct to the customer) orders placed online are more difficult to interrogate. Some landlords have tried to include a share of online sales in Turnover as a way to deal with this, but that is not necessarily an ideal solution from a tenant perspective.
“Click and collect” is another grey area. It is arguable that anything collected from store should be included in turnover but the more common position is that orders placed online and collected from the store from stock sent to the store for that purpose will not go into turnover but an order made online and collected from the store from stock that was already there would be included in Turnover.
Returns
The value of returns to store is usually deducted from Turnover. Where there are returns into store that can skew the figures if appropriate records are not kept as to whether the original purchase was made in that store or from the internet (or indeed another branch of the tenant’s business). It is not fair to the landlord that there are deductions from the Turnover (and therefore their rent) for items bought elsewhere but returned to this store.
Gift Vouchers
Gift vouchers are another point of negotiation. Turnover generally includes the value of all goods sold, however they are paid for. Accordingly, goods paid for by way of gift voucher would form part of Turnover. That makes sense but then there is the issue of the sale of the gift voucher itself. Should that be included in Turnover? Arguably yes, if it has been sold at the store. However that creates a double counting problem. A £50 gift voucher sold in a store then redeemed in the same store would count as £100 of Turnover for the store but the retailer only got £50 in cash from the original customer. There is also the issue of gift vouchers being sold in one store and redeemed in another. If both stores have turnover rents then the same issue could apply – with £50 in Turnover each going through two separate stores for the one receipt of £50.
For this reason tenants will generally look for either the sale or redemption of gift vouchers to be excluded. Different retailers can have different preferences, based on their systems and how they can identify gift voucher sales and redemptions. Both landlords and tenants have good grounds for looking for consistency across their portfolios, as using different methods can have adverse consequences.
Payment of Turnover Rent
Turnover rent, by its very nature, is only payable in arrears once the turnover figures are known. This is usually accounted for annually. Where there is no base rent there would be on account payments made monthly or quarterly. Beware any attempt for turnover rent to be paid periodically on top of a base rent as that can leave the tenant out of pocket.
Landlords often ask for turnover figures monthly in leases anyway but for turnover rent situations they will insist on robust provisions for delivery of turnover certification, potentially with penalties or further payments to be made where certification is late. Often landlords will want such certification to be audited and tenants have to be sure that they can comply with the requirements in their lease, both as to the level of confirmation that can be given and how long it will take to get.
Trading
A landlord needs to ensure their tenant is fully trading from the property and will insist on a keep open clause being included in the lease. A tenant should seek to ensure that their obligation to keep their premises open excludes circumstances where the store is legitimately closed. For example, due to repairs, refitting or as a result of damage caused by insured risks/uninsured risks etc.
The landlord may also wish to include a mechanism for dealing with days where the premises are closed in breach of the keep open requirement. Common methods are to apply a specified daily rent figure for such days or use the previous year's trading figures to calculate the rent during any closed period. That poses some issues where there is only partial closure (i.e. the tenant trades on the day but doesn’t trade the required hours) as the turnover for the part day still goes into Turnover (and rent is paid on that) on top of this extra rent.
An alternative is to make a notional addition to the Turnover figure for the closed period. Tenants will want to make sure this is not a “penalty” for failure to trade but is a reasonable method of the rent being adjusted to put the landlord in the position they should have been.
Alienation
Due to the unique correlation between the tenant and the rent on a turnover rent lease there are usually some differences on alienation from what might otherwise be usual.
Assignation
A landlord may look to prohibit assignation completely but that’s obviously not very palatable to a tenant and there are possible alternative options. On completion of an assignation, the rent payable could revert to an open market rent, determined either by a standard rent review or, where the base rent is a specific % of the Open Market Value by a formula.
Alternatively, there may be a mechanism for a new Turnover Rent % to be calculated. These can be complex and great care has to be taken to ensure there are no unintended consequences. That also has the issue of the assignee perhaps not knowing what their rent is going to be until a period after completion of the assignation, which may cause issues.
Sub-letting
Sub-letting of whole is often completely prohibited as the landlord wants to ensure that the party that they contracted with is the one trading from the property (as that is the basis on which the turnover rent % has been agreed). As a compromise, a landlord may agree that on sub-letting the rent payable under the lease reverts to an open market level. In the circumstances, this may lead to the tenant paying higher fixed rent than they had originally anticipated but they may be able to recover this higher rental sum in full from their new sub-tenant.
Takeaway
This is a complex and evolving area and it is essential that parties take early advice to ensure they do not end up in difficulties. Contact your usual Brodies contact if you require any advice.
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Legal Director
