The Drafting of Percentage Leases

Abstract

THE use of percentage leases for commercial establishments is widespread in the United States and is becoming increasingly common in Canada, particularly in the larger cities.' In the ordinary percentage lease the rental payment is established at a fixed percentage of the tenant's sales or receipts. A fixed minimum rent is usually provided, theoretically to assure to the landlord a return sufficient to pay the fixed costs arising from his ownership of the property. The standard formula provides for payment as rent to the landlord of the guaranteed minimum rent or of the percentage of sales (often described as additional rent), whichever is the larger amount. Variations in this form are to be found. The guaranteed minimum rent may be omitted or the percentage applying to sales may vary according to the volume of sales or to the type of goods sold. The guaranteed minimum rent is more likely to be omitted in a long-term lease where it is usual for a tenant to pay the fixed cost of maintaining the property. The popularity of percentage leases arises from their advantages over the ordinary fixed rental lease from the standpoint of both landlords and tenants of commercial premises. For the landlord the return on his investment varies directly with business conditions. In periods of business prosperity the percentage lease provides him with an increased yield from his investment together with a hedge against inflation and rising maintenance costs. Moreover where the rental value of the property is in doubt the landlord may, by lowering or omitting the minimum rent, attract more aggressive tenants to share the business risk. For the tenant operating with a predetermined margin of profit and with a predetermined percentage of this margin allocated to rent, the increased rent presents no undue burden. Conversely, during periods of business decline, diminishing rental payments are matched by falling prices and decreased maintenance costs to the landlord, and the tenant is afforded the advantage of a declining rent in line with his ability to pay. In practice the guaranteed minimum rent may be little less than a normal fixed rent would be and the percentage feature gives the landlord the opportunity to gain from the tenant's business ability. The tenant is usually not averse to this arrangement where he feels that the property location and business outlook more than outweigh any possible increased rent. Possible disadvantages to percentage leases should be pointed out. A competitor operating under a fixed rental lease can reduce his rent, viewed *B.A., LL.B. (Toronto), LL.B. (Harvard). Mr. Landis is presently associated with the Toronto firm of Sinclair, Goodenough, Higginbottom, and McDonnell. IThe rising popularity of percentage leases in the United States is indicated by the addition in 1954 of section K 200. 1, entitled Percentage Rental Agreements, to the West Publishing Company's General Digest of All American Cases, vol. 22.