Real estate strategies for retail businesses in a changing world: Leases vs. license - by Bernie Kennedy

Since the last article in this series, the retail world was again stunned when Amazon purchased the upscale grocery chain Whole Foods for $13.4 billion. The announcement raises the spectre of Amazon transforming another aspect of our lives–grocery shopping–and with it a further challenge to traditional brick and mortar retail.

While it may be premature to predict the rapid demise of traditional supermarkets (after all, the grocery industry in the U.S. is an $800 billion industry), it is not hard to imagine in the not-too-distant future that grocery stores will be, as Joshua Rothman suggested in a recent New Yorker column, “thinner on the ground.”

What will be the likely effect of this most recent threat to traditional retail stores, and how are retailers to respond?

Joseph Armano of Jones, Lang LaSalle estimates that “10% of all retail spaces” will be closed or converted to other uses as part of the many strategies being employed to compete in a disrupted market with an excessive supply of space. “This includes tenants closing stores, renegotiating leases and subletting or subdividing space,” according to Armano.

Closing stores speaks for itself, and renegotiating leases will be a topic for deliberation in another article.

However, for today’s consideration, subdividing and subletting space raises particular issues for tenants to consider. Among these are the limitations on subletting placed upon tenants by the use clause in the lease (particularly in the shopping center context). Typically, leases also include conditions, financial and otherwise, imposed by landlords upon tenants seeking to sublet space.

But assuming that neither of those stands as an impediment, the tenant faces another question: whether to enter into a sublease or a license agreement for the excess space.

While the terms sublease and license are often used almost interchangeably, they are distinctly different legal concepts that create significantly different rights and responsibilities. A tenant who finds she has excess space because of changes in the retail marketplace would do well to consider those differences.

So how are a lease and a license different, and how are those differences important in making the decision on how to proceed with regard to excess space? A lease is a grant of an exclusive interest in real estate for a specific term for a stated consideration. Importantly, it is irrevocable. By contrast, a license is merely a privilege to use another’s property on a non-exclusive basis and is, by its nature, revocable at will.

Understanding the differences between a lease and a license reveals the advantages in considering using the latter. For one, the fact that a license is merely a revocable privilege gives the licensor greater control over the property. And since a license is personal to the licensee and not an interest in real estate, it is not transferable.

The other major advantage of using a license is that the licensor is not subject to the complex, time-consuming process that eviction proceedings entail. And unlike the landlord-tenant relationship, a licensor may use self-help to remove a defaulting licensee.

But caution is urged in drafting a license agreement because the courts will disregard the label assigned to the document in favor of the intention of the parties expressed within. Just because you call it a license does not mean it will be construed as such if the language of the document actually evinces the intent to grant an irrevocable and exclusive possessory interest in real estate. 

Among the factors that are considered by the courts in making that determination are exclusivity, consideration, length of the term and revocability. Typically, if an agreement is for a term of years at stated consideration for each year and provides for exclusivity, it will most likely be construed to be a lease.

However, in its most recent pronouncement on the subject, the New York State Court of Appeals found an agreement to be a license rather than a lease, even though the agreement was for a term of years, contained a payment structure that looked like rent, granted at least partial exclusivity and contained a revocation clause that permitted terminations as long as they were not arbitrary and capricious. 

The decision seems to indicate that the revocability factor is the most important consideration in determining whether an agreement is a lease or as license, possibly leading to greater flexibility in structuring license agreements in the future favoring landlords and those looking to subdivide their premises as a result of downturns in the retail market.

But as in any fact-based process, caution should be employed in drafting and an experienced real estate attorney should be consulted.

Bernie Kennedy is a co-managing member (partner) at Bond, Schoeneck & King, Garden City, N.Y.