July 5, 2013

A burrito is not a sandwich

A well-drafted exclusivity clause in a lease can be the one of the strongest defensive weapons against competition available to a business. For instance, a coffee shop might insert a clause into a lease to stop its landlord from leasing to any other coffee shops in the same shopping plaza. Or, a pharmacy franchisor might insist to a landlord that one of its locations be the only pharmacy in a mall. For this reason, franchisors often insist on inserting exclusivity clauses into leases. Landlords, for their part, do their best to keep them out.

Believe it or not, a 2006 case in Massachusetts turned on the issue of whether a burrito counts as a sandwich. The lawsuit involved a sandwich shop that sued its landlord for allowing a quick service Mexican restaurant to open up in the same shopping plaza as it. The exclusivity clause in the lease restricted the landlord from entering into new leases with businesses that primarily sell sandwiches. The sandwich shop argued that a burrito is a “sandwich” and that the Mexican restaurant was therefore a competing sandwich shop. After consulting a number of dictionaries and reviewing the parties’ conflicting expert reports, the judge ultimately found that a burrito is not a sandwich.

In truth, what a Massachusetts judge thinks about burritos is not really very interesting. Your guess is as good as his. However, the case illustrates the importance of drafting exclusivity clauses carefully and negotiating them with diligence. If you don’t, you may end up getting less from your lease than what you thought you had bargained for.

Most sophisticated franchisors have well drafted exclusivity precedents in their offer to lease templates. Landlords, however, rarely accept these canned exclusivity agreements without major amendments. As such, there tends to be some negotiating that goes on regarding the exact terms of an exclusivity agreement at the time a lease is being negotiated.

Issues arise when the actual wordsmithing or “write downs” of exclusivity clauses is done by non-legally trained leasing staff working for the franchisor. Such staff members often fail to appreciate the significance of making minor changes to an exclusivity clause. Landlords attempt to water down exclusivity clauses by introducing ambiguous terms which can be interpreted a number of ways.

The problem for franchisors is that if there is any ambiguity in an exclusivity clause then it will be interpreted by a court against them. An old principle of law provides that an ambiguous term will be construed against the party that imposed its inclusion in the contract (the contra proferentem doctrine). If a court is faced with two reasonable conflicting interpretations of an exclusivity clause, one which allows a competitor to enter a shopping plaza and one which does not, they will choose the interpretation that allows the competitor to enter.

Courts are also guided by a general distaste for covenants which constrain competition. From a public policy perspective, courts prefer there to be more competition in the marketplace and fewer restraints on trade.

Enforceable restrictive covenants safeguard the long term earning power of a location. Losing even 20% of sales to a major competitor can make or break a location. Accordingly, it is crucial to make sure that exclusivity clauses are enforceable and block major competitors from moving into a nearby location. If a location fails, it often ends up being the franchisor that is left holding the liability bag for the lease. The franchisor may also be exposed to claims by the franchisee of a failed location.

This article originally appeared in the Spring 2013 issue of the TheFranchiseVoice.