Percentage rent clauses - clauses requiring tenants to pay a portion of their gross sales as additional rent - are a standard fixture in retail leases. As e-commerce transactions become more common, landlords should review their leases to ensure that they share in Internet sales secured by their retail tenants. Consider the following example:
On his lunch break, a man walks into a shop ("Store") to buy a shirt. After browsing, the man remains uncertain and needs to contemplate his purchase. Upon arriving home, the man decides that he must have the shirt. He subsequently turns on his computer, visits "www.Store.com" and makes an Internet purchase. Although the shirt is purchased from Store, it is not purchased at Store. The landlord, beneficiary of a percentage rent clause, now faces the problem of losing its percentage on the sale of the shirt.
Should Internet sales be included? The answer to this question depends on (1) the definition of "gross sales" in the lease's percentage rent clause and (2) the radius restrictions in the lease. Below is an abbreviated definition of gross sales and a radius restriction clause set forth in a standard shopping center lease form:
"'Gross sales' shall mean the entire amount of the actual sale price of all sales of goods and services and all other income and receipts whatsoever of all business conducted at, on or from the premises, including, without limitation: mail, telephone, facsimile and other orders received or filled at the premises."
"Tenant shall conduct tenant's business only under the trade name ('Store'). Tenant and tenant's affiliates, owners and subsidiaries shall not directly or indirectly own, operate, control, engage or have a financial interest in any business similar to that authorized to be conducted hereunder, or use or permit the use of the same or similar trade names, within (X miles of the) premises."
As set forth, if the tenant's Internet operations and hardware are located at the leased premises and orders are filled and shipped from these premises (or from within X miles from the premises), the landlord has a strong argument for including those Internet sales in tenant's "gross sales."
But the landlord's argument weakens dramatically as e-commerce drifts further away from the leased premises and into the ether of the World Wide Web. The question quickly becomes one of fact: How many and what type of contacts to the leased premises must an Internet sale have to allow for inclusion into "gross sales"?
The key factors to consider in determining if an Internet sale has sufficient contacts to the leased premises include the following:
* Order-taking and fulfillment. Is the order being taken from a computer terminal on leased premises, from a computer off-site (within X miles of the leased premises), or from a third-party contractor 1,000 miles away? Is the order being shipped from the leased premises, from tenant's warehouse (within X miles of the leased premises), from a fulfillment center, or directly from the manufacturer or wholesaler?
* Location of the purchaser. Is the purchaser ordering from a terminal within X miles of the leased premises, or perhaps the billing address or home address is within X miles of the leased premises?
* Location of product delivery. Is the order being shipped to a location within X miles of the leased premises?
* Hardware location. Is the computer hardware hosting the virtual Store located on the leased premises or within X miles of the leased premises?
There is no clear formula for what minimum contacts an Internet sale must have to the leased premises to warrant inclusion in the calculation of percentage rent. Disputes arising from Internet sales will likely be resolved on a case-by-case basis.
The future of percentage rent clauses In order to avoid disputes over which Internet sales should be included in "gross sales," leases should contain express provisions protecting against losses in percentage rent. For example, a landlord's percentage rent will most obviously be eroded by Internet sales shipped to or purchased by customers within 10 miles from the leased premises.
A landlord should include in the definition of "gross sales," "all sales pursuant to mail, electronic mail, telegraphic, telephone, Internet, or other similar orders received or filled in, at or from the premises or ordered by any party with a billing address or shipped to any location within 10 miles of the premises ...."