As originally published in Daily Journal of Commerce
Folks in the hotel or restaurant industry are probably very familiar by now with “radius restrictions.” These requests are increasingly being included in contracts by landlords in commercial leases, owners in management agreements (such as for hotels, restaurants, theaters or other venues operated on behalf of the owner for a fee), and licensees in brand franchise agreements.
The restrictions typically limit the tenant, manager or licensor from opening, operating, permitting or otherwise engaging in their business in another location within a certain radius or area, known as the area of protection (or AOP).
When encountering a proposed radius restriction clause, negotiate carefully. While many radius restrictions are reasonable, they can easily become overbroad. A savvy “restricted party” will think beyond only present operations to how the radius restriction may impact other business opportunities.
Following are some of the questions you should ask.
Who is restricted?
Be wary of restrictions on not only the restricted party, but also “affiliates” who may not be direct parties to the contract. Affiliates could include upstream entities (such as investors and parent companies), downstream entities (including new ventures and “mini concepts”), or sister entities that have a common parent with the restricted party, and possibly others.
For example, a restaurant operator could have many investors – including one that also owns a bookstore within the AOP. The bookstore, by means of the affiliate investor, could violate the radius restriction, placing the restaurant operator (the restricted party) in default.
Consider creating carve-outs in the agreement to account for the possibility of future mergers or acquisitions.
When is the restriction in force?
A radius restriction does not need to live as long as the contract. In fact, one can burn off after a period of years or upon certain milestones or events, such as the achievement of financial thresholds.
Also, consider when the restriction goes into effect. Does it start when the parties execute the contract or when the property opens? These nuances could add several weeks or years to the radius restriction’s term.
If the restricting party is adamant on a radius restriction, consider stepping back the terms: for example, five miles for the first five years and one mile for the remainder of the term. Also, consider scaling back the type of restriction. Go from an agreement to not “own or operate” to just “not own.” Additionally, know your wiggle room. Can the restricted party be in development during the term of the restriction and just not open until the term expires?
Take note if the restricting party has an early termination right. If the restricted party is prohibited from developing opportunities during the radius restriction’s term, and then the agreement is terminated early, the restricted party is stuck with no current agreement in the market and nothing in the pipeline to replace the terminated agreement.
How are the lines drawn?
Though radius restrictions are commonly expressed in terms of a circle, with the real estate or front door at its center, this is not the only approach. It’s far better to put the compass down and plan radius restrictions on a street-by-street basis.
It’s better with more specifics. Phrases like “within the central business district” or “Lloyd Center” can be confusing, while language like “bounded by the northwest corner of Main Street and Second Avenue” can improve contracts and leave little gray area for potential disputes.
What is restricted?
Some radius restrictions try to preclude a restricted party from doing anything conceivable (“… shall not own, operate, control, have control over, invest, brand, co-brand, permit, market or otherwise consort with another business or location within the territory …”).
Fair restrictions limit the restricted party from only those activities that could harm or negatively influence the business of the restricting party. For example, if a licensor licenses its full-service restaurant brand to a licensee, it may not be necessary to restrict a similarly named coffee shop across town, because the two ventures likely are not competitive.
Regardless of the size or nature of a company or its growth potential, radius restriction provisions require attention to detail. As always, negotiation strength depends on the relative power of the parties, but be careful to not excessively limit chances for future growth in order to get one deal.