For the past 12 to 18 months, office building owners have been energetically implementing new tactics to attract tenants back to their buildings as the pandemic becomes less impactful. One growing trend among owners is hiring outside vendors to provide added-value building amenities for tenants, such as conference room services, fitness centers with nutritionists, and unique food and beverage offerings. One of our landlord clients even enters each tenant traveling through the building lobby into a lottery for NFL tickets. These new amenity relationships, however, are complex and in some cases do raise certain legal issues.
In certain cases, these amenity operations may be structured as leases or license agreements, where the vendor bears all operating expenses and retains the revenue from the business–other than rent or fees payable to the building owner. However, in many cases, the structuring of these arrangements may find office tower landlords outside their comfort zone. Rather than using traditional lease documents to seal these deals, these arrangements are generally documented as management and consulting arrangements, akin to those used by hotels with their providers of spa and health services, restaurants, and catering.
In fact, landlords may find themselves negotiating with a counterparty that expects to apply provisions typically associated with the hospitality industry, which may concern a traditional office landlord. For instance, a hotel owner often gives an in-house manager a high degree of discretion, authority, and control to run operations at the owner’s expense. If an office vendor expects to mimic this structure, landlords will have to determine their comfort level with embarking outside their usual rental practices. Other vendors without hotel experience may have different expectations. So, landlords would be wise to expect a range of negotiation approaches from different vendors.
Some points to consider:
- Structure. Building amenity arrangements are sometimes structured as leasing relationships or even licenses—but not always. A management or consulting arrangement is generally preferable if the vendor does not bear responsibility for its own expenses or retain the revenues, as a tenant or licensee would. Often the economics will consist of a fee paid by the landlord to the vendor, unlike rent that flows in the other direction to the building owner. Since no leasehold or other real estate interest is created, these relationships are theoretically easier to terminate.
- Employees. A building owner may expect the vendor to run the operation using the vendor’s own employees. However, some vendors may have the opposite expectation – that the building owner will be the employer. They may be accustomed to merely supervising and directing the employees of a third party, as they would with a hotel manager. However, unlike in a hotel, an office building management team may have little experience hiring employees for these services. This issue can be problematic if neither side is willing to assume employment obligations.
- Control Over Cash. As with any business operation, the owner or vendor must pay expenses from specifically designated funds. The parties should determine who can access bank accounts and cash and provide accounting support for all expenses and revenue. Regular financial reporting will be necessary for vendors paid based on revenue or profits. The parties should decide who is in the best position to provide this.
- Operating Expenses. Similarly, the parties will need to determine who bears the cost of these operations and the obligation to cover any possible funding shortfalls. In a lease, the answer is simple: it’s the tenant. But in a management or consulting context, a vendor may see its role as simply managing or advising an operation that draws on the owner’s funds. If that is the case, an annual budget process can serve as a mechanism to limit the vendors’ latitude in spending money that isn’t theirs.
- Concept and Intellectual Property. Is the vendor creating a new concept? If so, the parties must determine who owns and controls it. For example, the building owner will likely want to own it to ensure a competitor does not replicate it and that the owner can use it in other locations within its portfolio, with or without the vendor. Or perhaps the owner plans to implement a vendor’s pre-existing branding concepts, in which case the vendor may expect to control the concept. The agreement will need to address the question of who owns the branding concept and any limits on its replication.
- Building Rules and Regulations. The vendor should expect to be obligated to comply with insurance requirements and other standards, just as building tenants and contractors are. Amenity vendors may not be familiar with the coordination necessary with office building management that will arise daily, whether related to elevator usage, HVAC, access, loading docks, trash, or parking. An agreed-upon percentage of the cost of building services should be allocated to the amenity’s operating expenses.
- Privacy. Amenity vendors may have access to personally identifiable information of building tenants and outside customers through their regular operations. Landlords should consider whether their vendors should comply with existing building policies or develop custom ones. Also essential is determining if they will be permitted to use the data for marketing purposes during or after the term of engagement.
- Tenant Expectations. The building owner may want to ensure that the offerings and pricing are appropriate for the building and commensurate with its tenant mix. In addition, various amenities may be located adjacent to each other and require coordination and integration, whether physically, such as seating areas, or conceptually, in terms of operational coordination and cross-promotions.
- Liquor License: Office building owners likely have never contemplated liquor licensing requirements within their buildings. Liquor licensing requirements vary from state to state and city to city and generally require extensive background checks. Landlords will want the counsel of a local attorney specializing in liquor licensing to ensure compliance before the first drop is poured.
- Key Personnel: Consider whether a vendor’s principal employee or owner, such as the chef, is critical to the success of this operation. If so, the agreement should specify how much time the individual must dedicate to the facility and the ramifications of failure to do so.
- Franchise. It may come as a surprise to people outside the hotel and restaurant industries that if a vendor licenses its brand to a third party in exchange for a license fee and with some level of control over the operations, the contract structure could be deemed an inadvertent franchise agreement, thereby implicating onerous federal and perhaps local statutes and regulations. This could result in significant legal liability, including potentially voiding the agreement as illegal and a refund of fees paid. This can only be avoided by either complying with the onerous documentation and other requirements of the franchise statutes, determining if an exception to the statutes is applicable, or restructuring the deal itself.
- Termination Rights: Unlike standard leases, management contracts commonly have “no-cause” termination rights for convenience (perhaps with payment of a termination fee), termination on sale of the property, and/or termination for failure to hit certain revenue thresholds or other so-called performance tests. The parties should consider whether these are appropriate to include in their agreement.