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Negotiating Theater Leases

Failure to recognize and properly deal with the special issues that arise in connection with movie theater leases can result in a variety of unexpected problems for shopping center owners. Given the size and number of multi-screen theaters in today's retail environment, these problems can have major economic effects.

Site plan and design Theater location is often restricted by existing major tenant leases and REAs. Permissible building areas negotiated prior to the recent changes in theater size may require modification. Similarly, existing height restrictions may not consider the extra height required for stadium seating or larger-format screens. Obtaining approvals may require payment of money or granting other concessions.

Stadium seating also exacerbates the "special purpose building" limitations of theaters. The significant costs required to change the design of the building for other uses should be taken into account, especially in the context of early termination by reason of default by the tenant. Building code requirements for exits may pose challenges for theaters being integrated with existing mall buildings and, at a minimum, may result in loss of GLA.

Late-night operations Since theaters usually operate later at night than other mall tenants, the possibility of the tenant being responsible for after-hours common area costs, such as security and lighting, should be considered. On the other hand, an argument can be made that these costs should be passed on to other mall tenants because theaters create additional sales for other tenants.

It is important to determine whether existing tenant leases restrict inclusion of after-hours costs in CAM charges. The extent of late-night use of the enclosed mall by theater customers for access to the parking areas should also be determined.

Exclusives Problems can arise from broad exclusives given to theaters and other tenants. A prohibition on additional movie theaters may not be a problem, but a prohibition on film exhibition may cause conflicts with tenants who use film as an incidental part of their business: filmed fashion shows and infomercials, for example. Other entertainment modalities, such as virtual reality activities, can also run afoul of a broadly drafted theater exclusive.

Prohibitions imposed by supermarkets and similar tenants against food sales may conflict with theater snack sales. These can be avoided by restricting supermarket exclusives to sale of food designed primarily for off- premises consumption or limiting the prohibition to supermarket use. More difficult to resolve is the conflict with restaurants and fast food operators arising from the expanding assortment of "real" food being sold by theaters.

Also, if exclusives given to tenants selling general merchandise don't permit incidental sales of competing items, conflicts can arise as theaters sell items that are related to the films being shown.

Operating covenants The landlord's desire to create some certainty as to the nature and scope of theater operations is difficult to reconcile with the tenant's desire to preserve flexibility. As Glenn Garfinkel, general counsel of Crown Theatres LP, notes, "Since the theater industry is affected by technology, theater operations will require flexibility to allow them to adapt to technological changes over lengthy lease terms."

In addition to typical negotiations - the term of the operating covenant and the name under which the business will operate - the parties need to struggle with issues like defining the quality and intensity of the operation. This requires answers to such questions as: Will it be a "first run" theater? Should operations be tied to the operations of other "first class" movie chains? How many screens must be operated? Does the number vary with time of day or season of the year?

Percentage rent The provisions should be specifically tailored to theater operations but should be broad enough to allow for evolving technologies and merchandising as well as a possible change in use. The lease should consider all revenues, not just ticket sales and concession receipts - for example, revenues from screen advertising.

"Four wall" deals - i.e., licenses or arrangements for the exhibition of a particular attraction - typically are dealt with by including only the amounts received by the tenant from the licensee (and not the licensee's ticket receipts). However, the number and duration of such events should be limited.

Sheldon A. Halpern is a partner in Pircher, Nichols & Meeks, Los Angeles

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