Defining turnover rents in the age of e-commerce
In the latest Weightmans Retail Review, Solicitor Michael Drapala looks at how retailers are coping with changing customer behaviour and confidence.
High street retail is struggling through a period of unprecedented uncertainty, brought on by fluctuating consumer confidence (not least because we are now very much in the run-up to Brexit), but also in part due to the fundamental and, in all likelihood, permanent disruptive changes in consumer behaviour and how we shop.
Increasing numbers of retailers are either succumbing to the added pressures felt by traditional brick-and-mortar retailers or are finding ways to relieve them. Following the very public difficulties experienced this year alone by Maplin, New Look, House of Fraser and most recently Homebase, some commentators are already dubbing 2018 the 'Year of the Company Voluntary Arrangement (CVA)'. In these incidents, some of the focus has been on the treatment of landlords rather than the retailers themselves, with landlords being asked or in some cases compelled to accept a dramatic reduction in future rents or the value of arrears claims.
If any stores within a portfolio contain 'turnover rents', they will be factored into any decision to vote through a CVA or otherwise. A turnover rent lease is typically one in which the base rent is discounted, usually to 75-80% of open market value, with the landlord receiving a proportion of the tenant’s turnover by way of a supplemental rent. This ostensibly appears to be the parties sharing the risk and reward as the tenant is insulated against poor trading conditions by a lower base rent, and the landlord shares in the profits by virtue of its share in turnover when times are good. On the face of it, this is a sensible bargaining tool; but as we are seeing in recent negotiations and as the way we shop changes, it begs the question — how do we define turnover?
How do we define turnover?
Historically, this has been a relatively straightforward process — it is, or has been, cash through the tills; physical sales made at or fulfilled from a retailer’s premises from customers making purchases at those premises. However, consumers are now exercising their buying power over the internet whatever their driver; sometimes consumers are in search of cheaper goods from online-only retailers with lower overheads; sometimes for the added convenience of the 'click-and-collect' services now commonly offered by a high street trying to remain relevant. Where goods are ordered online, how — and critically, in the context of retail property, where — is the turnover generated by those sales attributed or ascribed by the retailer?
If a customer places a click-and-collect order, via a mobile app for example, with the product ordered being 'picked-and-packed' in a distribution centre before being collected in store, where is that order 'fulfilled' for the purpose of that order counting towards the turnover for a particular store with a turnover rent provision? Is the situation any different if the order is picked and packed in the store from which it is to be collected?
If, as in the first of the two scenarios described above, the order comes from the distribution centre, one might reasonably conclude that the store-front is no more than a post-box, and that these products can’t count towards that store’s turnover. In the latter situation, where the products have, in a meaningful sense, come from the shelves of the store from which they are being collected, a more readily acceptable argument might be made that such a click-and-collect order should count towards the turnover of the store from which it is collected. Defining when the point of fulfilment occurs can be a point of contention as we are finding out when negotiating turnover rent provisions in leases, and both parties to a lease negotiation might be well-served to stick to clearly quantifiable terms — for present purposes, for example, ‘collected’ would seem to be more unambiguous than ‘fulfilled’.
A landlord will want to include as broad a definition of turnover as possible, including cash through the till, online orders placed in store, and online and click-and-collect orders placed remotely but actually collected in store for starters.
For a prudent retailer, it is critical that turnover be defined clearly and narrowly — as far as possible, retailers will want to try to constrain the definition of turnover to cash through the till — physical sales of physical products, to customers in store. A retailer-friendly definition of ‘turnover’ should exclude orders which do not originate in the store to which lease negotiations relate and, in fact, should exclude any orders which do not have any meaningful ‘nexus’ to the physical store (i.e. where the store acts as little more than a PO-box).
A retailer with the muscle to command it should also try to ensure that deductions are allowed against turnover for returns of goods bought in-store, and returns of online orders and click-and-collect orders collected in-store.
However, as hinted at above, how successful any retail tenant will be in negotiating the inclusion or exclusion of any of these points will depend very much on the strength of its individual bargaining position, which may be influenced by the retailer’s financial covenant strength, the strength of the retailer’s brand, the desirability of the location of the store to which negotiations relate, etc.
One thing can be said with some degree of certainty — the traditional cash-through-the-till means of assessing turnover for a store is not the only metric for calculating turnover rents. For as long as changes in technology facilitate the evolution of retail, bricks-and-mortar retail must evolve with it, which means that settled answers for those drafting and negotiating retail leases are unlikely to appear any time soon.