The Problem with Open-Ended Refund Deduction Rights

Like many landlords, you may agree to let percentage rent tenants deduct refunds from their gross sales. This right gets triggered when a customer returns merchandise to the tenant. But if, as many retail leases with deduction rights do, the lease says that the tenant may deduct “sales of merchandise for which cash has been refunded,” you may be inadvertently giving a percentage rent break that you didn’t intend, warns a New Orleans management consulting firm that represents landlords. The danger is that the tenant may rely on the clause to deduct sales that it didn’t originally include in its gross sales calculation.   

Pitfall: Tenant May Deduct Refund on Sales Generated Elsewhere

A gross sales deduction for customer refunds is fair to the extent the tenant included the refunded sale in its gross sales to begin with. But customers may buy an item from one location and return it for a refund at another. 

For example, a brick-and-mortar store may provide a refund for an item that the customer originally bought online or via catalog order. Or, the original sale might have been made at a different location of the same franchise, as where a customer buys a bra at a Victoria’s Secret store in New Jersey and returns it to a Victoria’s Secret store in New York. 

In deducting refunds from a sale it didn’t include in its gross sales, the tenant artificially reduces the gross sales on which its percentage rent is based. The New Orleans consultant says that this kind of landlord SNAFU happens with alarming frequency, citing an audit in which his firm found that a tenant was deducting over 10 percent of its gross sales as customer refunds on items sold at other stores. And since it didn’t sell the item, it naturally didn’t include those sales in its original gross rent. Unfortunately for the landlord, the lease allowed for deductions on “sales of merchandise for which cash has been refunded.” 

Result: The tenant didn’t commit a lease violation, and there was nothing the landlord could do to recover the refund deductions to which the tenant shouldn’t have been entitled. 

Solution: Limit Deductions to Sales Included in Gross Sales

You can avoid this problem by ensuring that the lease allows the tenant to make deductions only on sales it made in and included as gross sales for the space it leased from you. Here’s some sample language you can include in the part of the lease that lists the deductions tenants may make from gross sales 

Model Lease Language

“Sales of merchandise for which cash has been refunded, but only to the extent of such refund, the selling price of such merchandise has been previously included in Gross Sales.”