Cotenancy Breach Remedies

Cotenancy Breach Remedies

A California court of appeal has held that a shopping center lease provision allowing the tenant to completely abate monthly rent starting when a cotenancy requirement was not satisfied was an unenforceable penalty since the tenant admitted it did not suffer any damages from the violation of the cotenancy requirement. But the court held that a lease provision giving the tenant the right to terminate the lease after the cotenancy requirement was not met for one year was enforceable. This decision is significant for retail landlords and tenants alike since cotenancy provisions are routinely included in shopping center leases, usually with tenant remedies of rent abatement and/or termination right, similar to this case.

In Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. the lease between the landlord and the tenant, Ross Dress for Less, conditioned Ross’s obligation to open and pay rent on Mervyn’s operating a store in the shopping center on the commencement date of Ross’s lease. The lease also granted Ross the option to terminate its lease if Mervyn’s ceased operations and was not replaced by an acceptable retailer within 12 months.

When the time came for Ross to take possession of Ross’s premises, Mervyn’s had filed for bankruptcy and was not operating. Ross took possession of its premises. But, as authorized by the lease, Ross did not open for business and did not pay rent. After 12 months, since the cotenancy requirement was still not satisfied, Ross exercised its right under the lease to terminate the lease. Landlord sued claiming Ross was obligated to pay rent not only for when Mervyn’s was dark but also for the entire 10 year lease term because the cotenancy provisions authorizing rent abatement and termination were unconscionable (i.e., extremely unfair) or, alternatively, an unreasonable penalty and therefore unenforceable.

Cotenancy requirements are included in retail leases for the benefit of the tenant and generally require other stores to be occupied by operating businesses in the shopping center to assure the tenant that the center is vibrant. A cotenancy provision may, for example, require a specific occupancy level, or the presence of particular named tenants, to ensure the tenant that there will be sufficient foot traffic at its location in order to drive sales and draw customers.

Cotenancy provisions are categorized as “opening” and “operating” requirements. Opening cotenancy requirements condition the tenant’s obligation to open for business or start paying minimum rent on satisfaction of the cotenancy requirement. Operating cotenancy requirements condition the tenant’s obligation to either continue to conduct business or to continue to pay minimum rent on the active operation of certain named tenants and/or a predetermined level of occupancy within the shopping center.

Cotenancy provisions vary depending on the circumstances, and there are many variations to the requirements and the tenant’s remedy, such as the right to delay the opening of the tenant’s store, payment of alternative rent, termination of the lease, or a combination of these remedies. The court stated that it was not making a categorical rule of law regarding enforceability of cotenancy provisions, given their many requirements and remedies. Instead, the validity of a cotenancy provision depends upon the facts and circumstances proven in a particular case.

In analyzing unconscionability, the court noted both the landlord and tenant were sophisticated and experienced in negotiating commercial leases, there were real negotiations between the parties and landlord was given meaningful choices both in initiating contact with Ross and during the negotiations of the lease. The fact Ross insisted upon cotenancy provisions was not determinative because the specifics of those provisions were subject to negotiations. Therefore, the court held there was no procedural unconscionability in this case, and thus unconscionability did not provide a ground for invalidating the cotenancy provisions in the lease.

In evaluating whether or not the rent abatement and termination provisions were penalties, the court considered each of these remedies separately. In general, a contractual provision is an unenforceable penalty if the value of the property that is forfeited does not bear a reasonable relationship to the types of harm anticipated if the provision is not satisfied.

With respect to the rent abatement, Ross admitted it would have no loss if Mervyn’s was not open by the commencement of the lease. Yet the rent forfeited was $39,500 per month. The court held that the rent abatement provision was an unreasonable penalty because there was no reasonable relationship between the value of the property forfeited by landlord ($39,500 per month) and the anticipated harm to Ross ($0 per month).

In assessing whether the lease termination provision was an unenforceable penalty, the court noted that when the lease was signed, the landlord did not own the property on which Mervyn’s was located. The lease termination provision arose from an occurrence of contingencies (Mervyn’s filing bankruptcy and not operating), which had no relation to any act or default of the parties. The court held the lease termination provision was not a forfeiture and therefore not an unenforceable penalty.

While enforceability of remedies for breach of cotenancy provisions is very fact specific, the parties should consider using either rent abatement which relates to tenant’s lost business arising from the cotenancy breach or agreeing to liquidate damages. For breach of an operating cotenancy provision, the amount of rent abated can be tied to the actual reduction in the tenant’s sales or profits, or the tenant can be required only to pay percentage rent while the breach lasts. For breach of an opening cotenancy provision, since the tenant’s store will not have been open, the parties cannot determine or refer to the tenant’s lost profits or gross sales. So, it may be more appropriate to use a liquidated damage provision and stipulate to a pre-estimate of damages. The amount of liquidated damages must still be reasonable under the circumstances existing when the parties enter into the lease.