Tenant Entitled to Claim Constructive Eviction Despite No Breach Statement in Estoppel Certificate and "Hell or High Water" Clause

Case: Reliastar Life Insurance Co. of NY v. Home Depot, U.S.A., Inc., 570 F.3d 513 (7th Cir. 2009) (applying New York law)

The One Sentence Summary: A federal court applying New York law holds that a tenant's execution of an estoppel certificate creates no warranties about present or future conditions not known by the tenant at the time of execution; and court holds that constructive eviction relieves a tenant of the obligation to pay rent even where the tenant signed a "hell or high water" clause.

What They Were Fighting About: Home Depot entered into a lease providing that the landlord was responsible for the "building pad." When the original landlord assigned the lease to a subsequent landlord, Home Depot signed an estoppel certificate providing: "Tenant has fully inspected the Premises and found the same to be as required by the Lease, in good order and repair, and all conditions under the Lease to be performed by the landlord have been satisfied; including but not limited to payment to Tenant of any landlord contributions for Tenant improvements and completion by landlord of the construction of any leasehold improvements to be constructed by landlord; . . . As of this date, the Mortgagor, as landlord, is not in default under any of the terms, conditions, provisions or agreements of the Lease and Tenant has no offsets, claims or defenses against the Mortgagor, as landlord with respect to the lease."

At the time of the assignment, Home Depot also signed a Recognition Agreement including the following "hell or high water" clause: "Tenant agrees that notwithstanding anything in the Lease or this Agreement contained to the contrary, until Mortgagee notify [sic] tenant that the Assignment has been released, Tenant shall be unconditionally and absolutely obligated to pay to Mortgagee in accordance with the Assignment all rents, purchases payments and other payments of whatever kind described in the Lease without any reduction, set off, abatement, or diminution whatever."

Two years after the assignment, Home Depot detected cracks in its store walls resulting from a defective building pad. Home Depot vacated the premises, stopped paying rent and claimed constructive eviction. The landlord/assignee filed suit against Home Depot for all moneys owed under the lease.

Court Holdings:

Estoppel Certificate

• Home Depot's execution of the estoppel certificate did not bar its constructive eviction defense because Home Depot had no knowledge of the building pad failure at the time it signed the estoppel certificate. In the estoppel certificate, Home Depot made no warranties about present or future conditions that were not known when it was executed.
• The Court stated that its holding "is consistent with the general purpose of an estoppel certificate, which is to assure one or both parties to an agreement that there are no facts known to one and not the other that might affect the desirability of entering into the agreement, and to prevent the assertion of different facts at a later date." (citing Lawyers Title Ins. Corp. v. Honolulu Fed. Sav. & Loan Ass'n, 900 F.2d 159, 163 (9th Cir. 1990)).

"Hell or High Water" Clause

• Although "hell or high water" clauses are generally enforceable under New York law, Home Depot was relieved of its obligation to pay rent if it was constructively evicted.
• Constructive eviction terminates a lease and relieves a tenant of all obligations under the lease.
  
  

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Landlord Entitled To Liquidated Damages Based On Loss Of Synergy, Goodwill And Patronage Resulting From Closure Of "National Tenant's" Store

Case: El Centro Mall, LLC v. Payless Shoesource, Inc., Cal. Court of Appeal, Fourth District, Division Three, No. G040038 (May 21, 2009)

The One Sentence Summary: In an action by landlord El Centro Mall seeking liquidated damages of $98,000 based on defendant Payless Shoesource's closure of its store before expiration of the lease term, Payless failed to show that the liquidated damages did not represent a reasonable estimate of the actual damages a mall landlord would suffer as a result of a "national tenant" like Payless ceasing operation, and thus failed to rebut the presumption of validity of the lease's liquidated damages provision.


What They Were Fighting About: Defendant Payless Shoesource, Inc. (“Payless”) leased space in plaintiff El Centro Mall, LLC’s (“ECM”) shopping center pursuant to a lease that expired December 31, 2005. The lease provided that Payless was to pay base rent, monthly percentage rent based on a percentage of Payless’ gross sales, and additional rent, which included all other costs such as common area maintenance and taxes. The lease required Payless to continuously operate and conduct business on the premises, and further provided that if Payless failed to continuously operate, the landlord was entitled to collect as liquidated damages (in addition to the base, percentage and additional rents) an additional charge of the greater of ten cents per square foot or $100 for each day of non-operation. The liquidated damages represented “the minimum damages which Landlord is deemed to have suffered, including damages as a result of Landlord’s failure to receive Percentage Rental, if any, under this Lease . . . .”

After closing its store in March 2005, Payless continued to pay the monthly base rent and additional rent through the end of the lease term (no percentage rent was owed), but refused to pay the liquidated damage amount. By stipulation, the trial court decided the case on briefs and stipulated facts, including alternative damage calculations depending on whether liquidated damages were recoverable. The trial court found that Payless did not overcome the presumption of validity of the liquidated damages clause and awarded plaintiff $90,226.80, which was the full amount of liquidated damages less a credit from reconciliation of CAM charges and taxes.


Court Holdings:

• The court first discussed Civil Code section 1671, which provides that a liquidated damages clause is valid unless the challenging party establishes the provision was unreasonable under the circumstances existing at the time the contract was made. The burden of proof on the issue of reasonableness is on the party seeking to invalidate the liquidated damages provision.
• The court held that to the extent the liquidated damages provision was intended to estimate damages for the tenant’s failure to pay percentage rent (as opposed to damages for loss of synergy, goodwill and patronage) during the period of non-operation, it was an unenforceable penalty. Because the lease separately provided the amount of percentage rent to be paid as damages if the lessor terminated the lease based on the tenant’s default, liquidated damages for failure to pay percentage rent were unnecessary except to penalize Payless.
• With respect to damages for loss of synergy, goodwill and patronage, however, the court held that substantial evidence supported the trial court’s decision enforcing the liquidated damages provision, and that Payless failed to meet its burden of proving that the liquidated damages provision was unreasonable under the circumstances existing at the time the contract was made.
• The court found that the evidence presented by Payless (i.e., that ECM allowed Sears, an anchor tenant, to vacate without paying liquidated damages, while other tenants who were not “national” tenants were required to pay liquidated damages) “may give rise to an inference the provision is arbitrary.”
• However, the court found that the evidence did not “conclusively prove the point” because there was no evidence of the circumstances surrounding the other leases, such as whether there was another reason Sears was not required to pay liquidated damages or whether the other tenants (General Nutrition Corporation, Sports Image and The Locker) were or were not “national” tenants similar to Payless.
• The court also noted that Payless failed to present evidence (e.g., expert testimony) that a charge of 10 cents per square foot was not a reasonable estimate of the actual damages the landlord would suffer if a tenant like Payless closed. In contrast, ECM presented an expert declaration stating that (1) in recognition of the fact that “national tenants” such as Payless generate significant foot traffic, landlords customarily require a covenant of continuous operation; (2) landlords also typically require a liquidated damage provision because it is difficult to estimate the damages from the loss of synergy, goodwill and patronage caused by a national tenant’s failure to continuously operate; and (3) the liquidated damage amount is directly proportional to the amount of space occupied by the tenant because larger stores are “likely to conduct more business, generate more goodwill to the retail center, generate more patronage to the retail center, generate more and better complimentary tenants at increased rents and also generate more percentage rent.”

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The Center is Failing: What Are Your Rights?

The Summary: In today’s financial climate, it is hard to keep up with the changes happening in shopping centers across the country. Retail space in shopping centers is staying vacant for several months or longer. Landlords are converting retail space to non-retail use or closing entire wings or floors of shopping centers. Landlords are even closing operations entirely at shopping centers to redevelop the property. What are a retailer’s rights when a mall begins to fail? Some retailers have favorable co-tenancy provisions in their leases that provide immediate rights under these circumstances. While co-tenancy provisions are the most obvious protection when a shopping center fails, tenants often have other protections under the lease and under the common law.

When faced with a failing shopping center, a tenant should follow three steps to evaluate its rights against the landlord.

First, a tenant should determine whether there is a co-tenancy provision in the lease, and if so, a tenant should monitor the landlord’s compliance with the co-tenancy requirements regularly. In the event of a co-tenancy failure, a tenant should assert its rights under the lease as quickly as possible.

Second, a tenant should evaluate whether there are other provisions in the lease that might offer protection. More general obligations and covenants in the lease may also offer grounds for relief against the landlord.

Third, a tenant should think beyond the lease language. State common law may offer additional protection to a tenant when a shopping center fails.

Step 1: Does The Tenant Have Co-Tenancy Rights Under The Lease?
Some tenants are in a position to negotiate co-tenancy provisions in their leases, such that if certain key stores or a percentage of stores in the center fail to operate, the tenant is entitled to relief. These provisions vary and should be closely scrutinized in this market, so that those tenants that are lucky enough to have them are enforcing them against their landlords.

Enforcing A Co-Tenancy Provision
A typical co-tenancy provision states that if one or more key stores (or anchor stores) at a shopping center is not occupied by the existing tenant or similar tenant, or if a certain percentage of the retail stores are not occupied by retail tenants, the tenant may pay reduced rent (often referred to as “alternate rent”) or terminate the lease. While co-tenancy provisions generally are enforceable, disputes relating to co-tenancy provisions may not be easy to resolve. Language in co-tenancy provisions can be ambiguous, which means that lawsuits regarding these provisions are sometimes subject to a trial rather than more efficient resolution by a judge. See Rathbun v. Cato, 93 S.W.2d 771 (Mo. Ct. App. 2002) (holding the term “similar type and size business” in a co-tenancy provision was ambiguous and its meaning must be determined based on evidence of the parties’ intent outside of the lease); Jo-Ann Stores, Inc. v. Property Operating Co., LLC, 91 Conn. App. 179 (2005) (holding term “first class retail purpose” in a co-tenancy provision was ambiguous).

Issues that often arise with co-tenancy provisions are when and how co-tenancy rights are triggered. For example, does the landlord have an obligation to notify the tenant when the co-tenancy requirements are not met, or is the tenant required to monitor the shopping center to confirm compliance with the co-tenancy requirements? This question is often governed by the specific lease language. For example, the lease may require the landlord to notify the tenant in the event of a co-tenancy failure. If the lease does not require notice, the tenant should periodically request information from the landlord regarding the occupancy of the key stores and other retail space. Even if the landlord provides such information, it is advisable that the tenant conduct its own inspection of the center and record occupancy levels.

“Making An Election” vs. Condition Precedent
Some co-tenancy provisions state that in the event of a co-tenancy failure, the tenant is entitled to “make an election” to pay reduced rent. How does this language affect a tenant’s rights? When the tenant has the right to “make an election” of remedies upon a co-tenancy failure, the landlord will argue that the tenant’s failure to make the election after a co-tenancy failure waives the tenant’s right to reduced rent or reimbursement of overpayments. Where a co-tenancy requirement is based on a certain percentage of leasable square footage, however, a tenant most likely will not be able to determine precisely when a co-tenancy failure occurs unless the landlord provides additional data. While a tenant should be vigilant about monitoring the shopping center’s occupancy and compliance with co-tenancy requirements, a tenant should take the position that it is the landlord’s obligation to provide the tenant with information relating to co-tenancy failure before the tenant is obligated to make an election of remedies.

Other co-tenancy provisions more simply state that if the co-tenancy requirements are not met, then the tenant is not required to pay full rent. This language creates a “condition precedent.” If the condition (the co-tenancy requirement) is not met, the tenant’s rent obligations are reduced automatically. This language is preferable to the “election” language as described above. Where there is a condition precedent, if for some reason the tenant continues to pay full rent after a co-tenancy failure, the tenant has a stronger argument for reimbursement of prior overpayments.

Step 2: Does The Tenant Have Other Rights Under the Lease?
If a lease does not include a co-tenancy provision, a tenant still should closely review the lease to identify other provisions that may provide rights when a center begins to fail. In many leases, the landlord covenants to do something for the benefit of the tenant. For example, the landlord may covenant to maintain common areas consistent with a first class shopping mall; conduct marketing and promotional activities; or provide security or other services. If the shopping center is failing, and as a result, the landlord fails to maintain it properly or comply with its marketing or security obligations, the landlord would be in breach. The lease will often set forth the remedies available in the event of such a breach.

Further, landlords may covenant in a lease to provide certain things to the tenant, such as a first class shopping center or regional retail development. A lease may include a specific description of the shopping center or attach a map of the center and its individual retail stores. If the shopping center no longer fits the description as set forth in the lease, the landlord may be in breach and subject to a claim for damages.

Even language relating to the tenant’s obligations in the lease may be of use when the center is failing. For example, a tenant may agree that its sales practices will be consistent with standards and practices generally acceptable in “enclosed first-class, full-retail-price regional shopping centers.” If the landlord has made changes to the center such that it is no longer operating a “first-class full-retail-price regional shopping center,” the landlord may be in breach of the lease.

These types of provisions and covenants demonstrate that the parties intended the shopping center to be more than the collection of leasable space. Rather, the parties intended the shopping center to be a destination in and of itself, and in entering into the lease, the tenant was agreeing to lease space in the shopping center as it existed at the time of the execution of the lease. A substantial change to the center could be a breach of the lease entitling the tenant to relief.

Step 3: Does The Tenant Have Common Law Rights Outside of the Lease?
Although a tenant typically cannot rely on state common law to assert rights contrary to the language of the lease, a tenant can use common law to bolster arguments based on the lease or to fill in gaps not addressed in the lease.

For example, if changes in a shopping center cause a landlord to breach a specific provision in the lease (e.g., co-tenancy requirements or covenant to provide center with specific characteristics), a tenant can file a lawsuit for breach of contract and seek damages. If the changes to the shopping center are so significant that the tenant cannot operate its store as contemplated under the lease, a tenant may have a right to terminate its lease based on the common law principles of constructive eviction, failure of consideration or impossibility of performance. See Causeway Partners 1, Ltd. v. Kinney Shoe Corp. T/A Foot Locker, No. 01-00-01280 (Tex. App. April 25, 2002) (unpublished) (rejecting landlord’s claim for breach of lease and holding tenant was constructively evicted when mall’s occupancy rate dropped well below 20% and there was no foot traffic). In addition, if the landlord has done something to undermine the tenant’s value in its lease, such as open a competing center nearby, the tenant can argue that the landlord has breached the covenant of good faith and fair dealing, which is a covenant implicit in every contract.

Further, a tenant should identify facts that might support a tort claim against the landlord. A landlord cannot lie to the tenant to induce the tenant to enter into or renew a lease. If a landlord misrepresented occupancy rates or that specific tenants would be leasing space at the shopping center, then the tenant may have a claim for fraud. The tenant should be careful to retain all records relating to the landlord’s representations. Even if the tenant can prove that the landlord misrepresented facts to induce the tenant to lease the space, the tenant will have the additional hurdle of proving that the lease agreement does not supersede any prior promises by the parties.

Conclusion
Retailers cannot avoid entirely the downturn in the economy, but they can take action to assert their rights against landlords when shopping centers begin to fail. First, a tenant should read the lease to determine whether there are specific provisions in the lease that set forth the tenant’s rights when the center undergoes changes. Second, a tenant should review the lease for more general provisions that may be breached by the landlord when the center begins to fail. If the landlord is not complying with its covenants in the lease, the landlord is in breach. Third, a tenant should consider common law claims. If the changes to the center are so substantial that the tenant cannot reasonably operate its store, the tenant may have a right to terminate the lease or seek damages based on constructive eviction, failure of consideration, impossibility of performance, breach of the covenant of good faith and fair dealing or possibly fraud.

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Retail Lease Tying Rental Rate To Rent Of Competing Tenant Or Its Successor Held Inapplicable Where Competing Tenant Is Defunct

Case: California National Bank v. Woodbridge Plaza LLC, Case No. 05CC03999 (Cal. Ct. App. 6/20/08)

The One Sentence Summary: California Court of Appeal held that a bank’s retail lease providing for an extended lease term at the lesser of the then prevailing rental rate or the latest square foot rental rate of a competing bank in the center or its “successor” in the center is construed to require rent at the then prevailing rental rate where the competing bank was defunct and the space previously occupied by the competing bank was occupied by six non-bank tenants.


What They Were Fighting About: The plaintiff was a bank whose predecessor entered into a 25 year lease in 1979 for retail banking space in the defendant’s shopping center. The lease provided that the plaintiff had an option to extend the term for 10 years at the then prevailing rate, but the rent for the extended term would not exceed the latest square foot rental paid by the competing bank in the center or its “successor” in the center.

Five years later, the competing bank in the shopping center ceased doing business, and the landlord was unable to lease the space to a bank or other single tenant. The landlord remodeled and divided the space previously occupied by the competing bank and leased the space to six new tenants who were not engaged in the banking business. When the plaintiff’s lease term concluded, it claimed a right to extend the lease term at a new rental rate that was the lesser of the fair market rental rate or the blended rental rate charged to the six tenants in the space previously occupied by the competing bank. The landlord contended that since the six tenants were not banks, there was no “successor” to the competing bank in the center. Thus, the landlord asserted a right to rent the space to the plaintiff at the fair market rental rate. A lawsuit was filed to have the court determine the rental rate for the extended lease term.

Court Holdings:

• The appellate court reviewed the trial court’s construction of the lease de novo.


• The court held that the term “successor” in the lease was ambiguous, and therefore, the court looked to the circumstances surrounding the execution of the lease.


• The court noted that when the lease was executed in 1979, the plaintiff and the competing bank in the center were competitors and the two major tenants in the center. Their lease terms were comparable, but rental rates for office space in the center were lower. The court concluded that: “[u]nless the parties anticipated use by a financial institution, there would be no point in tying plaintiff’s rent to rent for those purposes.”
  
• The court rejected the plaintiff’s argument that the landlord’s interpretation of the lease was unfair even though it was the landlord that divided the space previously occupied by the competing bank and leased it to non-banks.
  

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Taxes Under a Lease: Not Just a Simple Pass-Through

The One Sentence Summary: While some view a tenant's obligation to pay taxes as a pass-through from the landlord, this characterization is often inaccurate. Landlords frequently collect more in taxes than they in fact pay, and sometimes they collect less. Courts and juries in deciding what amount of taxes the landlord is entitled to charge a tenant, look not to some notion of fairness or a pass-through, but to the language of the lease. Thus, determining a tenant's obligation for taxes is no different from determining a tenant's obligations for other charges under a lease. The first place to look is the written lease.

Typically, a retail lease will provide a formula for calculating taxes in a form similar to the following:



In examining the lease to determine whether a tenant’s obligations for taxes is calculated properly, a tenant should focus on three main issues.

1. What types of taxes fall into “total taxes paid by landlord”? Taxes from the government can come in various forms, and determining what types of taxes are the responsibility of a tenant typically depends on how the term “taxes” is defined in the lease

2. What parcel(s) can be included in “total taxes paid by landlord”? Is the landlord limited to the parcel on which the tenant’s store is located? Can the landlord include its tax obligations for other tax parcels at the center?

3. Once it is resolved what types of taxes and what parcels can be included in “total taxes paid by landlord,” the next step is to calculate the portion of the taxes that can be charged to the tenant. This is calculated by taking the square footage of the tenant’s space (the numerator) and dividing it by some measure of total square footage of the center (the denominator). While the numerator is typically undisputed, the denominator is often an issue for dispute.

Issue 1: What types of taxes is the landlord permitted to include in calculating the total taxes subject to allocation to the tenant?

It is in the landlord’s interest to classify as many government fees as possible as taxes, so that its tenants will ultimately be responsible for these charges. For example, a landlord may pay a fee to the government in lieu of a tax and then attempt to charge its tenants for a portion of the fee. And, landlords are increasingly attempting to pass through to retail tenants “business license” or “gross receipts” taxes, which typically are taxes imposed by cities based on revenues received by commercial landlords. Since retailers are required to pay their own taxes to the cities, requiring a tenant to pay for the landlord’s share of business license or gross receipts taxes often results in a double tax to the retailer.

Like any lease dispute, the question of what types of taxes can be included in calculating the tenant’s charge for taxes is determined by examining the parties’ intent as expressed by the plain language of the lease. See e.g., Sheplers, Inc. v. Kabuto Int’l (Nevada) Corp., 63 F. Supp. 2d 1306 (D.C. Kansas 1999) (interpreting retail lease dispute based on the plain language of the lease). A retail tenant’s first line of defense to limit its obligations for taxes is to negotiate a narrow definition of what types of taxes can be included in this charge. For example, a tenant can seek to specifically exclude from the definition of “taxes” any business license, gross receipt, income, or franchise taxes, or any charge paid to a governmental authority in lieu of taxes.
If the lease language does not specifically exclude business license or gross receipt taxes or fees paid in lieu of taxes, a tenant may still have a strong argument that the parties to the lease did not intend a particular tax to be the tenant’s responsibility. Again, the definition of “taxes” in the lease is critical. The term may be defined narrowly, such that by its plain language, it does not include the charge being asserted by the landlord. A narrow definition of “taxes,” such as “those taxes and assessments that will during the term of the lease be assessed as a lien on the land, buildings and improvements comprising the real property tax parcel of which the Premises and the building in which the Premises are located are a part . . . .,” simply would not include business license or gross receipt taxes. This language also likely would not include payments by the landlord to a governmental authority in lieu of taxes.

Further, if the provisions of the lease relating to taxes are not conclusive, the tenant may be able to rely on language in other portions of the lease to challenge the landlord’s attempt to pass through other charges as taxes. See Sheplers, 63 F. Supp. 2d at 1313. The tenant will want to look for language in the lease demonstrating that the parties did not intend to include fees in lieu of taxes or business license or gross receipt taxes as part of a tenant’s obligation for taxes.

Finally, if any correspondence or meeting notes relating to the negotiations of the lease support the tenant’s position that the parties intended a narrow definition of “taxes,” this evidence should be identified and used to challenge the landlord’s attempt to use a broader definition.

Issue 2: What parcel(s) are included in calculating the landlord’s total real estate taxes subject to allocation to the tenant?

Since a landlord’s real estate taxes are generally tied to specific real estate, the next question is what parcel(s) can the landlord include when calculating its total taxes that are subject to allocation to the tenant. Centers are sometimes developed on multiple tax parcels. Anchor stores may sit on their own tax parcels or be part of a larger parcel. In addition, tax parcel lines may change over the period of a lease. Portions of a center may be on the same parcel as the tenant’s leased space when the lease is executed but at some point become part of a different parcel. Thus, the question arises: Can the landlord include taxes paid on all parcels in the center in determining a tenant’s tax obligations? Or is the landlord limited to only the parcel on which the tenant’s store is located?

Again, the answer to these questions is governed by the language of the lease. Tenants should be vigilant to confirm that they understand what parcel(s) are being included in the total taxes paid by the landlord, and that the lease provisions support the inclusion of each of those parcels. In some cases, this evaluation is simple – the taxes provision in the lease may specify the parcels that can be included in calculating the tenant’s tax obligations. In other cases, the lease language may not be as clear. For example, it may permit the landlord to include all tax obligations for the “center.” In those cases, the tenant should examine how that term is defined elsewhere in the lease and whether it excludes certain parcels, anchor stores, etc. Further, the tenant should be aware of any changes to the parcel maps in case those changes would result in a reduction of the tenant’s tax obligations.

Issue 3: How are applicable taxes apportioned to the tenant?

Once the parties have agreed to the types of taxes that can be charged to the tenant and the parcel(s) that can be included in the calculation, the next step is to calculate what portion of the applicable taxes will be allocated to the tenant. This is determined by using a fraction in which the numerator is the square footage of the tenant’s leased space and the denominator is some measure of total square footage of the center.

What goes into the denominator is the primary issue of dispute in calculating what portion of the applicable taxes will be allocated to the tenant. It is in the landlord’s interest to keep the denominator as small as possible. In contrast, it is in the tenant’s interest to use the largest denominator possible. Thus, a landlord may want to exclude anchor stores or include only the square footage of the parcel where the tenant’s leased space is located, while a tenant would want to include the total square footage of the entire center, including anchor stores.

Another issue that arises is whether the denominator should include total square footage of all “leased space,” as opposed to total square footage of all “rentable” space. The tenant would prefer to use “rentable space” because it would be a larger number and result in a smaller portion of taxes being charged to the tenant.

Further issues can arise even if the parties agree that the denominator will include total square footage of “rentable space” and they agree to the applicable parcel(s). Suppose a center is experiencing low occupancy and the landlord decides to close an entire wing of the center or convert it to a non-retail use (e.g., a public library), or suppose the landlord closes an area of the center for remodeling. The question arises whether that space is “rentable” square footage under the lease. The landlord may argue that the space is not rentable because it is not being offered for rent. The tenant would argue that it is still “rentable,” despite the landlord’s decision to opt for a different use. Also, in the case of a lease that excludes anchor stores from the denominator, if anchor store space becomes vacant and is no longer used for an anchor store, there is a question whether the anchor store exclusion still applies to that space.

Once again, the tenant should examine the lease to determine the parties’ intent in calculating the proper denominator. See e.g., F.S. Associates, Inc. v. Jandi Realty, LLC, 14 Misc.3d 1204(A), 2006 WL 3718249 (N.Y.City Civ. Ct. 2006) (holding retail tenant was responsible for 100% of real estate tax increases based on plain language of the lease). The tenant should examine the lease provisions regarding taxes as well as the lease as a whole to identify support for the argument that the parties intended to include the total rentable square footage of the center in the denominator (or the largest square footage supportable under the lease). In addition, the tenant should identify communications outside of the lease that may support its interpretation of the lease.

CONCLUSION

A retail tenant should regularly audit what taxes are being charged to the tenant and how they are calculated. The tenant should evaluate what types of taxes can be included in charges to the tenant, what parcel(s) can be included, and whether the tenant’s share is being calculated consistent with the lease and the parties’ intent. A tenant should never assume that it is required to pay all taxes asserted by the landlord as a non-negotiable pass-through. Rather, a retail tenant’s obligations for taxes are governed by the lease and are subject to negotiation and interpretation just like other provisions in the lease.

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Landlord Must Provide Tenant with Supporting Documentation of Actual Common Area Expenses Incurred

Case: McClain v. Octagon Plaza, LLC, Case No. B194037 (Cal. Ct. App. 1/31/08)

The One Sentence Summary: Where retail lease requires tenant to pay its share of common area expenses based on landlord's statement of the expenses, tenant is entitled to review landlord's supporting documentation to verify that the stated expenses were incurred and that the amounts are accurate.


What They Were Fighting About: Plaintiff McClain, doing business as A+ Teaching Supplies, entered into a lease for space at a shopping center owned and managed by defendant Octagon Plaza. The lease stated that the leased premises were "approximately 2,624 square feet" and occupied 23 percent of the shopping center. In addition to paying base rent, tenant was required to pay as additional rent 23 percent of the common area expenses within a specified time period after landlord provided tenant with a "reasonably detailed statement" of the actual expenses. After entering into the lease, plaintiff discovered that her unit occupied only 2,438 square feet, or 186 square feet less than stated in the lease and represented by defendant during their lease negotiations. The shopping center was also 965 square feet or 8.1 percent larger than represented by landlord. As a result, plaintiff's share of the common area expenses should have been 19 percent rather than 23 percent. The size differences increased plaintiff's rent and additional rent payments by more than $90,000 during the lease term. The lease contained exculpatory language that any statement of size was an approximation and agreed to by tenant as reasonable and that any payment based thereon was not subject to revision if the actual size were different. Plaintiff filed suit alleging claims including misrepresentation, breach of the implied covenant of good faith and fair dealing, and an accounting. The trial court sustained a demurrer without leave to amend on the misrepresentation and implied covenant claims, and after trial ruled that plaintiff failed to establish her claim for an accounting (or an unrelated claim for alleged violation of the Consumer Credit Reporting Agencies Act). The court of appeal reversed with respect to the claims for misrepresentation and an accounting.

Court Holdings:

• With respect to the accounting claim, the court held that the implied covenant of good faith and fair dealing entitles tenant to review documentation supporting landlord's statement of common area expenses. Because tenant's share of the common area expenses is based on the actual expenses incurred by landlord, tenant is entitled to verify that the expenses listed in landlord's statement were actually incurred and in the amounts shown.
• However, the court emphasized that tenant's right to review supporting documentation was limited. The court permitted landlord to decide whether to provide tenant with copies of the documents or allow tenant to review the originals. Moreover, the court rejected tenant's request to audit landlord's records in order to determine whether certain expenditures were necessary or appropriate. Tenant was only entitled to verify that the stated expenditures were actually incurred.
• The court further held that tenant adequately pled a fraud claim based on landlord's misrepresentations about the size of the leased premises and its percentage of the entire shopping center's square footage. Tenant alleged that had she known the correct size, she would not have agreed to the base rent and share of common area expenses stated in the lease. Landlord's use of the term "approximation" did not preclude liability for a material misrepresentation about size.
• Tenant's fraud claim was not barred by exculpatory language in the lease. Under California Civil Code section 1668, contractual provisions that would protect one against liability for his own fraud are against public policy. Thus, the lease provisions stating that the size approximations were reasonable, agreed upon, and not subject to revision regardless of actual size could not defeat a fraud claim.
  
  

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What Makes For A Successful Tenant Overcharge Claim Against A Shopping Center Owner Or Operator

The One Sentence Summary: In successful claim after successful claim, it is the lease language that is most important.

Full Posting:

Every year there are thousands of disputes in which retail tenants claim they are overcharged by owners and operators of shopping centers for CAM expenses, utilities, taxes, marketing fund payments and other charges. The disputes can be for hundreds of dollars or millions of dollars depending on the magnitude of the overcharges, the period over which the overcharges can be collected and the number of leases involved. Some of these disputes are resolved quickly and favorably to tenants, others are dropped, and some result in lawsuits. From a retailer perspective, the overcharge claims that are the greatest success are those that are resolved quickly and for a substantial percentage of what the tenant seeks. The relief can come in the form of cash or other forms of compensation, such as agreements to reduce charges in the future or providing the tenant some other benefit such as closing an underperforming store or extending a lease on favorable terms.

So what are the characteristics of successful tenant claims? Twenty years of representing retailers has shown that the most important characteristic of a successful tenant claim is being able to convince the shopping center owner or operator that the claim has merit (meaning an objective fact finder has a high probability of finding the tenant was overcharged). Even if a tenant claim has merit, a tenant may still have some difficulty resolving a claim if a shopping center owner does not believe a tenant will take action. Under such circumstances action, namely a lawsuit, may be required. The question then becomes what will persuade a court or jury and the issue comes back to what claims have merit.

In evaluating the merits, there are three criteria that come into play. The first and most important is the language of the lease. Does the language support the claim being made by the tenant? The second criteria is whether so-called “extrinsic evidence” supports the position of the tenant regarding the meaning of the lease. Extrinsic evidence is nothing more than information other than the language of the lease itself. The third criteria, once the meaning of the lease is established, is whether there is evidence that the landlord breached the lease.

CRITERIA 1 – THE LANGUAGE OF THE LEASE.

There is no question that the single most important criteria in demonstrating a claim has merit is what the lease says. The ability of a tenant to convince an objective fact finder, or to convince a landlord that an objective fact finder might side with the tenant, will be determined primarily by the tenant’s ability to link its claim to language in the lease. A claim that a tenant is merely overcharged because it is paying more than its “fair share” is not likely to be successful. Rather, a tenant needs to point to lease language that has been violated leading to an overcharge.

In decided case after decided case, what has mattered most is tenant’s ability to link the claim of an overcharge to language in the lease. For example, in Sheplers, Inc. v. Kabuto International (Nevada) Corp., a 1999 decision by a federal district court in Kansas, the dispute focused on whether certain management fees and expenses were properly charged to the tenant as CAM costs. The court rejected the landlord’s argument that the lease permitted it to include in CAM charges any costs associated with managing the shopping center, because the lease specifically stated that common area expenses include “the operating, managing, equipping, lighting, repairing, replacing, and maintaining the common areas.” Therefore, only management costs specifically related to the common areas were properly included in the CAM expenses.

At times, consideration of the language in the lease will involve the application of lease interpretation rules to lease language. The rules of interpretation commonly applied by courts include:

• When the terms of a lease are clear and unambiguous, the intent of the parties should be found within the four corners of the agreement.
• Terms should be given their plain and ordinary meaning.
• Lease provisions should be construed in the context of the entire lease.
• All lease language should be given meaning and effect.
• A practical interpretation should be given to lease language so that the parties’ reasonable expectations are realized.
• And in some states a rule of last resort: Ambiguous language should be construed strictly against the drafter.

Thus, in addition to favorable lease language, the application of a rule of interpretation often makes for a strong claim by a tenant. For instance, the court in Sheplers v. Kabuto emphasized that its interpretation limiting CAM charges to only those expenses related to managing the common areas was supported by other language in the lease, thereby applying the rule of interpretation that lease language should be construed in the context of the entire lease. Other lease language stated that CAM “shall specifically exclude all costs associated with the leasing activity in the shopping center and all capital expenditures.” Therefore, the court concluded that all tenant-specific management activity, including problems with specific tenant spaces and capital expenditures for specific tenants, should not be included in CAM charges.

One of the most common rules of interpretation applied by courts is the principle that the words in a lease are to be given their plain and ordinary meaning. In Dinnerware Plus Holdings, Inc. v. Silverthorne Factory Stores, LLC, a 2004 decision by a state appellate court in Colorado, the court ruled that the lease language meant that the tenant was not obligated to pay any pass-through charges unless other tenants were obligated to do so. The court based this conclusion on the plain and ordinary meaning of the phrase “provided that all other tenants are similarly obligated” in the lease’s language regarding payment of pass-through charges.

CRITERIA 2 – EXTRINSIC EVIDENCE.

While the words of the lease are the most important criteria in determining the meaning of a lease, there are times that other evidence is considered. Other evidence considered in interpreting the meaning of a contract is referred to as “extrinsic evidence” or “parol evidence.” The consideration of such evidence will vary depending on the language of the lease, which may include provisions that state that the language is intended to constitute the intent of the parties and replace any prior statements, and specific state court rules regarding the consideration of such evidence. Some states, such as California, allow the consideration of extrinsic evidence to demonstrate that which would otherwise appear clear on its face is really ambiguous. Other states, such as New York, require that there be a determination first that the document is ambiguous on its face before the consideration of parol evidence is allowed. Regardless, it is almost a certainty that each side will bring up and seek to introduce to the court extrinsic evidence to support their interpretation of contract language.

Rarely is extrinsic evidence from tenant witnesses, actions or documents supporting tenant or extrinsic evidence from landlord witnesses, actions or documents supporting landlord highly persuasive. For example, in South Towne Centre, Inc. v. Burlington Coat Factory Warehouse of Dayton, Inc., a 1995 decision by an Ohio state appellate court, the court considered self-serving extrinsic evidence on whether the parties intended the expense of a new shopping center sign to be chargeable as a CAM cost. The court concluded that the extrinsic evidence – testimony by the landlord’s and tenant’s witnesses about what the parties intended – did not clarify the parties’ intentions, and therefore the extrinsic evidence did not resolve the issue. Ultimately, the court applied the rule of strict construction against the drafter based on the landlord’s failure to specifically include the signage expense in the lease’s list of chargeable CAM costs.

The extrinsic evidence that is most often persuasive is evidence created by one side and used against the other side. Such evidence can be in the form of documents, testimony or actions. An example of such evidence is course of dealing evidence. For example, in Johanneson’s, Inc. v. Kraus-Anderson, Inc., a 1999 decision by a state appellate court in Minnesota, the court in disallowing a 5% management fee relied on the fact that from 1986 through 1995 the landlord had charged the tenant only for its share of actual maintenance expenditures plus the salary and benefits of the shopping center’s manager. Later, starting in 1996 the landlord began charging 5% of the tenant’s gross revenues as a fee for the landlord’s related management company to manage and maintain the common areas. The court seemed persuaded by the prior dealings between the parties that the additional 5% management fee was impermissible and not intended to be a chargeable CAM expense.

CRITERIA 3 – EVIDENCE OF BREACH.

If the tenant has developed a persuasive argument as to the meaning of the lease based on the lease language and rules of interpretation, there still remains a critical step in the process of advancing a strong claim. The tenant must have factual evidence that the landlord has breached the lease provision. In other words, assuming the tenant has shown that the lease means “x,” the tenant must show that the landlord failed to do “x” and did “y” instead.

There are circumstances where there is no dispute as to the facts once the meaning of the lease is established. The strongest tenant claim is one where the undisputed evidence shows there was a breach. However, there are many circumstances where complete evidence is not available to tenant. In some cases, the reason is that landlord has not provided it and in others, it is that center owner and operator never collected the evidence and it will be difficult to reconstruct the relevant evidence.

When information is available but not provided, it is almost always the case it can be obtained through discovery, if a lawsuit is filed. In such circumstances a tenant can consider how likely the evidence will support the claim in making an evaluation and recognize that a shopping center owner would likely provide the evidence if it supported the shopping center owner’s position.

When relevant information was not collected and it is difficult to reconstruct the relevant evidence, tenant may still be able to make a persuasive claim. First, courts apply common sense in evaluating evidence whether or not the landlord has breached the lease. Evidence presented by the landlord of its alleged compliance with the CAM provision in Sheplers v. Kabuto was found to be unpersuasive by the court under a common sense review. The landlord’s property manager testified that 100% of the on-site management costs were related to CAM. The court found “it impossible to believe that 100% of the property manager and her assistant’s work is directly related to CAM” particularly in light of the property manager’s admission that she and her assistant spent time on tenant-specific matters including leasing activity. Second, courts recognize that the landlord often has exclusive control over information needed to establish a breach. The lease in Sheplers required the landlord to provide the tenant with reasonable detail and a breakdown regarding CAM expenses, so the court shifted the burden to the landlord to show that the challenged management costs were CAM-related. The court explained: “Giving the provision such an effect is sound policy because defendant has complete control over all the records related to CAM expenditures.”

The bottom line: In successful claim after successful claim, it is the lease language that is most important. While extrinsic evidence and factual support of breach are also important, the starting point is the language of the lease.

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