Enforceability of Commercial Lease Co-Tenancy Provisions
A commercial lease co-tenancy clause conditions a retail tenant’s opening for business or continuing operations at the designated property upon another tenant opening for business or continuing operations at the same property. These clauses usually emphasize the importance of “anchor” tenants, which attract customers to the retail property and enhance the property’s financial viability.
In a 2015 opinion by California’s Fifth Appellate District, Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. (one of the first opinions to address a co-tenancy clause), the court examined a co-tenancy rent abatement clause allowing the tenant to take possession of the property without paying any rent due to the anchor tenant’s failure. The court held that the rent abatement aspect of the co-tenancy clause was an unenforceable “penalty” because it resulted in a forfeiture disproportional to the range of harm that would be anticipated by a breach. See 2015 Money and Dirt post here: Commercial Lease “Co-Tenancy” Clauses: Unconscionable, Penalty, or Enforceable?
However, in an opinion recently filed by California’s Third Appellate District — JJD-HOV Elk Grove, LLC v. Jo-Ann Stores, LLC — the court rejected a similar “penalty” argument and upheld a co-tenancy clause, emphasizing the “general rule that courts enforce contracts as written.”
Here are the details:
Facts: co-tenancy clause allowed a tenant reduced rent if other leases in the shopping center fell below certain thresholds
The lease between shopping center landlord JJD-HOV Elk Grove, LLC (“JJD”) and retail tenant Jo-Ann Stores, LLC (“Jo-Ann”) contained a co-tenancy provision. That provision required the shopping center to have either three anchor tenants or 60 percent of the space leased. If the shopping center fell below both of those thresholds, then Jo-Ann was allowed to pay a lower, “substitute” rent.
The normal lease rent started at $36,458 per month with increases every five years. The “substitute” rent was set by a formula negotiated into the contract — the greater of 3.5 percent of Jo-Ann’s gross sales or $12,000 per month.
After two anchor tenants closed, Jo-Ann gave notice to JJD that it would start paying the substitute rent pursuant to the co-tenancy provision. Jo-Ann paid the substitute rent for around 20 months. When a new anchor tenant opened in one of the spaces vacated by a former tenant, Jo-Ann returned to paying the normal contract rent.
JJD sued, arguing that the co-tenancy provision was an unenforceable “penalty” under the 2015 Grand Prospect Partners opinion, and that Jo-Ann owed $638,293 in back rent at the normal contract rate.
Jo-Ann filed a cross-complaint seeking a judicial declaration that the co-tenancy provision was valid and enforceable.
Trial court: co-tenancy clause enforceable
The trial court ruled in favor of Jo-Ann, finding the co-tenancy clause was not a penalty.
JJD appealed.
Court of Appeal: affirmed; reduced rent triggered by condition precedent is not a penalty
The Court of Appeal affirmed the trial court’s judgment.
In its opinion, the court examined Civil Code section 1671— a statute cited in the Grand Prospect decision. Section 1671 addresses the enforceability of contractual “liquidated damages” provisions, which set a fixed amount of compensation to be paid by one party in the event of a breach of contract. Under section 1671, if a liquidated damage clause is unreasonable under the circumstances existing at the time the contract was made, it is an unenforceable penalty.
However, the court rejected the analysis of the Grand Prospect decision and held that section 1671 did not apply to the co-tenancy clause because the clause did not address any anticipated “breach.” Instead, the co-tenancy clause simply established a condition precedent based on the shopping center’s reduced occupancy, which, when triggered, resulted in substitute rent. The court held that section 1671 was “inapplicable to the facts of this case because there is no suggestion that reduced occupancy in the shopping center resulted in JJD’s breach of the parties’ agreement.”
The court agreed with Jo-Ann that the rule governing the case: the parties’ written agreement “should be controlling and enforced,” particularly since it was a commercial lease, and “the court cannot supply material stipulations or read into the contract words which it does not contain so as to change the meaning of the words contained in the contract.”
The court noted that the lease was negotiated by the parties with assistance of counsel, and concluded: “The parties thus considered the risk of reduced occupancy in the shopping center, and agreed Jo-Ann would pay Substitute Rent if that risk occurred. … JJD has received precisely the Substitute Rent it agreed to receive, and we find no basis for relieving JJD from the burden of its agreement.”
Lesson
In contrast to the 2015 Grand Prospect opinion, the recent opinion in JJD-HOV Elk Grove views co-tenancy clauses as addressing conditions precedent relating to occupancy, rather than liquidated damages arising from breach. Under that framework, the co-tenancy clause at issue could not be construed as a “penalty,” and was fully enforceable.