November 01, 1996

Going Dark Aggressively (1996, 10:06)

Going Dark Aggressively

Probate and Property, November/December 1996, Volume 10, Number 6

By Patrick A. Randolph Jr.

Consider a shopping center with a successful anchor department store tenant_so successful that the developers of a proposed new center nearby are courting it. The tenant is not happy where it is, but it has a long-term lease. The tenant suspects that if it opens at the new location, its own competition will doom the existing center. If the landlord cannot find a substitute anchor tenant to compete with the old tenant and the good will it has created, the other smaller tenants will fail or vacate and the center itself will become dark. The anchor tenant's lease contains no express continuous operation duty. Nevertheless, would the old center's owner have remedies against the anchor to prevent it from competing with its own leased space?

Alternatively, consider an anchor grocery store tenant that is unhappy at its present location. A new center is being built nearby. If a competitor moves into that center, the compe-tition for the customer's dollar will be intense, even ruinous. But if the grocery store vacates its present space, another grocer might move into it and create the same competitive environment. The grocery tenant decides that it will move to the new center and either leave the old location dark or rent it to a non-competing use such as a specialty grocer or a liquor outlet. Perhaps the tenant even plans to enforce the old landlord's covenant to restrict grocery uses in other parts of the old center. Nothing in the lease prevents these actions. Can the grocery tenant succeed in its scheme?

This article focuses on shopping center anchor tenants that relocate and compete with their original space. Are they subject to an implied covenant to operate? In the absence of express continuous operation clauses, do these tenants have any duty to operate as anchors in their old locations? Do they at least have the duty to cooperate in subletting or assigning their old spaces to equivalent replacement tenants? What if the relocating tenant "freezes" the old space by renewing its lease but keeping the premises dark or under-used? Have courts viewed these activities as predatory or simply as lawful business competition?

The Economic Interdependence Rationale: Cases Establishing the Theory

Most of the appellate cases involving implied duties of continuous operation in shopping centers focus on the tenant's implied responsibility to generate percentage rents. When an anchor tenant is involved, however, the landlord is likely to be as concerned about the overall economic effect of the tenant's leaving as it is about the loss of percentage rent. From the landlord's perspective, the various elements of the shopping center are economically dependent on one another, and the tenant knew this when moving in. The landlord often argues that the tenant implicitly agreed to support the balance of the center by functioning as an anchor and that this economic interdependence alone should create an implied covenant of continuous operation. This economic interdependence argument is often the most honest explanation of the landlord's real injury.

Some anchor tenants do not pay fixed rent at all. Some that have percentage rent clauses do not generate additional rent because sales do not exceed the stipulated minimum (which may be the reason the tenant wants to move). If a landlord can argue that the tenant agreed to support the economic interdependence of the center, the landlord can claim damages for injury to the center, not just for lost percentage rent. Probably the leading case adopting the economic interdependence argument is Ingannamorte v. Kings Super Markets, Inc., 260 A.2d 841 (N.J. 1970). That case involved a grocery store anchor tenant that had moved to a nearby location and left the old location dark. When the tenant attempted to exercise a renewal option in the old lease, the landlord sued to terminate the lease so that it could relet to someone else. The old lease was for a fixed rent and had no continuous operation clause but did restrict the use to a grocery store operation. The court interpreted the use clause as an agreement not to keep the store dark. It found the tenant in breach of this clause and permitted the landlord to terminate the lease.

Ingannamorte is inconsistent with earlier cases interpreting use clauses. Those cases had almost uniformly viewed use clauses as barring changes in use but not requiring continuous operation. The real thrust of Ingannamorte is that an implied duty arose from the tenant's acceptance of its role in the mutual support that a landlord and tenant provide to one another and to the other tenants in a shopping center. The lease, for instance, prohibited the landlord from leasing any other space to a grocery store. Thus, the center had nurtured the tenant and permitted it to establish a market base in the expectation that its economic strength would in turn benefit the balance of the center.

Some more recent decisions have applied Ingannamorte's economic interdependence rationale in the context of relocating tenants. Perhaps the most notorious example is Hornwood v. Smith's Food King No. 1, 772 P.2d 1284 (Nev. 1989), in which a grocery store tenant relocated and sublet its old space to a lower volume user. The court measured damages, in excess of $1 million, based on the depreciation in the overall value of the center resulting from the tenant's actions. The Hornwood decision is dramatic but contains little theoretical discussion of the basis for the court's decision. The Hornwood court relied on First American Bank & Trust Co. v. Safeway Stores, Inc., 729 P.2d 938 (Ariz. Ct. App. 1986), in which the tenant, relying on an express right to assign and sublet, relet its space to a lower volume tenant. The Safeway court found an implied duty to operate continuously or to transfer the space to a tenant of the same character. The court mixed its theories, stressing both the economic interdependence argument and the percentage rent features of the lease. The landlord's non- compete clause was also a factor in the court's decision.

A case that is more explicit in its holding for the landlord is Columbia East Associates v. Bi-Lo, Inc., 386 S.E.2d 259 (S.C. Ct. App. 1989). In that case, an anchor grocery tenant relocated virtually next door, refused the landlord's request to relet its old space to a competitor and left the space dark for a long time before it looked for any subtenants. The tenant paid a fixed rent and had a free right to assign or sublet. Relying on the economic interdependence theory, the court imposed a duty of good faith and fair dealing on the tenant to sublet the space to an appropriate store. The court did not explain the damages award of $400,000, but presumably the award was based on the landlord's lost revenues or value from other space in the center. See also Tabet v. Sprouse-Reitz Co., 409 P.2d 497 (N.M. 1966). Veteran shopping center lawyers may puzzle over these cases. They know that continuous operation clauses are typically negotiated in shopping center leases. It is rarely an accident that the parties omit one from the lease_particularly when the lease expressly allows unfettered subletting and assignment. Consequently, it is difficult to conclude that parties implicitly intended continuous operation duties to exist when they did not so expressly provide. Perhaps in the rare case of a nonexistent or very low minimum rent in a percentage rent lease, the parties necessarily intended that there be some level of operation. But anyone in the shopping center business knows that tenants regularly come and go, moved by the dictates of the marketplace. Landlords that expect tenants to stay ought to bargain for an appropriate covenant in the lease.

Once the principle of good faith and fair dealing raises its head, however, lease language often goes out the window. The best example of this is Olympus Hills Shopping Center, Ltd. v. Smith's Food & Drug Centers, Inc., 889 P.2d 445 (Utah Ct. App. 1994), in which the lease contained an express continuous use clause but allowed the tenant to operate any lawful retail business. The tenant relocated its full service grocery operation and sublet to a discount box outlet, allegedly to drive full service customers to its new location. The court held that the tenant breached its duty of good faith and fair dealing in its selection of a substitute tenant. The court further held that a four month closure while the old tenant moved out and the discount box operation moved in breached the tenant's good faith and fair dealing responsibility. Such an interpretation distorts the real meaning of the doctrine of good faith and fair dealing, which is to implement the transaction as the parties truly intended it. The doctrine should be used only to effect the parties' intent in ways that are consistent with the overall structure of their deal. If the parties expressly state that the tenant can operate any lawful retail business, then it is difficult to understand how they could have implicitly intended that any new business must generate the same traffic as the old one. Olympus Hills gave the landlord more than it bargained for.

Contrary Cases

Wishful thinking landlords' lawyers might view the Ingannamorte line of cases as a trend favoring the landlord's position. In fact, the opposite is true. Most appellate decisions that have considered Ingannamorte have not accepted the case and the theory it spawned. Most appellate cases acknowledge that parties to shopping center lease negotiations are sophisticated, knowledgeable people who know what they want and how to express their desires in formal language. Although it might seem extreme to permit a tenant to leave old space dark to freeze out competition, the tenant bought that right when it signed a long-term commitment to pay rent for the space. If the landlord wanted more than rent and wanted the tenant's continued operation on the premises, then it certainly could have implemented that requirement in the lease. The landlord might have received less rent, or even a less attractive tenant, if it had bargained hard for continuous operation in the lease. For that reason, most courts conclude the landlord chose to risk the possibility of a dark anchor space if economic conditions later changed. In short, the majority rule appears to be that shopping center tenants and landlords are only as economically interdependent as their lease language dictates.

The decision in Plaza Associates v. Unified Development, Inc., 524 N.W.2d 725 (Minn. Ct. App. 1994), is typical of the majority view. In this case, a drugstore tenant leased space in a shopping center under a long-term lease requiring percentage rent. The tenant moved across the street after 40 years in the same location. The landlord argued for an implied continuous operation covenant, both because of the percentage rent provisions and bec