Co-Tenancy Rights – Use Them Or Lose Them

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It’s been a while since we wrote about rules of contract construction or about the consequences of dilatory behavior. Now, we’ve just seen a September court decision from the United States District Court for the District of Minnesota that gives us a good opportunity to cover both. As a bonus, it deals with a lease’s continuing co-tenancy provision.

The co-tenancy provision was pretty typical. In principle, to be an “Anchor Tenant” meant almost any “large, well-known national or regional retail store.” A co-tenancy failure was where certain identified space at the shopping center lacked such an Anchor Store for 120 days. Absent such an Anchor Store for that period, and if certain other conditions existed, the tenant with the continuing co-tenancy right could begin to pay “Alternative Rent” equal to the lesser of the lease’s stated rent or 3% of its gross sales. None of that was at issue at the Minnesota shopping center. The landlord agreed that the tenant’s co-tenancy right had been triggered and that it would be entitled to pay Alternative Rent, but for one issue. It claimed the tenant waited too long to exercise its right to the reduced rent. It wasn’t because an Anchor Tenant was found for the empty space. It was because the now-gone Anchor Tenant had vacated at the end of July 2016 and the claiming tenant, after paying full rent for 30 months, made a $250,000 retroactive claim in January 2019 for excess rent paid.

This is where we are compelled to reproduce the tenant’s “remedy” clause from its lease. It is long, but when reading it, readers should focus on two of its aspects – the tenant’s remedy, and the landlord’s “counter-remedy”:

If at any time after the Rental Commencement Date the On-Going Co-Tenancy Requirement is not satisfied, and such non-satisfaction continues for one hundred twenty (120) days . . . then Tenant will have the right to pay, in lieu of monthly Minimum Rent, a monthly amount equal to three percent (3%) of Tenant’s gross sales for the preceding calendar month, as “Alternative Rent”, but in no event shall such Alternative Rent exceed the Minimum Rent payable under this Lease for such month. If Tenant shall continue to pay Alternative Rent in excess of twelve (12) consecutive months, and for so long as such non-satisfaction of the On-Going Co-Tenancy Requirement shall continue, Tenant shall have the right to terminate this Lease by sixty (60) days’ written notice delivered to Landlord. In the event Tenant continues to pay Alternative Rent and has not elected to terminate this Lease at such time due to the non-satisfaction of the On-Going Co-Tenancy Requirement, Landlord will have the right to demand by written notice delivered to Tenant on or before the last day of the fourteenth (14th) full calendar month following the initial non-satisfaction of the On-Going Co-Tenancy Requirement (the “Demand Notice”) that Tenant do the following: either (i) terminate this Lease by thirty (30) day written notice delivered to Landlord within sixty (60) days after Tenant’s receipt of Demand Notice or (ii) discontinue Alternative Rent and recommence the payment of Minimum Rent per Paragraph 6 of Basic Lease Provisions on the sixtieth (60th) day after Tenant’s receipt of the Demand Notice. Upon any termination pursuant to this Section 16.3, the parties shall have no liability under this Lease for obligations arising after that date.

On its face, nothing in the clause limits the time period within which the tenant could make its claim. On the other hand, the landlord’s right to force its tenant to choose between staying at full rent or quitting the premises is tied to a notice given within 14 months after the co-tenancy failure began. Interestingly, since the tenant had to wait 120 days (about four months) before it could start paying Alternative Rent, the 14 month period ends after the tenant has been “on” Alternative Rent for only 10 months.

For those readers who have not already noticed, unless the tenant or the landlord exercise their respective lease termination right, the reduced Alternative Rent could continue forever. The tenant might like such a “break,” but it landlord probably would not. That’s what the court saw as the crux of the problem. By the time the tenant made its claim for Alternative Rent, the 14-month notice limit for the landlord to terminate the lease had ended. Did the draftspeople “see” that? We think not. Boo!

Over the years, we have periodically reproduced what one court or another listed as “rules of construction.” Generally, they don’t vary much from jurisdiction to jurisdiction. Consequently, many of the reproduced lists overlap. Few have been comprehensive. This federal court, however, has gone a step further than all of those earlier courts and has given us a list worth copying and saving. Here it is:

The primary goal of contract interpretation is to determine and enforce the intent of the parties.

Interpretation of unambiguous contracts is a question of law for the court, as is the determination that a contract is ambiguous.

The terms of a contract are ambiguous if they are susceptible to more than one reasonable interpretation.

A contract’s terms are not ambiguous simply because the parties’ interpretations differ.

If the court determines that the contract language is unambiguous—meaning it has only one reasonable interpretation—it will give effect to that language and determine the parties’ intent from the language of the written contract alone

If the court determines that a contract is ambiguous, it may admit parol, or extrinsic, evidence of the parties’ intent

Only if a preponderance of the evidence does not prove the parties’ intent should the factfinder apply the canon of contra proferentum [interpretation against the person who drafted the document] and construe ambiguous terms against the drafter

Contract provisions are not to be read in isolation, but instead in light of their surrounding context. (Provisions of a lease should never be interpreted in isolation, but rather in the context of the entire agreement.

Lower courts and parties have, several times, been criticized by appellate courts for failing to heed context clues. (“The court’s focus on scattered references in the purchase agreement . . . is far too simplistic and inconsistent with our historic approach to contract construction. . . . Words and phrases cannot be read `out of context with the entire agreement.’”)

The intent of the parties is not ascertained by a process of dissection in which words or phrases are isolated from their context, but rather from a process of synthesis in which the words and phrases are given a meaning in accordance with the obvious purpose of the contract as a whole.

Because of the presumption that the parties intended the language used to have an effect, courts will attempt to avoid an interpretation of the contract that would render a provision meaningless.

Pay attention to the last item on the list because it, alone, explains why the tenant lost its right to pay the reduced rent even though there was a co-tenancy failure.

The tenant lost its right to claim Alternative Rent because, if it were permitted to wait 30 months to do so, the landlord’s right to terminate the lease would be rendered useless. The court understood that the tenant’s right to a reduced rent and the landlord’s right to demand the tenant to choose between staying or returning to full rent were “paired” – a bargained-for balancing of interests. Nowhere in the lease’s text was that said, but applying the rules of contract interpretation supplied that unwritten term. As the clause was written, the landlord could not make its “go or stay demand” until it tenant had been paying Alternative Rent for 12 months, but also could not make such demand more than 14 months after the Anchor Tenant space lost its tenant.

So, we’ll offer the following, single comment (and warning): “Who wrote that?” When we write “customized” lease (or other agreement) provisions, we need to do a “what if” analysis. Very often, we start with a proposed clause and then add, delete, and move words. And, very often we wind up with unworkable clauses. Every change makes sense on its own, but when we’re done, the clause is broken. Our guess is that this is exactly what happened in Minnesota. We know that the back-and-forth process can be exhausting and it is easy to get tired of revising a clause until each party “signs off,” but that’s no excuse not to step back, even take a day, to re-read what has been created. It also makes sense to have someone else, someone not involved in the drafting process, to read these Frankenstein creations. When was the last time any of us have done that? In situations where there is a pool of talent, perhaps there should be a rule that redlined (comparison) versions of a document are independently reviewed and that all “custom-crafted” agreements be handled the same way.

Lastly, why did the tenant wait so long to make its claim? Did its store manager not know about the co-tenancy provision? Almost certainly, the answer is: “No.” Most likely, the loss of the required Anchor Tenant had little effect on the store’s sales. It might have had an effect, but overall rising sales could have disguised the loss. The lesson for tenants is that if you’ve negotiated for a co-tenancy right, you’ve got to monitor the situation. Certainly, automatically examining every location’s sales figures is a starting point, but that doesn’t work for new locations or where other factors at a location can disguise the effect of an anchor vacancy on your own sales. Telling the store manager once is also a route to failure. Store managers change; they also forget. Stores need to be “polled” periodically, perhaps monthly, as to significant changes at the shopping center. Store managers need to report significant changes even if their own sales are unaffected. “Use it or lose it” lease provisions demand continual monitoring.

[To read the court’s decision, click: HERE]

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Comments

  1. Margaret Petersen says:

    Hi Ira – Yikes, this is a scary decision, in part b/c, as you note, it’s so easy to “Frankenstein” lease provisions like this to death and still miss some “what if?” scenarios. As such, I’m absolutely thrilled when s/o with an arms length to the negotiation trenches reads a lease I’ve negotiated to the point where I’m sick of looking at it and feel lost in the weeds… Beyond that, the point you note about the store manager likely knowing about the co-tenancy clause I think could very well NOT have been the case. A tenant with a provision like this *probably* is a larger company with a significantly sized home office organization. As such, there can be a series bureaucratic jumps from the R/E department and R/E legal over to the Store Ops side, starting with the, let’s say, VP or EVP of Ops down to the regional VP or director to the regional manager to the store manager (or some variation of the foregoing), with the store manager possibly having no idea what a co-T clause is or that there might be any legal (lease-related) impact of a major s/ctr tenant going dark. As an in house r/e counsel this was often one of my nightmare scenarios, that there was something at the local level that I didn’t know about or that the R/E department didn’t know about. I made a point of providing the Store Ops folks, down to the store manager, with a cc of the lease following lease execution, together with a lease abstract, and for a time I was part of the store manager training program (before it was trimmed to a shorter training period, so the boring r/e and r/e legal stuff was cut), in part so that I could alert the Store Ops side to provisions like the co-T clauses, which require “field observation” to enforce. But… once there was store manager turnover, this was hard to manage going forward. I also instituted a pretty rigorous estoppel process where all sorts of levels and departments were consulted to ferret out issues like a failed co-tenancy, and with time the R/E department, especially as the recession took hold, learned to keep a closer eye on co-tenancy issues, but with a large organization (i.e., large store count), and even with the foregoing types of “preventative maintenance,” something like a co-T failure can fall through the cracks. That said, a co-T failure of THIRTY months without anyone saying anything really is pretty bad… BUT, as with the scenarios in many of your posts, there but for the grace of God could go any one of us!

  2. Jason Kirkham says:

    Do you think the decision would have been different if, instead of seeking retroactive claim for “overpayment” of rent, the tenant had asserted a right to pay percentage rent going forward? That would have avoid the landlord’s loss of its counter-remedy, but still given the tenant the benefit of its bargain.

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