Daily Development for 4/3/01

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

LANDLORD/TENANT; COMMERCIAL; CONTINUOUS OPERATION; IMPLIED DUTY: Tennessee upholds "diminution in value" damages measure for violation of implied covenant of continuous operation. Landlord can also get lost estimated rents in the same action.

BVT Lebanon Shopping Center, Inc. v. WalMart Stores, Inc., 2001 WL 10518 (Tenn. 3/1/01)

In 1985, WalMart took over an existing store in the landlord's center.

The lease provided for percentage rent against a fixed minimum base rent. In 1988, WalMart and the landlord agreed to expand the store substantially. The landlord paid for the expansion. The parties extended the lease term eight years, to 2005 and to double the base rent.. Neither the old lease nor the amended lease contained a continuous operation clause.

WalMart operated for five years without exceeding the minimum necessary to trigger percentage rent. Then, for five years, it did pay percentage rent. Then it decided to relocate to another location in the same market area.

WalMart opened a Bud's Discount Store in the space. Bud's earned only one ninth the gross rents that the WalMart store had earned, and consequently paid only the base rent. The landlord sued for breach of a duty of continuous operation. It alleged that the "use clause" stating that the tenant would operate a discount merchandise store stated a duty of continuous operation. It also argued that the base rent was not substantial and that therefore there was an implied duty of continuous operation.

The trial court found for the landlord and awarded damages equal to lost percentage rent, amounting to $2.5 million, but refused to award damages based upon the diminution in the value of the center. The Court of Appeals, in an upublished opinion, affirmed as to liability. As to damages, the court, concluded that diminution in value was the appropriate damages remedy here, rather than lost rent. The court stated that the only evidence in the record regarding the diminution in value of the center was from plaintiff's expert, who estimated the diminution at $4.7 million. So the court slugged WalMart with that without even remanding, and also entered a substantial attorney's fee order.

The editor excoriated the case in comments for the DD of 7/7/99 (on the DIRT Website: http:www.umkc.edu/dept/dirt/ Of course, nobody listens to him. But perhaps WalMart should have. The editor noted that the Court of Appeals opinion was unpublished and would not affect precedent in this area. He suggested that WalMart might just want to pay up rather than risk an appeal that might write some new law.

But, faced with a judgment of about $4.8 million, WalMart decided to approach the Tennessee Supreme Court. After all, in 1975, the Supreme Court had issued a ruling denying an implied duty of continuous operation in a grocery store case and had expressly rejected the notion that an implied duty could be based upon the notion that the various stores in a shopping center were "economically interdependent." Kroger v. Chemical Securities Co., 526 SW.2d 468 (Tenn 1975).

Was the appeal a good idea? Well, not exactly. It is true that the Supreme Court vacated the $4.7 million damages award and remanded for further proceedings at the trial court. It remanded found that the Court of Appeals was a little abrupt in concluding that the only evidence in the record as to diminution in value was the plaintiff's expert's opinion. The Supreme Court noted that WalMart had also presented an expert, who opined that the diminution caused by WalMart's departure (and not by other factors) was a scant $55, 000.

It is also true that the court did not further discuss the analysis by which the lower court found an implied covenant. So there won't be more bad precedent on that issue published in the books. But this is about all the comfort WalMart can take. On remand, the trial court (backed by the enthusiastic Court of Appeals, may well conclude that the $4.6 million figure was correct.) Further, the Supreme Court embraced wholeheartedly the notion that diminution in value damages are an appropriate measure for breach of an implied duty of continuous operation. In fact, it danced around the room with the concept.

Consequently, we have a ringing endorsement for this measure of damages, which had not garnered too many friends until now.

Even worse for WalMart, the Supreme Court held that the damages award was not duplicative of the lost rent award, and that the landlord could recover both, leaving WalMart with a potential loss of $7.3 million and rising. A concurring judge took pains to note that the restrictions that might apply to the "special damages" claim for the diminution in value would not necessarily apply to the proof of the lost rent claim. (Don't sell that Wal-Mart stock yet - you can bet that all current Wal-Mart leases specifically state that there is no continuous operation duty.

Comment 1: The recent cases go about 60%/40% against the implication of a covenant. The editor's general view of these implied covenant cases in the shopping center context is that the minority of cases that impose an implied covenant are wrong. The results are shaped somewhat by the "going dark aggressively" feature where the tenant moves to a competing location and blocks the use of the old location be continuing to operate there on a reduced basis. It's not clear from this case whether WalMart offered to the landlord that it would vacate its old space if the landlord wanted. In any event, there likely were no other tenants who wanted a space that size.

There are a few circumstances where the landlord can claim legitimately that the facts compel an inference that the tenant was expected to operate.

The Peqot case, cited in the DD for the earlier version of the instant case, is an example, where the total rent was based upon production of bottles and the tenant shut down the bottling plant. The gas station "gallonage leases" are another good example. These are cases where the only return the landlord would receive at all resulted from activity on the property. It seems safe to assume that the parties contemplated that there would be some such activity, and the burden should have been on the tenant to bargain for language providing otherwise.

But in shopping center cases, there always is an amount of rent that is payable. In absolute rent, that amount is more than token, and could be described as "substantial." Furthermore, no one in the commercial leasing business is unaware of the commonly used "continuous operation clause." This is an item that is the subject to extensive discussion in most shopping center contexts. In many of the anchor tenant cases, the landlord in fact has extracted continuous operation clauses from all the minor tenants, and it boggles the imagination to believe that the landlord anticipated it was getting such a commitment from the anchor tenant when the lease was silent.

Lately, in the new world of "Big Box" tenants and "power centers,"

landlords have less bargaining strength than before. "Big Box" tenants, the editor has learned, rarely agree to continuous operation. Some agree to open and that's it.

In the instant case, it is clear that we had sophisticated landlords in the

1988 lease revision landlords who certainly knew how to spell "continuous operation" and knew the meaning of the concept. It is true that they agreed to build an addition for WalMart that would not be fully paid out by WalMart's base rent. But, like in the modern "power center" leases, the developers likely were counting on the profit motives of WalMart to keep WalMart in place and operating for a sufficient period for the developers to recoup.

Further, who's to say that the developers expected a return only from WalMart's rent? The developers had many other tenants in the center drawn there by the WalMart anchor. You can bet that those tenants didn't get the sweetheart lease rates given to WalMart. Their leases may easily have compensated the landlord already for the bargain that Wal Mart received. And if they didn't, this was because the landlord took a business risk and lost, not because WalMart violated an implied understanding.

Courts should imply covenants only when compelled by trade practice or unavoidable circumstance. Neither of these factors leads to the implication of continuous operation clauses in shopping center leases ever (or hardly ever).

Comment 2: Very few courts have found that diminution in value is an appropriate measure of damages for breach of continuous operations clauses. This strikes the editor as correct in most cases, since the landlord typically is arguing that the covenant was implied because the rent return was inadequate. Therefore, one would assume that the lost rent alone would compensate for the breach of the implied covenant.

In this case, if we accept the view that an implied covenant was appropriate at all, one can conceive of an argument that the landlord's anticipated increase in the value of the center was an incentive for the landlord to enter into the lease, since the base rent was inadequate to reimburse the landlord for its investment in the new construction and, in the view of the court, below market. The landlord had no assurance that WalMart would generate any percentage rent in fact it didn't do so for five years. If WalMart was aware of this incentive, as it likely was, then the "diminution in value" claim makes some sense.

Comment 3: Here, note the landlord gets a "double recovery," diminution value plus estimated lost percentage rent. The court makes no effort to determine whether the double benefit to the landlord is consistent with the appropriate return that the court found missing in the original deal.

Why isn't sauce for the goose sauce for the gander?

Comment 4: A major problem with recognition of an implied covenant to operate so as to generate percentage rent is that it takes the court, at least in a case like this, down an uncertain path of predicting future performance. WalMart was not prohibited from opening a competing store. Nor was it required to operate at any certain level of commitment.

It is difficult to see, in fact, why the opening of the Bud's store was in any way inconsistent with WalMart's percentage rent obligations. The editor would conclude that, for these reasons and others, courts shouldn't find such implied duties at all, even if other reasons supported such a finding. In this case, the editor suspects that the landlords expected all along to recoup their investment profit from the increase in the rent generating capacity of the rest of the center, anchored by WalMart. If that's the case, then if an implied covenant were found at all, the damages should have been limited to diminution in value.


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