Daily Development for Monday, December 3, 2001

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

LANDLORD/TENANT; EXTENSIONS AND RENEWALS: Agreement to extend continuous operation clause for an identified period constitutes a de facto agreement to operate beyond the lease term.

Rouse-Randhorst Shopping Center v. J.C. Penney Co., 2001 U.S. Dist. LEXIS 18928 (D.N.D. Ill. 11/16/2001)

Rouse and Penney were successors in interest to the landlord's and tenant's interests in an anchor tenant space in a shopping center. The lease had commenced (under different parties) in 1961. In 1981, Carson Pirie (Penney's predecessor) had agreed with the then landlord to extend the lease until 2001. Tenant had a number of extension options beyond that date.

Also in 1981, the parties agreed to a separate amendment that establshed an operating covenant (a continuous operation clause) that expired in 1996, five years prior to the then scheduled termination date of the lease.

In 1988, Rouse acquired the landlord's position, and in 1989 Rouse entered into an agreement with Carson Pirie to extend the operating covenant until 2004. Penney took over the Caron Pirie lease in 1990 and expressly assumed its covenants. Although the operating covenant was contained, apparently in a different document, it was a lease amendment, and the court concludes that Penney's expressly assumed that as well.

The covenant contained a clause indicating that it was not effective unless the other anchor tenants in the shopping also accepted it, and Penney argued that there was no evidence that such acceptance had occurred. The court, however, held that Penney had waived this argument by assuming the lease and operating for a decade.

In 2001, at the end of the lease term, Penney stopped operating and stopped paying rent. Rouse sued for damages for breach of the operating covenant.

Held: The operating covenant imposes an obligation on Penney to continue as a tenant through the term of that covenant. The court viewed the covenant as "unambiguous" in this regard.

"Here the unambiguous contractual terms simply do not conflict. Penney's assertions to the contrary, there is nothing inherently irreconcilable about the lease term and the term of the Operating Covenant. Nothing in the lease provisions precluded Penney from fulfilling the duties that it specifically assumed under the Operating Covenant, either by exercising its first option to extend the term of the lease or by remaining in possession of the premises as a holdover tenant. When Penney assumed all of the lessee's obligations under the lease in 1990, it knew full well that the original lease term ended on June 30, 2001 while the Operating Covenant ended on June 30, 2005. At no time were the dates in those two provisions linked either expressly or impliedly. There is simply no support for Penney's suggestion that this Court should rewrite the Operating Covenant by pretending that it had said 2001 instead of 2005, so as to make it coterminous with the lease expiration."

The court stated that it was not rewriting the lease for the parties. Indeed, it comments that such an action would be "impermissible" here where the language of the agreement is "unambiguous." But it notes that if it were rewriting the lease, it might as easily have viewed the operating covenant as an extension of the lease until 2005 as it could have viewed it as terminating coterminous with the original lease term. The court then throws in a few platitudes from the "landlord's handbook" the importance of continuous operations clauses.

Comment 1: This little district court case is not going to be much precedent in any event, and it is hard to evaluate the decision fully because the court does not give us the language of the "unambiguous" operating covenant. Further, we no little about the bargaining between the parties either at the time of the creation of the operating covenant, at the time of its extension, or at the time of the Penny's assumption. All of this apparently struck the court as "irrelevant" in light of its conclusion that the contract was unambiguous.

Comment 2: It does seem anomalous for the parties to agree to a separate operating covenant that is not coterminous with the lease term. Note that, originally, the covenant ended before the lease term. But the possible explanation is that the covenant was drafted to be subscribed to by all of the major tenants together, and it may well have been made coterminous with the lease terms of one of the other major tenants.

Comment 3: Although the editor suggests a logical explanation for the lease term and the operating covenant term being "out of synch," this does not mean that the editor views the relationship of the lease term and the operating covenant's term to be free from ambiguity. Unlike the court, the editor sees this issue as wholly ambiguous.

The court suggests that it was not extending the lease term, since there was a holdover provision stating that the tenant, if it held over, would be a month to month tenant on the same terms and conditions as the operating covenant. (Of course, this probably simply restated the common law on this point.) But the court's conclusion makes clear that the tenant cannot be regarded as a month to month tenant, since a month to month tenant can terminate on a month's notice.

To further underscore the ambiguity, consider the landlord's position. Is it bound to be a landlord for the next four years, or can it terminate the "month to month" holdover? Are we saying that Penny had agreed operate continuously for four years, but that its term could be ended on one month's notice from the landlord? This is obviously an absurd construction, as to operate continuously Penny would have had to be geared up for an operation that could not economically be terminated on thirty days notice.

In short, the court must have concluded that the parties had unambiguously agreed to a mutually binding four-year extension. But this is out of odds with other parts of the lease, since there was no provision for an extension of four years. The lease provided only for five-year extension options.

Comment 4: In sum, the editor does not necessarily contend that Penney's predecessor did not agree to extend the lease for four years when it agreed to a ten year operating covenant. Nor does the editor contend that Penney didn't understand what it was getting into when it assumed that covenant. But it does appear that the issue was far from clear in the documents, and that extrinsic evidence would be necessary to support that conclusion. Absent any clear extrinsic evidence, the editor would conclude that the moving party had failed in its burden of proof and that there was no default.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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