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Daily Development for Wednesday, February 14, 2001

Thanks to Mort Fisher in Baltimore for the tip on this one.

LANDLORD/TENANT; COMMERCIAL; RECAPTURE CLAUSE: Recapture clause based upon tenant's failure to operate for 60 days operates independently of standard default clause in lease; therefore landlord need give no notice of default before terminating leased based upon recapture clause.

Willow Oaks Assoc. v. Food Lion, Inc., 200 U.S. App. LEXIS 29524 (11/20/00) (unpublished opinion)

Super Fresh operated a grocery store in Landlord's center. The lease contained a clause giving the landlord the right to "recapture" the space and terminate the lease if the tenant failed to operate in the premises for a period of 60 days. The clause contained exceptions for acts of God and even for tenant remodeling. The court does not mention, and we can assume the lease did not contain, any other continuous operation provision.

Super Fresh apparently was not doing well at this location, and the landlord, catching wind of this, commenced negotiations with Food Lion to move into the Super Fresh space. During the course of these negotiations, not surprisingly, Landlord's agents said lots of enthusiastic things about the possibilities for Food Lion in that space and how happy they would be to have Food Lion there. The plans were that Food Lion would demolish and rebuild the space for its own uses.

Food Lion, despite these negotiations with the landlord, opened up a "back channel" negotiation with Super Fresh directly to take an assignment of the Super Fresh lease. The lease provided that the landlord could not withhold consent to an assignment absent a "reasonable basis." Landlord had thirty days to respond to a request for consent. Landlord's own negotiations with Food Lion, of course, suggested that the landlord had little basis upon which it could object to an assignment to Food Lion.

Super Fresh closed its doors, expressing no intent to reopen or remodel, on January 17. On February 19, it completed an agreement with Food Lion to sell its business and assign its lease to Food Lion. On March 8, fifty days after it terminated operations, Super Fresh formally requested that Landlord consent to the Food Lion assignment.

Twenty nine days later (79 days after Super Fresh went dark ), Landlord notified Super Fresh that it was not consenting to the lease because there was no lease. Landlord had elected to invoke the "recapture clause" and was terminating the lease as of that date. Food Lion sued to preserve the assignment.

The appeals court here affirmed a summary judgment for Landlord upholding the termination.

The court concluded that the landlord correctly concluded that the "consent to assignment"clause was irrelevant when the landlord terminated the lease on other grounds. It pointed out that Super Fresh could have preserved its right to assign the lease if it had stayed open, and it was Super Fresh's conduct that gave rise to the landlord's termination option arising.

The court rejected the argument by Food Lion that the lease contemplated a notice of default 30 days prior to the landlord's termination of the lease under the "recapture clause." Although there was standard language requiring such notice for nonmonetary defaults, the court noted that the recapture clause appeared to state its own terms and conditions, and there was no need to refer over to other parts of the lease. In fact, the court noted, the tenant's failure to operate was not a "default" in the lease at all, it merely served as a condition for the landlord's option to recapture.

Finally, Food Lion urged that the landlord's friendly negotiations to draw Food Lion into the property led Food Lion to rely to its detriment by preparing to take over the space, triggering an estoppel. In response, the court noted the somewhat obvious fact that Food Lion itself was negotiating in two channels at once, and indicated that neither side had committed to exclusive negotiations. Thus, Food Lion had no reason to believe it had a deal before the papers were signed, and any reliance was at its risk.

Comment 1: The issues are reasonably straightforward, at least when addressed by a court committed to provide a base of predictability upon which commercial negotiations can be founded. Both Super Fresh and Food Lion had lots of contract and negotiation options available to them to protect their position. When they failed to take advantage of any of these, they were at risk that the deal they hoped to make would not gel.

Reading behind the lines, it appears that the landlord ultimately had other plans for the premises and no longer wanted Food Lion in the space. Until it was "locked in" to a deal with Food Lion, it had every right to change its mind.

The case is refreshing after the difficulties presented to the transactions community in the now defunct but unmourned Prudential case, which suggested that a party engaged in negotiations essentially has already "agreed to agree" and to deal exclusively with the negotiating counterpart. Such thinking shackles negotiations with weights and chains that lead to bad deals, or even no deals. Commercial parties need clarity, flexibility and independence to make their own deals. This decision gives them all that.

Comment 2: It's interesting to note that the parties had included room for the tenant to remodel within the "recapture" clause. Although this fact didn't help the tenant here, it clearly might have if the tenant could have struck its deal with Food Lion sooner and Food Lion had commenced remodeling activities. As a drafting tip, it's always a good idea to include specifically a right to go dark for remodeling purposes whenever there are lease consequences for going dark. And don't forget the study the language dealing with "abandonment, vacation or desertion" of the premises. These clauses can amount to a de facto recapture clause, or worse, and they can skid past your view as so much boilerplate.

In PRC Kentron v. First City Ctr. Assocs., II, 762 S.W.2d 279 (Tex. App. 1988), for instance, a court held that a tenant was in breach of lease covenant holding that it would not "desert or , resulting in heavy damages, when it relocated its office activities out of landlord's building and to another premises, even though it continued to pay rent, keep the doors locked, and otherwise look after the premises. The court held that the tenant had breached the lease's prohibition against "abandonment." The editor thinks the case is wrong, and prefers the contrary holding, on virtually parallel facts, in Turks Head Realty Trust v. Shearson Lehman Hutton, Inc., 736 F.S. 422 (D.R.I. 1990), where the lease said that the tenant could not "vacate or abandon" the premises. Also see Scot Properties, Ltd. v. WalMart Stores, Inc., 138 F.3d 571 (5th Cir. 1998), which somewhat limits the reach of PRC Kentron when it refuses to hold that a tenant that "goes dark" but continues to pay rent violates a lease prohibition against "deserting" the premises.

For a case upholding a trial court's determination that a tenant bound by a continuous operation clause was unreasonable in closing for 62 days in order to remodel a premises from a full service grocery to a "warehouse" grocery operation, see Olympus Hills Shopping Ctr. v. Smith's Food & Drug Ctrs., 889 P.2d 445 (Utah 1994) (a case the editor has criticized for other aspects of its holding on "good faith and fair dealing" in the past). The tenant here would have been wise to negotiate for specific remodeling and renovating "windows" as an exception to its continuous operation duty.

A tenant's case on this issue is In re Ames Dept. Stores, Inc., 136 B.R. 357 (Bkrtcy. S.D. N.Y. 1992), where the court held that six month's down time while the tenant looked for and found an assignee was not a breach of an express continuous operation clause. The court stated this as an interpretation of the lease as well as an application of bankruptcy policy.

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