Daily Development for Thursday, February 2, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
LANDLORD/TENANT; EXCLUSIVE USE; ENFORCEMENT: Order Restored!! Restrictive covenant in commercial lease is unenforceable where tenant has no interest in shopping center other than prohibiting competition.
Tippecanoe Assocs. II, LLP v. Kimco Lafayette 671, Inc., 829 N.E.2d 512 (Ind. 2005).
SES leased a store in its Sagamore shopping center to Kroger. Kroger operated a supermarket on the premises the lease for which contained a restrictive covenant preventing SES from leasing any other space in the shopping center to another grocery store. Kroger later closed all of its supermarkets in the area and assigned its lease to Pay Less, which operated grocery stores in the area. Pay Less acknowledged acquiring the Sagamore center lease in order to prevent competition with its other area stores.
Pay Less later subleased the Sagamore space to H.H. Gregg, an appliance dealer. So the former Kroger space was no longer operated as a grocery store. But Pay Less still had other stores in the area that it wished to protect from competition from stores in the Sagamore Center.
Pay Less owned the Tippecanoe Associates II, LLC (“Tippecanoe”). Tippecanoe sought to enforce the restrictive covenant against the current owner of the Sagamore shopping center, Kimco Lafayette 671, Inc. (“Kimco”) in order to prevent Kimco from leasing other space in the center to a competitor grocery store.
Kimco filed a complaint to have the restrictive covenant declared unenforceable. The trial court granted Kimco’s request on the grounds that the original purpose of the covenant could no longer be achieved. The Court of Appeals reversed, holding that there had not been sufficient changes in circumstances to support invalidating the covenant. Tippecanoe appealed.
The Supreme Court of Indiana noted that restrictive covenants in shopping center leases are generally found consistent with the public interest and found not to restrain competition unreasonably. The Court held that the dispositive fact was that the space was no longer being used as a grocery store; therefore, there was no interest for the covenant to protect. Pay Less voluntarily abandoned grocery store operation in the space, severing the restrictive covenant.
Restrictive covenants in shopping center leases may be used to protect interests of the tenants who maintain a current protectable interest in the center. It is improper to permit enforcement of an anticompetitive covenant by a non-tenant who acquires the right to exclude others from the center without investing in the center. Enforcement of a restrictive covenant in the possession of a non-tenant contradicts the policy behind restrictive covenants unless justified by a balance of the legitimate concerns of the promisee, the public interest, and the detriment to the promisor.
A dissenting opinion focused on the fact that the covenant was freely bargained-for and should not be set aside unless it materially and adversely affects the contract. The dissent also disagreed with the majority’s creation of a bright line test, that covenants are unenforceable when severed from the occupancy, because it essentially rewrites commercial leases and restrains parties from freely entering bargained-for agreements. The Court upheld the trial court, finding the restrictive covenant unenforceable.
Comment: The editor danced around the room when he read this one. He was very critical of the court of appeals opinion, which was reported as DD 11/2/04. Here are some of the editor’s comments on the court of appeals case:
Comment 1: Wow!! Here's a case where the appeals court actually overrules the judgment of the court below on the equities and overturns a finding of changed circumstances where there seems to be abundant evidence to support it. Further, the only basis on which the covenant can be supported has to do with factors arising after the covenant was entered into and outside the area covered by the lease. How can it be right?
There is no indication in the covenant that the benefit is to run beyond the property that was the subject of the lease. In essence, this would be a finding that the benefit is "in gross." To the contrary, the lease covenant states that the covenant will "run with the land." To say that there was land outside the shopping center benefitted by the assignee/sublandlord, and that the covenant attaches to that land, strikes the editor as dramatic overreading of the intent of the parties here. Basically, the courts holding makes an anticompetition covenant completely merchantable. Here, for instance, the court virtually admits that the assignee's purpose in obtaining the apartment store sublessor's rights was to obtain the enforcement rights of the anticompetition covenant.
Whether this represents good or bad economic theory (the editor is still puzzling that one out), the case is a startling expansion of the traditional notion of the purpose of covenants that run with the land and totally inconsistent with the traditional province of equity in refusing to enforce covenants on the basis of "changed circumstances."
An acceptable interpretation for the editor would have been if the court had acknowledged that the covenant existed and was enforceable if and when the tenant would benefit from its enforcement, because the premises had been converted back to grocery use, but no sooner. Note that in this was there were only ten years left of the 40 years originally controlled by the Kroger lease. The appliance store tenant apparently had leased those years. This covenant should not have been enforced.
Comment 2: The editor is further of the view that the court ought to view the original intent of this covenant to be to protect the property within the center, and that the court therefore ought not to have enforced it by injunction at a time when no such property could be protected, and likely would not be.
But the dissenting judges in this case raise an interesting issue: What if in fact the original parties to the promise in question intended to limit the landlord’s use of his property in order to protect off premises activities of the promissee? In the view of the dissent, the majority opinion categorically strikes down any such anticompetitive agreements. The editor isn’t convinced that the majority really intended to go that far, but let’s assume that it did.
First, both the dissent and the majority deny any intention to invoke federal or state antitrust laws here. They are keeping the discussion purely at the level of the role of state courts in interpreting clear agreements between commercial parties. In that context, is it appropriate to conclude categorically that the parties could never agree that a landowner should restrict the use of his land in order to protect activities conducted outside that land by the promissee? Stated in that way, the dissent definitely has a point. There are plenty of covenants executed by buyers and sellers of real estate that protect one of the parties from competition located on other land. Absent a clear antitrust violation, why not enforce them?
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