Daily Development for Friday, November 9, 2007
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; COMMERCIAL; CONTINUOUS OPERATION; IMPLIED OPERATING COVENANTS: No implied operating covenant can be based upon use clause stating “restaurant use and no other use.”  Language suggests only restriction on use, not duty to operate.

Giessow Restaurants, Inc. v. Richmond Restaurants, Inc.,  232 S.W.3d 576 (Mo. App. 2007)

This case involves an extra long term lease, which makes it somewhat more interesting.  It is for a former HoJo’s location, operated by Howard Johnson’s as a sublessee under a long term ground lease for 25 years.  When that use ended, landlord entered into a revised sublease with a new subtenant for an initial 15 year term, but Subtenant had rights to extend the lease in successive ten year increments for an additional 49 years.   Tenant, at its own expense, made extensive renovations.

The lease provided for a relatively low fixed rent - $25,000, plus 7% of the gross over a floor (the same floor set by the original parties to the HoJo’s lease fifteen years earlier, despite inflation).  If the gross doubled the floor amount, then the percentage rent continued to apply, but to a cap of $20,000.  All told, as far as the editor can make things out, the maximum percentage rent was about $45,000.  Since the lease was to last for 80 years, one assumes that the maximum likely would be reached assuming regular operation of the establishment and inflation. 

The tenant operated for 20 years, then started losing money and closed the restaurant, but continued to pay the base rent (apparently payable monthly).  The landlord attempted to terminate the lease, presumably because it wanted to recapture and relet.  Tenant resisted and this case ensued. 

The sublease expressly states that Tenant could use the property "for no other purpose or business than that of a restaurant, ice cream parlor, bar, tavern and cocktail lounge for the sale and dispensing of food and liquor, and for all activities related and incidental thereto[.]"

The court noted that neither this language, nor any other language in the lease,  expressly placed a duty on Tenant to ensure the existence of such a business.

“Lessor is correct that it is a restrictive clause, because it restricts the purposes for which Lessee may use the property. However, the restrictive clause does not thereby also require that Lessee must, at all times, put the property to use. Rather, it articulates the purposes for which Lessee may use the property, should it choose to use the property. Lessor disregards the fact that the Amended Agreement is intentionally silent beyond this restrictive clause. Indeed, a provision which restricts use of the premises is not identical to a provision which enjoins nonuse of the premises.”

This principle of interpretation is well established in other jurisdictions (at least in the retail lease context) had been applied in Missouri.  See, e.g. Crestwood Plaza, Inc. v. Kroger Co., 520 S.W.2d 93 (Mo. Ct. App. 1974). 

But a 1988 Eighth Circuit  case (Emro Marketing Company v. Plemmons, 855 F.2d 528 (8th Cir. 1988)(2-1 decision))  applying Missouri law to the circumstance of a “gallonage lease,” a relatively rare agreement in modern times, had found used such a use clause as the basis for implication of operating covenant.  In Enro, a ground lease for a Nickerson Farms store provided for $100 per month base rent and a percentage based upon gallonage of gasoline pumped at the location.  The tenant continued to operate a convenience store but closed the pumps and paid $100 per month (plus taxes) as its whole rent.  Historically, gallonage leases have occupied a special place in the vast firmament of implied operating covenant cases (and it is vast) and generally an implied covenant was found.

The trial court, noting that the percentage rent payable under this agreement likely was almost double the fixed rent if the gross revenue figures were reached (we’re not told what sort of revenues the tenant had experienced), concluded that the essence of the lease arrangement was a percentage return, and thus chose to follow the Enro lead an interpret the use clause as an operating covenant.  The appeals court here slammed the door on that interpretation, presumably for the future.  If there is another gallonage case, it will have to rest its analysis on something other than a use clause, if it is to succeed at all. 

Comment 1: The editor has reported on probably a dozen other implied use covenant cases over the years of DD’s, and most of them have come down for the tenant.  But many involve larger, out town tenants, such as Wal Mart, and local good ole’ boy developer landlords, and (dare we say it) some of the trial courts tend to “home town” the tenants, leading to a proliferation of appeals, usually successful, overturning the operating covenant finding.  There are just enough cases holding for the landlord, however, such as in Enro to make things interesting and to give the trial courts a “hook” to make a deal for the landlord that it had been unable to make with its tenant. 

Comment 2: Because of the huge amount of authority, there is an extensive discussion of this issue in Friedman on Leases (Randolph Edition) in Section 6.9.  The author has left Mr. Friedman’s extensive case analysis intact, and has simply appended his own analysis of cases arising in the 20 years or so since Mr. Friedman wrote his materials.  The author’s discussion commences at page 5-56 in the Treatise. 

Comment 3: An example of a landlord favorable case that implied a continuous operation covenant because of an “inadequate base rent” is BVT Lebanon v. Wal-Mart Stores, Inc., 48 S.W. 3d 132 (Tenn. 2001).  The landlord there had agreed to a significant investment in an expanded store facility when it negotiated the lease, and the court concluded that it had a legitimate expectation that percentage rents would amortize that investment. 

Although the basis for finding the implied operation covenant in BVT was a claim that the landlord was entitled to a flow of percentage rents, but court then turned around and awarded damages to the landlord based upon diminution in the value of the center resulting from Wal-Mart’s going dark, including the loss of other tenants with cotenancy clauses.  The editor disagrees with the BVT decision, and wrote it up as the DD for 4/3/01 under the header “Biggest, Worstest Implied Continuous Operation Clause Yet.” 

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