DIRT DEVELOPMENT for September 18, 2009
Daniel B. Bogart Donley and Marjorie Bollinger Chair in Real Estate Law
Chapman University School of Law, Orange, California

LANDLORD/TENANT; FIXTURES: Even when tenant is required to erect building according to approved plans and specs, and then to return building at least end, HVAC installation shown on the plans is not part of the “improvements” to be returned, but rather a fixture, and Tenant is not responsible for its condition.

C.W. 100 Louis Henna, Ltd., v. El Chico Restaurants of Texas, L.P., 2009 WL 2902735 (Tex. Ct. App. Aug. 27, 2009)

El Chico entered into ground lease with Boardwalk Center in September of 1996. Boardwalk assigned its interest to Henna in April 2006.

Pursuant to the lease, El Chico agreed to construct a restaurant building on the leased property. The ground lease obligated El Chico to construct the Improvements according to plans and specifications approved by the landlord, Boardwalk. The lease defined Improvements to include "building and other improvements and appurtenances that may hereafter be erected." The lease described the use: "restaurant, a related cocktail lunge, and such other uses as are incidental to the operation thereof and for any other purpose …."

The ground lease was to run for a ten year term, and gave El Chico the ability to renew for four successive five year periods.

According to the lease, El Chico did not have the right to remove or demolish the structure it agreed to build, and was required to carry insurance on the Improvements. El Chico was required to return the property to the landlord at the end of the Term "in good repair and condition, loss by fire or other casualty, condemnation, act of God, ordinary wear and tear excepted." At the end of the Term, the Improvements were to become property of the landlord.

At about the time that Boardwalk assigned its interests as landlord to Henna, El Chico ceased operating a business in the premises. El Chico informed Henna that it had ceased business at the site and further, that it would not exercise its option to renew at the end of the term. To make things easy on Henna, El Chico stated in its letter to Henna that it would not interfere with the marketing or showing of the property and would execute a termination agreement prior to the expiration date of the lease if Henna found a new tenant or sold the property.

Henna purchased all of El Chico's "furniture, fixtures and equipment" in June 2006. Henna's purchase agreement stated that it acquired this material "AS IS." Henna assumed responsibility for utilities, security and other carrying costs for the property. El Chico continued to make base rent payments.

Then the inevitable problem arose.

In January of 2007, prior to the end of the term of the lease, Henna learned that the rooftop air conditioning units on the building constructed by El Chico had been vandalized. Apparently "copper thieves" stripped the units of valuable wiring and conduit. In addition, the units had been damaged by hail. The damage was estimated to equal $38,496.

There were several issues at play in the case, but the one that is most interesting here has to do with the proper designation of the HVAC units. Henna argued El Chico was obligated to repair or keep insured the HVAC units and that therefore El Chico breached the lease contract. El Chico responded that the HVAC units were fixtures that Henna purchased "as-is." The trial court agreed with El Chico, and the Texas Court of Appeals affirmed.

The lease apparently used the word "fixtures" without defining it. According to the court, the failure to specify what fixtures meant for this particular lease transaction indicated the parties' intent to incorporate the conventional understanding of the term. Paragraph 12 of the lease permitted the tenant to take "removable fixtures" at the end of the term as well as personal property "provided that Tenant repairs all damage to the Improvements caused by such removal." This, according to the court, is "consistent with the common meaning of trade fixtures in Texas law, "trade or business fixtures" under the lease are considered to be removable personal property." The same provision of the lease excluded fixtures from the definition of Improvements.

As noted, the lease required El Chico to return the Premises and Improvements at the end of the term in good repair and condition. Furthermore, Tenant was required to maintain the Improvements.

El Chico's lawyers did a good job of conveying their view of facts of the case. According to the opinion, although rooftop HVAC units had a 45 ton air conditioning capacity, and made the restaurant use of the Premises possible. "The units were not attached to the building … so that they could be removed and replaced without injury to the building." Furthermore, according to the opinion, the HVAC units provided "many times greater than that needed if the building were to be used for other retail or office use." The inference is that El Chico could legally remove the HVAC units, and that the landlord, or the next tenant, would install replacement rooftop units more suited to the subsequent use.

Texas courts have defined trade fixture to mean "such articles as may be annexed to the realty by the tenant to enable him properly or efficiently to carry on the trade, profession, or enterprise contemplated by the tenancy contract or in which he is engaged while occupying the premises, and which can be removed without material or permanent injury to the freehold." Boyett v. Boegner, 746 S.W. 2d 25 (Tex. Ct. App. 1998).

The court stated "several Texas courts, addressing similar facts, have held that air-conditioning units are trade fixtures as a matter of law." Nevertheless, the court agreed with Henna that there "is no rule or presumption in Texas law that air conditioning units are always trade fixtures. The issue, rather, turns on the parties' intent, which here we ascertain from the lease."

Henna argued that Improvements for purpose of the lease included the HVAC units because these were described and depicted in the plans and specifications for Improvements that landlord approved pursuant to the terms of the lease. The plans and specifications included a drawing of a four unit 45 ton HVAC unit on the rooftop, similar to the one El Chico ultimately installed.

The court was not persuaded by Henna's arguments. The court read the language of the lease (against the drafter) very carefully. According to the court, paragraph 5 of the lease - detailing construction of the Improvements - "does not purport to incorporate into the lease's "Improvements" whatever property might have been depicted in the plans and specifications." Rather, this provision only required that the Improvements would be constructed "in conformity" to the plans and specifications."

Henna pointed out also that the lease specifically described El Chico's use as "the operation of a restaurant … and for any other lawful purpose." Taken together, Henna argued that Improvements under the lease included HVAC, and that given the stated use, this must have been both parties' intent.

Henna attempted to distinguish prior Texas case law. Those cases held that HVAC units were fixtures, but involved instances in which tenants installed units in pre-existing buildings; El Chico constructed the building on which it then installed rooftop units. The court considered this a distinction without a difference: "The critical issue, rather, is whether the parties intended the air conditioning units to be permanent additions to the building, or temporary additions to aid the tenant, El Chico, while it was operating a restaurant in the building." The court held that the latter was true.

As a last ditch argument, Henna asserted that, when it purchased El Chico's fixtures, the bill of sale did not list the HVAC units. The court dismissed this argument quickly, pointing out a catch all phrase in the bill of sale covering "all furniture, fixtures and equipment." More importantly, the court stated that the intent the parties at the time they executed the ground lease is what matters - not what the parties may or may not have said in the bill of sale. This intent and not the bill of sale define the meaning of "Improvements" and of "fixtures."

Reporters Comment 1: Friedman on Leases 24.3 explains that trade fixtures are typically removable by the tenant. The ability to remove fixtures is a departure from the early common law that prohibited tenant from removing anything attached to the land. Friedman also confirms the court's statement in El Chico that "a clear intent that installations belong to the landlord or tenant is controlling." 24.5. The treatise suggests that air conditioning units fall within the definition of trade fixtures, except to the degree that stipulations in the lease declare otherwise. "The common law of fixtures, as between landlord and tenant, often descends to an academic exercise in the face of stipulations. … The specific items involved by these stipulations may, among other things, include air conditioning, heating and refrigerating installations…." 24.6. The court's recitation of the common law seems on solid ground.

Reporter's Comment 2: The landlord could obviously have done a much better job of describing what was included in Improvements and not in fixtures. The property was in the exclusive possession of El Chico and the landlord was not in a position to evaluate whether the HVAC was well maintained. There is always the possibility that tenant will default on the lease and only after it is evicted or vacates will landlord discover problems in the property. The landlord could have better protected itself.

Reporter's Comment 3: The lease did require landlord's approval for plans and specifications of the Improvements, which approval was given. The court says that this means only that the HVAC units had to conform to the plans and specs, and not that the HVAC (as described) became part of the Improvements. The court is drawing a fine line between what "conforms" and what is incorporated. This distinction probably frustrated the landlord most of all, and is the most interesting aspect of the opinion.

The Reporter for this item was Daniel Bogart of the Chapman Law School. 

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