Daily Development for
Friday, May 3, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

LANDLORD/TENANT; COMMERCIAL; CONTINUOUS OPERATION; IMPLIED DUTY: Two new cases review existence of implied duty, one says "yes," the other "no." East Broadway Corp. v. Taco Bell Corp. 542 N.W.2d 816 (Iowa 1996); Westside Center Assoc. V. Safeway Stores 23, Inc., 49 Al. Rptr. 2d 793 (Cal. App. 1996).

(1) The "Yes" case: In East Broadway, the twenty year lease had a base rental set at an annual rate of 13% of the total value of the premises. Landlord constructed the improvements for the tenant, and the "value" determination was tied to the construction cost. In addition, the parties talked about a "cost of living" adjustment, but later agreed upon amendement that deleted the "cost of living" adjustment and instead gave the landlord 5% of the gross sales over $17,000 per month.

There was no continuous operation clause; but the Tenant was limited in its use so that it had to "deal exclusively in the sale of Mexican food."

Tenant had the right to assign subject to approval of Landlord, which approval would not unreasonably be withheld.

Tenant paid percentage rent, up to $41,000 during the first nineteen years of the lease. In the last year of the lease, tenant built a new building nearby and relocated its business there. (Landlord, incidentally, sold to another landlord just prior to the move.) At the termination of the lease term, landlord brought suit for lost percentage rent during the last year. The trial court instructed the jury that it could find an implied covenant of continuous operation if the base rent was not "substantial." The jury awarded damages of $53,000 - more than twenty five percent higher than any percentage rent paid in the past.

On appeal, the court of appeals held that there was no basis on which the jury could conclude that the base rent was insubstantial, and reversed.

On appeal to the Iowa Supreme Court, held: Jury verdict affirmed. Court of Appeals is reversed.

The court commented: "It was for the jury to determine what the parties intended and what the parties considered to be relatively the more important or substantial part of the rental payment." It indicated that percentage rent clauses commonly are viewed as "inflation hedges" in long term leases, and therefore the landlord legitimately may have viewed the percentage rent as a vital element of return. The cost of living index that the landlord originally tried to get would have tripled the base rent by the end of the lease.

Comment 1: This is the first case in Iowa squarely on point on the existence of a continuous operation clause in a percentage lease. It seems clear that no large chain tenant ought to risk the wrath of an Iowa jury. There will be no protection from the judiciary. Any tenant wishing to do business in Iowa should demand a specific disclaimer of a continuous operation duty.

Comment 2: The case is out of step with the majority of cases that would have found, as a matter of law, no implied continuous operation duty under these facts. The parties intended that the tenant could assign the lease and the landlord's investment, plus interest, clearly was returned under the base rent. The rent was "substantial" by the measures applied in most jurisdictions.

(2) The "No" case: In Westside Center Associates, an anchor supermarket operator (Safeway) in a shopping center had a percentage lease that contained no continuous operation clause, and no restriction on useage. In fact, the lease provided that "Lessee makes no representation or warranty as to the sales which it expects to make in the leased premises." Safeway could assign or sublet, with landlord's consent, which could not be unreasonably withheld. The lease had four five year renewal options. In the last 15 months of a twenty year lease, Safeway "went dark." It continued to pay base rent. A year later, Safeway renewed the lease for another five years. About the same time, Safeway removed all of its fixtures. The removal of the fixtures apparently made it less likely that a substitute tenant would be interested in the space.

The ownership of the shopping center was fragmented, and the plaintiff in this case was not the owner of the supermarket land or the landlord of the supermarket, but the landlord for other properties in the center.

Plaintiff's properties suffered substantially from the existence of the vacant "anchor" shell. "Faced with foreclosure" it sold its interest for what it claimed was a $2 million loss. Even though plaintiff was not the supermarket's landlord, it sued for breach of an implied covenant of continuous operation and tortious interference with prospective economic advantage. Plaintiff argued that the supermarket operator's intention in renewing its lease but staying dark was to destroy the value of the property in the center and then purchase the property itself at a bargain price.

Plaintiff had a "plausible" story explaining its theory, involving the personalities and relationships of certain Safeway executives and other shopping center developers. But it had a number of hurdles to overcome in establishing the breach of a duty Safeway owed to it.

The court rejected the notion that there was any implied duty of continuous operation. It cited a recent California statute that provides that if there is no express limitation on use, then no limitation on useage will be implied. Cal. C.C. Sec. 1997.210. This is an interesting cite because, in context, the court seems to be ruling that "uses" discussed in the statute include continuous operation obligations. This reading is not express in the language of the statute. But the court's reading here is only part of its discussion of the implied covenant issue, and it apparently does not realize that the statute is possibly dispositive of the whole question.

The court also held that there was no implied duty to leave the fixtures where they were. But it does hold that the tenant had an implied duty of good faith and fair dealing with regard to how it exercised its renewal rights. This is a significant ruling, although it is lost in the overall conclusions reached by the court here, since the landlord in this case was not objecting to the tenant's conduct. The court concluded that the landlord owed no duty to Plaintiff to enforce any implied duty in the lease so as to benefit Plaintiff, and that Plaintiff was not a third party beneficiary of any of Safeway's duties as lessee.

But the court goes on to recognize, properly, that Safeway had a general duty to refrain from deliberately taking action with the purpose of injuring or disrupting Plaintiff's business relationships with existing tenants or third party business partners. It held that there was no duty to avoid such consequences with regard to "an unknown class of ptoential buyers or investors."

As Plaintiff could not identify a particular party with whom it was negotiating to sell the shopping center land it owned, the court concluded that there was no cause of action even for intentional interference with prospective economic advantage.

Plaintiff had also attempted to negotiate the purchase of the landlord's interest in the Safeway property, and alleged that Safeway's actions in devaluing that property had interfered with its ability to successfully complete those negotiations. Of course, the proximate cause of damages here became quite remote, because many other factors affected the relative values here and the impact of a failure of Plaintiff to acquire the landlord's estate in the Safeway property had only theoretical relationship to Plaintiff's ability to derive a high price for the rest of its property.

In sum, Plaintiff got a nonsuit, but in doing so made some interesting law on the duty of good faith and fair dealing as applied to options to renew.

Comment: Only a few states courts would spend this much time on such a case. Plaintiff's theory was extreme. It had taken business risks, and had lost. Had it been able to demonstrate a particular animus on the part of some Safeway employees, it perhaps had a better chance, but even then it was a long road from there to demonstrable consequential damages.

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