Daily Development for Wednesday, July 7, 1999

Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

LANDLORD/TENANT; COMMERCIAL; IMPLIED COVENANT OF CONTINUOUS OPERATION: Tennessee court finds implied covenant in percentage lease based upon facts that base rent does not equal market rent at time lease was amended and that landlord, at time of amending, substantially expanded premises at its own expense.

BVT Lebanon Shopping Center, Ltd. v. WalMart Stores, Inc., 1999 WL 236273 (Tenn. App. 1999)

WalMart had taken over a percentage lease of another retailer in a shopping center. In 1985, following acquisition of the landlord's interest by BVT, WalMart and BVT entered into an amendment of the lease that substantially altered its terms. The landlord agreed to increase the size of the premises from 50,000 square feet to 84,000 square feet, according to WalMart's specifications, at a cost of $1.5 million. WalMart agreed to an increase in the base rent from $136,000 to $272,000 and to an eight year extension of the term of the lease to 2005. For five years thereafter, WalMart did not exceed the minimum gross sales necessary to trigger percentage rent. Thereafter, however, from 19901995, it paid percentage rent in the last five years, increasing quickly until, in the final year, the percentage rent was $123,000.

WalMart then moved its store to a new "super center" a few miles away. It replaced its WalMart operations with a Bud's Discount City store a WalMart subsidiary. The Bud's Store did not generated substantially lower gross income than the WalMart store $2,000,000 annually vs. over $18 million.

The landlord sued on a theory of breach of an implied warranty of continuous operation, and the trial court found for the landlord, awarding damages in the amount of $2.5 million for lost rent. WalMart appealed as to liability, and the landlord appealed as to damages. The Tennessee Court of Appeals affirmed the finding against WalMart, but reversed the damages ruling, instead indicating that a much higher damages figure $4,695,000 diminution in market value. The court of appeals distinguished a very strong protenant ruling by the Tennessee Supreme Court twenty five years before Kroger v. Chemical Securities Co., 526 SW.2d 468 (Tenn 1975). In Kroger, a landlord also had built to suit for a tenant and had agreed to a percentage rent. Despite the fact that the landlord had depended heavily on the presence of the tenant as an "anchor," and several other tenants had "kick out" clauses based upon this tenant's continued presence. Nevertheless, the Tennessee high court, reversing courts below, concluded that there was no breach of good faith and fair dealing and that the tenant had no duty to support the landlord's business plans.

As to the loss of percentage rent, the Kroger court had noted that the base rent under the lease was "substantial." The court in WalMart, here, fixed upon that analysis, and concluded that the instant case was different because the base rent here was lower than market rent for the space. WalMart's rent was $3.40 per square foot whereas, according to the court, the evidence showed that the market value in the area in 1985 ranged from $4.59 to $5.40 per square foot. Further, the court concluded that the $136,000 increase in the base rent standing alone was insufficient to amortize the $1,500,000 cost that the landlord undertook to expand the property to WalMart's specifications.

Consequently, the court concluded that the parties expected, and implicitly agreed, that a discount department store that would generate substantial gross revenues, similar to WalMart, would occupy the premises. The Bud's operation generated about one tenth of the revenues generated by WalMart at the time that WalMart vacated and about one third of the 1935 WalMart revenues. Thus, according to the court, Bud's did not satisfy the implied continuous operation pledge.

Piling on still more, the appeals court affirmed the award of $176,000 in attorneys' fees under the lease.

Comment 1: The potential damages hit that WalMart faces here, and the danger of an injurious precedent at the Tennessee Supreme Court level, may lead WalMart to settle this case rather than to continue the appeal.

This leaves standing, albeit unpublished, a really awful opinion that does substantial injury to the jurisdprudence in this area. The appeals court does almost nothing with the hundred or so opinions that do not suppor the results it strains to reach here, and focusses instead on the few dozen that do support it, and in fact reaches for the more radical of those. The court, for instance does not address the question of why the landlord, a sophisticated business operation, failed to bargain for an express continuous operations clause in 1985 a time when the legal turmoil as to whether such clauses ought to be implied was well known in the legal community.

It also fails to address what standards really apply to the implied continuous operation duty. Bud's was a discount department store within every meaning of the term other than that adopted by the court. Unlike the Arizona Safeway case, where the tenant replaced a grocery store, which had been protected and nurtured by exclusive clauses, with a discount liquor store, the new use in this case was exactly of the same character as before. What if WalMart had used the same name but simply opted to downplay its marketing efforts? Is there an implied duty of marketing?

And why is it that the doubling of the base rent did not amount to the establishment of a "substantial" rent. Remember in this case WalMart generated no percentage rent for five years after the amendment of the lease. Presumably the landlord was not realizing the fair market value for the premises during those years. Was WalMart in breach? Probably not. Percentage rent opportunity has to be counted for something, whether it pays off or not. Few courts in the past have expressly required that base rent equal market rent in order for it to be deemed "substantial" in this context.

The landlord, even if it gets no promise of continuous operation, can expect that tenant to attempt to make a good return from a premises if the base rent is substantial, simply for the tenant's self interest. This in fact is the deal that WalMart makes on all of its new leases, which contain an express negation of continuous operation clauses. And WalMart is not alone. The court's concern about the landlord not getting what it expected is at odds with market reality today and in 1985.

Chances are pretty good, by the way, that the landlord was making lots of money from ancillary leases of other stores in the same center, feeding off the WalMart presence. This, in fact, is the real explanation for the WalMart rent. The landlord saw an opportunity to attract WalMart. And, let's be honest, the landlord knew that it didn't have a snowball's chance in Tennessee of getting WalMart to sign an express continuous operation covenant. It was willing to take a chance anyway.

Comment 2: The court didn't emphasize the fact that the landlord had an expectation of profiting from renting out the rest of the center at high rents because the Kroger precedent apparently shut the door on the landlord making such an argument. The Tennessee Supreme Court in Kroger expressly rejected the "economic interdependence" rationale for implication of continuous operation duties. But the appeals court here was not free to ignore the fact that the landlord, for perfectly sound economic reasons, had every motive to draw WalMart into remaining on the premises for whatever period of time WalMart chose to do so, with no legal duty to remain longer.

Comment 3: Interestingly, one of the precedents that the court chooses to emphasis most strongly is Pequot Spring Water Co. v. Brunele 698 A.2d 920 (Conn. App. 1997), discussed in the DIRT Daily Development for April 9, 1998, along with many of the other recent cases cited as authority by the court here. The editor agreed with the Pequot case because it involved a situation in which there was zero base rent, clearly indicating that the parties contemplated the tenant to continue operations. This is similar to the "gallonage" cases of the 1930's and 1940's, but none of these cases, including Pequot, involve the market considerations that are common and well understood (except by the Tennessee Court of Appeals) in shopping center development today.

LANDLORD TENANT; LANDLORD'S REMEDIES; DAMAGES; INJURY TO SHOPPING CENTER: Tennessee court upholds "injury to center" damages in implied continuous operation case.

BVT Lebanon Shopping Center, Ltd. v. WalMart Stores, Inc., 1999 WL 236273 (Tenn. App. 1999), discussed under the heading: "Landlord/Tenant; Commercial; Implied Covenant of Continuous Operation."

Comment 1: A small number of courts around the country, all of them cited and heavily relied upon in this case, have held that it is appropriate to award to a landlord damages based upon diminution in the overall value of a shopping center when a tenant breaches a continuous operations clause.

The most significant of these cases is Hornwood v. Smith's Food King, which has a long and "snakebit" history (to use a phrase turned by the Tennessee court here), but was first decided on appeal in 807 P.2d 208 (Nev. 1991). The Tennessee court fails to note that in Hornwood the tenant had agreed to an express continous operations clause and therefore it was perhaps appropriate to conclude that the parties anticipated that the tenant's continued operations were of significance to the landlord's other activities in the center. The other cases relied upon by the Tennessee Court, Pleasant Valley Promenade v. Lechemer, Inc., and ScottReitz Ltd. V. Rein Warsaw Assoc., also involved express continous operation covenants. (Both are lower court of appeals cases, unlike Hornwood.)

Comment 2: Where, in fact, the parties knowledgeably conclude that the bargain reflects the fact that the tenant will continue to provide a presence that will add value to the center, then it makes some sense for the landlord to argue that the tenant's breach might lead to a damages claim for lost of that expectation.

But where the parties have no such legitimate expectation at time of contract, and the only expectation that the landlord arguably has is that the tenant will continue to operate to generate percentage rentals, then the damages recovery ought not to reflect a breach of a promise that never existed.

There is a difference between generating percentage rent and supporting a shopping center as an "anchor." Let us assume that WalMart agreed to pay to the landlord all the arguably possible percentage rent it would have generated. Did it still have a duty to operate in order to satisfy the expectations of the landlord's other tenants? The editor suggests that this conclusion is not a conclusion permitted to the court in this case under the decided authority in Tennessee, Kroger v. Chemical Securities Co., 526 S.W.2d 468 (Tenn. 1975). If WalMart had no such duty, then how can it be liable in damages for failure to perform the duty?

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