GRAND PROSPECT PARTNERS, L.P., Plaintiff, Cross-Defendant and Respondent,
ROSS DRESS FOR LESS, INC. et al., Defendants, Cross-Complainants and Appellants.
[As Modification on February 9, 2015]
APPEAL from a judgment of the Superior Court of Tulare County No. VCU237296. Paul A. Vortmann, Judge.
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Arnold & Porter, Sean M. SeLegue, Jerome B. Falk, Jr., Jeremy McLaughlin; Bartko, Zankel, Bunzel & Miller, Benjamin K. Riley, Simon R. Goodfellow; Dowling Aaron, Donald R. Fischbach and Steven M. Vartabedian for Defendants, Cross-Complainants and Appellants.
Caldwell Leslie & Proctor, Christopher G. Caldwell, Michael D. Roth and Albert Giang for California Retailers Association, The Gap, Inc., Bed Bath & Beyond Inc., H&M Hennes & Mauritz L.P., Petco Animal Supplies, Inc., and VF Outdoor, Inc. as Amici Curiae on behalf of Defendants, Cross-complainants and Appellants.
Bingham McCutchen, Stephen Zovickian, Robert A. Brundage; Caswell Bell & Hillison, Robert K. Hillison and Kimberly L. Mayhew for Plaintiff, Cross-defendant and Respondent.
This appeal addresses whether cotenancy provisions in a lease for retail space in a shopping center are unconscionable or unreasonable penalties and, thus, not binding on the landlord. The enforceability of cotenancy provisions has not been discussed in an opinion published by a California appellate court. This opinion does not establish a categorical rule of law holding cotenancy provisions always, or never, are enforceable.
Instead, it illustrates that the determination whether a cotenancy provision is unconscionable or an unreasonable penalty depends heavily on the facts proven in a particular case. Here, the facts show the provisions were not unconscionable and only the rent abatement provision operated as an unreasonable penalty.
Grand Prospect Partners, L.P. (Grand Prospect), the owner and operator of the Porterville Marketplace shopping center, filed this action to challenge the enforceability of provisions in its commercial lease with Ross Dress For Less, Inc. (Ross). The provisions conditioned Ross’s obligation to open a store and pay rent on Mervyn’s operating a store in the shopping center on the commencement date of the lease, and also granted Ross the option to terminate the lease if Mervyn’s ceased operations and was not replaced by an acceptable retailer within 12 months.
The opening cotenancy condition was not satisfied because Mervyn’s filed for bankruptcy and closed its store in 2008. As authorized by the lease, Ross took possession of the space, never opened for business, never paid rent, and terminated the lease after the 12-month cure period expired.
Grand Prospect claims Ross was obligated to pay rent for the full 10-year term of the lease because the provisions authorizing rent abatement and termination were unconscionable or, alternatively, an unreasonable penalty and thus unenforceable. The trial court agreed with both theories, found Ross had breached the lease by failing to pay rent and terminating the lease, and directed the jury to determine the amount of damages resulting from each breach. The jury awarded $672, 100 for unpaid rent and approximately $3.1 million in other damages caused by the termination.
Ross appealed, contending the cotenancy provisions in the lease were not procedurally and substantively unconscionable and were not an unreasonable penalty.
As to unconscionability, which requires proof of both procedural and substantive unconscionability, we conclude the evidence establishes there was no procedural unconscionability. The parties were sophisticated and experienced in the negotiation of commercial leases for retail space, their negotiations involved several drafts of the letter of intent and subsequent lease, and Grand Prospect’s decision to approach Ross first about renting the space was a free and unpressured choice. Ross’s insistency on cotenancy provisions during negotiations did not make the lease a contract of adhesion or otherwise deprive Grand Prospect of a meaningful choice.
As to unreasonable penalties, the rent abatement and termination provisions must be examined separately because they involve separate consequences triggered by different (albeit partially overlapping) conditions. As a
general rule, a contractual provision is an unenforceable penalty under California law if the value of the property forfeited under the provision bears no reasonable relationship to the range of harm anticipated to be caused if the provision is not satisfied.
Here, the trial court’s determination that the rent abatement provision constituted an unreasonable penalty is supported by its findings of fact that (1) Ross did not anticipate it would suffer any damages from Mervyn’s not being open on the lease’s commencement date and (2) the value of rent forfeited under the provision was approximately $39, 500 per month. There is no reasonable relationship between $0 of anticipated harm and the forfeiture of $39, 500 in rent per month and, therefore, the trial court correctly concluded the rent abatement provision was an unenforceable penalty.
As to the lease termination provision, California courts have adopted a specific rule that holds no forfeiture results from terminating a commercial lease based upon the occurrence of contingencies that (1) are agreed upon by sophisticated parties and (2) have no relation to any act or default of the parties. These facts are present in this case and, therefore, the rule compels the conclusion that the termination provision did not constitute a forfeiture. Because no forfeiture occurred as a result of the termination, the termination provision did not create an unreasonable penalty.
We therefore modify the judgment to award damages only for unpaid rent.
Ross is the nation’s largest retailer of off-price apparel and home fashion. The trial court found Ross had more than 259 stores in California and more than 1, 000 stores nationwide. In 2008, Ross’s annual sales totaled more than $6.4 billion.
Grand Prospect is a California limited partnership. Its sole asset is a shopping center named the Porterville Marketplace, located in Porterville, California.
Grand Prospect is managed by David H. Paynter, its sole general partner. Paynter received a bachelor’s degree in business administration, majoring in finance. At the time of trial, he had over 33 years of experience in real estate. In 1998, Paynter formed his current company, Paynter Realty and Investments, which is based in Tustin, California. Paynter Realty and Investments is involved in both development of shopping centers and managing those
properties. Paynter testified that he had been a partner in developing over 60 shopping centers and that Paynter Realty and Investments currently owned and operated seven shopping centers. Two of those shopping centers (in Clovis and Visalia) leased space to Ross.
Grand Prospect’s sole limited partner is John F. Marshall, who is a 50 percent owner. Marshall is a commercial real estate broker who received a college degree in business administration in 1974. Marshall started working in real estate in 1976, moved exclusively to commercial real estate in 1979, and started his own real estate company in 2001. His company specialized in selling and leasing shopping centers. Marshall met Paynter in 1983 when both were working on a shopping center project in Turlock. Marshall was familiar with Ross, having acted as its broker in numerous lease transactions between 2002 and 2011.
In 2005, a former grocery store building became available at the Porterville Marketplace and Marshall contacted Ross to see if Ross would be interested in the location. In October 2005, Marshall (acting as Grand Prospect's broker) showed Mike Seiler of Ross the site and several other locations in Porterville. Seiler worked with Marshall to prepare a letter of intent, which was similar to the one used for a store in a Clovis shopping center managed by Paynter. Seiler, not Marshall, was responsible for the letter’s contents. After making changes, Seiler emailed the letter of intent to Marshall and directed him to forward it to Paynter.
The first version of the letter of intent presented to Paynter was dated October 20, 2005, set the initial term of the lease at 10 years with minimum rent for the first five years at $10.50 per square foot with an increase to $11.00 for the second five years. The letter of intent provided four five-year renewal options, each with a $0.50 increase in rent. The letter of intent also contained cotenancy provisions that required, at commencement and throughout the full term of the lease, 70 percent of the leasable floor area in the center be occupied by retail tenants, including Target and Mervyn’s occupying 87, 000 and 76, 000 square feet, respectively.
The negotiations of the letter of intent were delayed when Paynter learned Target was considering moving out of the shopping center. Eventually, Target decided to stay in Porterville Marketplace and expand its store. As a result, Paynter delivered his revisions to the letter of intent to Ross in the spring of 2007.
After further negotiations, the final letter of intent, dated July 11, 2007, was signed by the parties. The minimum rent was $13.25 for the first 10
years and $14.00 for the first option period with $0.50 increases for each of the three remaining option periods. The calculation of the 70 percent occupancy requirement stated that it would exclude Ross “and Target as to the Commencement Date to be further negotiated in the lease, from the numerator and denominator.…” Target was required to occupy 126, 000 square feet on the commencement date and during the term of the lease; Mervyn’s 76, 000 square feet.
With the nonbinding letter of intent in place, the parties began negotiating the lease for 30, 316 square feet of space in the Porterville Marketplace.
On April 4, 2008, the lease for a Ross store at Porterville Marketplace was executed on behalf of Ross by James Fassio, executive vice president, and Gregg McGillis, group vice president of real estate (the Lease). Four days later, Paynter signed the Lease on behalf of Grand Prospect.
The terms of the Lease’s cotenancy provisions required Mervyn’s to be operating its business in 76, 000 square feet on the commencement date of the Lease. Other aspects of the cotenancy provisions are described in part I.B, post.
Actions Under the Lease
In early July 2008, Grand Prospect notified Ross the construction work on the store had been completed and Ross, if it chose, could take delivery early. Jack Toth, then Ross’s director of real estate responsible for the San Joaquin Valley, responded with an email stating Ross intended to take delivery on February 9, 2009, as stated in the lease.
In late July 2008, Mervyn’s filed for reorganization under federal bankruptcy law. In October 2008, the bankruptcy case was converted to a liquidation under chapter 7 of the Bankruptcy Code. The Mervyn’s store in the Porterville Marketplace closed on December 31, 2008.
In October 2008, Paynter became aware that Mervyn’s was going to close its stores and, as a result, Grand Prospect could not meet the opening cotenancy requirement in the Lease. Paynter contacted Toth and told him about Mervyn’s liquidation. On October 24, 2008, Toth sent Paynter an e-mail
asserting: “We negotiated hard for the Mervyn’s co-tenancy because it makes a huge difference to us financially. Without Mervyn’s, we will open very soft and it will take much longer for Ross to get established in Porterville.” Toth made two proposals for amending the Lease. Under the first, Ross would pay two percent of sales as rent and, once a suitable replacement tenant was found, would go back to full rent. Under the second proposal, the requirement for Mervyn’s as a cotenant would be eliminated and Ross would pay a fixed rent of $10.00 per square foot for the initial term (versus $13.25).
The parties were unable to negotiate a modification of the Lease. On February 6, 2009, Ross advised Grand Prospect that it accepted delivery of the store as the Lease required, “subject to all its rights under the Lease, including the Required Co-Tenancy provisions of Section 6.1.3.” The February 9, 2009, delivery date meant that the commencement date of the Lease was May 10, 2009.
On May 10, 2009, neither Mervyn’s nor a replacement anchor tenant was open for business in the Porterville Marketplace. Relying on the cotenancy provisions in the Lease, Ross opted not open a store or pay rent.
In January 2010, Grand Prospect notified Ross that it had entered into a lease with Kohl’s Department Stores to occupy 24, 000 square feet of the Mervyn’s 76, 000 square feet space. Ross regarded Kohl’s as an acceptable replacement for Mervyn’s, but concluded the lease between Grand Prospect and Kohl’s did not cure the cotenancy failure because (1) Kohl’s had not leased the required 76, 000 square feet and (2) Kohl’s was not scheduled to open within the 12-month cure period.
On January 21, 2010, Ross advised Grand Prospect that it would terminate the Lease 30 days after the expiration of the 12-month period.
In May 2010, one year after the commencement date, Ross provided Grand Prospect with formal notice that it was terminating the Lease because the reduced occupancy had remained in effect for 12 consecutive months.
Grand Prospect leased the Ross space to Famous Footwear (6, 000 square feet) and Marshalls of California, LLC (24, 316 square feet) in 2011. These businesses opened and began paying rent in July and March of 2012, respectively. These leases also contained cotenancy requirements.
In April 2010, before Ross terminated the Lease, Grand Prospect filed a complaint against Ross for declaratory relief, breach of contract and unjust enrichment. Grand Prospect requested (1) a judicial declaration that the cotenancy provisions were unenforceable and (2) money damages for unpaid rent, future rent and expenditures on tenant improvements.
In June 2010, Ross filed a cross-complaint against Grand Prospect, seeking a judicial declaration of the parties’ rights and duties under the Lease.
In November 2012, a jury trial began. On the 13th day of the jury trial, December 17, 2012, the trial court issued an oral ruling on the issues that had been reserved for the court. It determined the cotenancy provisions were unconscionable and were an unenforceable penalty and struck those provisions from the lease. By striking the cotenancy provisions from the lease, the court found that Ross had breached the lease by failing to pay rent and terminating the lease. The court rejected Grand Prospect’s cause of action for unjust enrichment.
The jury was then instructed on two issues related to damages. First, the jury was directed to determine the amount that would reasonably compensate Grand Prospect for Ross’s failure to pay rent and its termination of the lease. Second, the jury was directed to determine the amount of damages, if any, Grand Prospect could have avoided with reasonable efforts and expenditures.
The special verdict form submitted to the jury required findings as to four items of damages. The first item addressed the worth of the unpaid rent that had been earned at the time of termination. The jury found this amount was $672, 100. The jury’s findings on the three other damage items, relating to the termination of the Lease, brought Grand Prospect’s total damages to $3, 785, 714.86.
After the trial court decided Grand Prospect’s contested motion for attorney fees and denied Ross’s motion for a new trial, it entered an amended judgment of $4, 701, 990.83 in favor of Grand Prospect, which included an award of approximately $916, 275 in attorney fees and costs.
Ross timely appealed.
I. Cotenancy Provisions
Cotenancy requirements are included in retail leases for the benefit of the tenant. They generally require other stores in the shopping center to be occupied by operating businesses. (1 Retail Leasing, supra, § 7.1, p. 7-2.) Their purpose is to assure the tenant that “(1) there is a critical mass of key tenants or occupants as well as a sufficient population of other retailers that have opened for business or will concurrently open when the tenant is required or intends to open, and (2) there is a satisfactory level of occupancy by these tenants or occupants during the term of the lease after the tenant has opened.” (1 Retail Leasing, supra, § 7.2, p. 7-2.) Cotenancy provisions usually are found only in retail leases. (Ibid.)
Cotenancy provisions can be categorized as opening cotenancy requirements and operating cotenancy requirements. (1 Retail Leasing, supra, § 7.4, p. 7-4.) “Opening cotenancy requirements condition the tenant’s obligation to open for business or commence paying minimum rent on satisfaction of the cotenancy requirement.” (Ibid.) “Operating cotenancy requirements condition the tenant’s obligation to either continue to conduct business or to continue to pay minimum rent on the active operation of certain named tenants and/or a predetermined level of occupancy within the shopping center." (Id. at pp. 7-4 to 7-5.)
The major points covered by cotenancy provisions are (1) the specific named cotenants and level of occupancy required, (2) any right the landlord has to cure failures to meet a cotenancy requirement, and (3) the tenant’s remedies if a cotenancy failure occurs. (1 Retail Leasing, supra, at § 7.1, p. 7-2.) These three major points can be resolved by the landlord and tenant in many different ways. Consequently, there is no standard form of cotenancy requirements. (See id.
at §§ 7.27-7.29, pp. 7-17 to 7-25 [two forms of opening cotenancy requirements, with three alternatives in the second form]; 2 Miller & Starr, Cal. Real Estate Forms (2d ed. 2005) § 2:21, pp. 512-563 [cotenancy requirements addressed in section 2.2 of sample retail lease for space in large shopping center under construction].)
Variation in cotenancy requirements may occur because a particular tenant’s business concerns about other tenants might be more complex than simply avoiding vacancies. For instance, a national greeting card store chain might be more concerned that the center’s supermarket continues in business than the center’s other stores because it has ascertained its stores perform
better in shopping centers anchored by a supermarket. (1 Retail Leasing, supra, § 7.2, p. 7-3.) As to the tenant’s remedies on the failure of the opening cotenancy requirement, they might include (1) the right to delay the opening of the tenant’s store, (2) payment of alternative rent, (3) termination of the lease, or (4) a combination of these remedies. (Id. at §§ 7.13-7.15, pp. 7-10 to 7-11.) Further variation can occur if a landlord seeks to impose conditions on the tenant’s exercise of these remedies. (Id. at § 7.20, p. 7-14.) Conditions may include the absence of a tenant default in the lease and, in the case of rent abatement, the tenant’s continued operation of its business on the premises. (Ibid.) Finally, how these various points are resolved during the negotiation of a commercial lease “varies greatly depending on the relative bargaining strengths of the landlord and the tenant.” (Id. at § 7.3, p. 7-3.)
The variation in cotenancy requirements, and the remedies given to a tenant when the requirements are not met, prevents the application of a categorical rule of law regarding enforceability. For instance, there is no general principle of California law holding cotenancy provisions in a commercial retail lease can never be unconscionable. Similarly, there is no categorical rule holding cotenancy provisions are unreasonable per se and therefore unenforceable ...