The California Supreme Court upheld a shopping center cotenancy provision, which allowed the tenant to pay reduced rent if the center's occupancy fell below a certain threshold, finding the lease provision was an enforceable alternative performance option rather than an unenforceable penalty.
But the high court did not disapprove of Grand Prospect Partners, L.P. v. Ross Dress For Less, Inc. (2015) 232 Cal.App.4th 1332 (Grand Prospect), which invalidated a cotenancy provision in a retail lease as an unenforceable penalty.
Background
In JJD-HOV Elk Grove, LLC v. Jo-Ann Stores, LLC (December 19, 2024) 17 Cal.5th 256, the lease of a retail tenant (Jo-Ann Stores) provided for two different rent calculations. One provided for a "Fixed Minimum Rent" in the initial amount of approximately $36,500 per month (with increases thereafter); and the other provided for a reduced rent (referred to as "Substitute Rent") in the amount of $12,000 (or, if greater, 3.5% of Jo-Ann's gross sales) per month in the event certain anchor tenants were not open for business or if the occupancy of the shopping center's gross leasable space dropped below 60%.
In July 2018, two anchor tenants closed and Jo-Ann invoked its right to pay Substitute Rent. The landlord claimed that the cotenancy clause was an unenforceable penalty citing Grand Prospect.
Jo-Ann sought declaratory relief that the cotenancy clause was an enforceable alternative performance provision and that Grand Prospect did not apply. The trial court granted summary judgment in Jo-Ann's favor and the Court of Appeal affirmed.
Supreme Court's Analysis
The Supreme Court noted how few California cases had analyzed the validity of cotenancy provisions, but the vast majority of other jurisdictions found such provisions to be valid. The Court first applied the "realistic and rational choice" test to determine whether the cotenancy provision, as a substantive matter, provided methods of alternative performance or for liquidated damages. If the cotenancy provision qualified as the former, then it would be upheld without further scrutiny.
The Court explained the difference as follows: "Where 'the contract clearly reserves to the owner the power to make a realistic and rational choice in the future with respect to the subject matter of the contract,' a valid alternative performance provision will be found." But "where the 'arrangement, viewed from the time of making the contract, realistically contemplates no element of free rational choice on the part of the obligor insofar as his performance is concerned...,' the provision will be deemed to provide for a penalty."
In JJD-HOV Elk Grove, the Court found the landlord had a "realistic and rational choice" within its power to either lease up the shopping center to the required occupancy level (for example, by offering reduced rent or other inducements) or accept reduced rent for failing to do so. The opposite was true in Grand Prospect. At the time the lease was entered into, the landlord did not own the premises, the vacancy of which, triggered the cotenancy provision.
Throughout the opinion, the Court emphasized the importance of enforcing contracts "as the parties have written them," especially where the parties were sophisticated and heavily negotiated the cotenancy provision, "even when specific terms could be deemed unreasonable."
The Court summed up: "It is not the place of courts to invalidate a contractual term when one party benefits or suffers commercial harm." Rather, parties are in the best position to allocate the risks and benefits of their transaction.
Why It Matters
Cotenancy provisions are typically included in retail leases to benefit the tenant. They generally require shopping centers to maintain anchor tenants or a minimum occupancy level in order to protect a tenant's financial viability at the center. A shopping center that is fully occupied with prominent anchor tenants will increase foot traffic and business of the entire center. But Landlords can also use cotenancy provisions in advantageous ways, such as to attract desirable anchor tenants to their retail centers.
Key Takeaways for Landlords and Tenants
- Well-drafted cotenancy provisions remain enforceable when landlords have the ability to cure the vacancy.
- Parties should document their sophistication, negotiation of terms and allocation of risk to support the enforceability of the cotenancy provision.
- Grand Prospect remains a cautionary tale where the landlord lacks control to cure the vacancy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
