When an Elk Grove shopping center lost two major stores — a Sports Chalet and a Toys R Us — one of the remaining businesses took advantage of a clause in its lease agreement that allowed it to pay lower rent when the mall’s occupancy dips.
Such agreements are built into commercial leases across the country. They lend retailers a measure of stability when once-thriving malls lose shops and foot traffic. And owners of large swaths of commercial real estate are often willing to offer such deals to attract tenants.
The shop in question, a Jo-Ann fabric store, had a clause in its lease ensuring that the landlord would keep the shopping center at least 60% occupied, or continuously rent to at least three larger stores, or “anchor” tenants. Otherwise, Jo-Ann could pay lower rent, cutting its normal, $42,292 monthly payments down to $12,000 per month or 3.5% of the store’s gross sales — whichever number was higher.
But in 2019, the landlord — JJD-HOV Elk Grove — sued Jo-Ann. It claimed the store shouldn’t have paid the lower monthly rate. The temporary loss of the anchor tenants hadn’t caused the fabric store any real harm, it argued. And the company pointed to a 2015 case involving a Ross Dress for Less in Porterville in which an appellate court found a similar agreement unenforceable.
The Superior Court found in favor of Jo-Ann. An appellate court upheld the decision. But the landlord appealed to the California Supreme Court, which took up the case.
It’s rare for the state’s highest court to take up a real estate transaction that has been negotiated between sophisticated parties, said Mark McKeen, an attorney with DLA Piper, who represented Jo-Ann in the case.
Indeed, as a general rule, courts tend to enforce contracts as written, said John Sprankling, a professor who focuses on property law at the University of the Pacific’s McGeorge School of Law. But the two appellate court decisions created ambiguity.
In court filings, the landlord cited a law typically used to defend consumers with little bargaining power who sign take-it-or-leave-it contracts. It’s often used, for instance, when renters sign apartment leases that contain exorbitant late fees, Sprankling said.
That law, he said, “is intended, really, to protect the little guy.”
The landlord argued that the vacancy of one of its storefronts was beyond its control because the tenant was in bankruptcy. And, it argued, that the two conflicting opinions, issued by neighboring appellate districts, created a disparity.
“Whether a family-owned mall must forfeit nearly $650,000 despite no harm to a national retail tenant now turns on which side of the street the mall falls. This is neither efficient nor fair,” the company argued in court filings.
Broadly, the firm argued, such commercial real estate owners are under “enormous stress” from online retailers and the COVID-era decline in retail foot traffic.
“Giving national chain stores huge windfalls at the expense of local commercial landlords will have serious, unfortunate consequences for the California real estate market,” the company argued in filings.
The Ohio-based retailer, meanwhile, argued that the landlord was aware of the agreement when it bought the property. And when businesses sign contracts, each one agrees to certain risks.
The court issued a unanimous decision last month in JJD-HOV Elk Grove v. Jo-Ann Stores. It ruled unanimously in favor of the retail chain. The landlord, the judges wrote, knowingly agreed to the terms of the lease.
“It’s a victory for retail stores, and probably also for consumers,” said Sprankling, the property law professor.
In its decision, the court wrote that both the landlord and the store were “sophisticated” parties with access to legal counsel.
“This was a bargained-for clause, it was not thrown in,” Sprankling said. “This is a fully negotiated contract, with counsel on both sides.”
Such agreements — so-called co-tenancy clauses — have become common over the past few years as the pandemic made businesses more anxious about large economic swings, Sprankling said.
Jacob Sarabian, an attorney with Whitney Thompson & Jeffcoach, who represented the landlord in the case, said that with the shift to e-commerce and changing consumer shopping habits, co-tenancy clauses will likely be litigated more often.
The case, Sarabian said, “highlighted the fact that these provisions too frequently operate as penalties that are unmoored to a tenant’s damages.”
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Annika Merrilees is a business reporter for The Sacramento Bee. She previously spent five years covering business and health care for the St. Louis Post-Dispatch.