The Enforceability of Cotenancy Clauses in Retail Leases

April 21, 2015

The California Court of Appeals recently decided a case that deals with the enforceability of cotenancy clauses in retail leases. This case was one of first impression in California, meaning that it was the first time that a California appellate court had dealt with these issues. This means that other California appellate courts may reach different conclusions and that ultimately the state supreme court may weigh in, but for now this decision is the only appellate guidance we have on these issues.

The case is called Grand Prospect Partners, LP v. Ross Dress for Less, Inc. The appeal dealt with whether cotenancy provisions in a retail lease in a shopping center are unconscionable or unreasonable penalties and, thus, not binding on a landlord. The Court did not decide that this question has a simple yes or no answer. Instead the Court determined that figuring out whether a cotenancy provision is unconscionable or an unreasonable penalty will depend heavily on the facts of each particular case. In this particular case, the Court decided that the provisions were not unconscionable and only the rent abatement provision was an unreasonable penalty. Here Grand Prospect Partners, the shopping center owner and operator, challenged the enforceability of the provisions in its commercial lease with Ross. These provisions conditions Ross's obligation to open a store and pay rent on Mervyn's operating a store in the shopping center and granted Ross the option to terminate the lease if Mervyn's ceased operations and was not replaced by an acceptable retailer within 12 months. Mervyn's went bankrupt, so it did not open a store. Ross took possession of the space, never opened a business, and terminated the lease after the 12-month cure period expired. Grand Prospect argued that Ross should have to pay the full 10-year term of the lease because either the terms were unconscionable or were an unreasonable penalty.

Unconscionability has been described as "extreme unfairness" in cases like A & M Produce C. v. FMC Corp. Here Grand Prospect had the burden of of proving unconscionability. They had to show both procedural and substantive unconscionability. Procedural unconscionability arises when there is unequal bargaining power that leads to a lack of true negotiation of terms. This can be demonstrated by showing a contract is a contract of adhesion, or by showing that the totality of the circumstances surrounding the negotiation of the contract demonstrate procedural unconscionability. Substantive unconscionability has to do with the fairness of the terms and whether they appear to be overly harsh or one-sided. Here the contract was not one of adhesion and the general circumstances did not demonstrate procedural unconscionability and instead showed that real negotiations occurred, so Grand Prospect's argument failed.

In order to determine whether the rent abatement provision was an unreasonable penalty the court had to identify the value of the property forfeited or transferred by Grand Prospect and the anticipated harm or damages that Ross was likely to have experienced as a result of the failure of the conditions in the rent abatement provision. Upon doing this, the court determined that this one provision did act as an unreasonable penalty.