Percentage Rent Does Not Imply an Operating Covenant

Andy Jacobson, Maslon LLP


Rebekah Fisher, Fisher Matthews PLLC


Editor’s Note:  Legal Corner contains case summaries and analysis of recent court decisions that impact retail leasing and lease administration.  These summaries focus on the leasing issues covered in each case and do not include detailed discussions or analysis of the procedural and peripheral issues in the cases.

Percentage Rent Does Not Imply an Operating Covenant

Clark v. F.T. Reynolds Co., No. CV 15-62-BLG-SPW-CSO, 2015 WL 9850705 (D. Mont. Dec. 30, 2015). Landlord and Tenant were parties to a commercial lease in Montana.  Tenant operated a grocery store that was part of a larger shopping center.  The lease provided for Tenant to pay base annual rent of $24,000 per year, plus 1.5% of Tenant’s annual net sales over $1.9 million. After operating at the premises for a number of years, Tenant moved its grocery store to a new location and started using the premises as a storage facility.  Landlord sued for breach of lease, claiming that: (a) Tenant had an affirmative duty to operate a grocery store on the premises; and (b) Landlord was entitled to audit the books and records pertaining to Tenant’s new off-site grocery store to determine if net sales at the new location were high enough such that Landlord would be entitled to additional rent payments under the net sales provision of the lease.  Although the lease used the words “store” and “sales” and other similar terms, the court stated that the use of such words was permissive, not restrictive.  Nothing in the lease agreement expressly stated that Tenant had an affirmative duty to operate a retail store on its premises.  Moreover, the court found no implied operating covenant because the express terms of the lease achieved the parties’ purpose of leasing the property and there was no legal necessity to alter the payment terms where the percentage rent was only intended to be in addition to the significant monthly minimum amount.  As a result, the court determined that Tenant was not in breach of the lease, and Landlord was not entitled to inspect the books and records relating to Tenant’s new off-site grocery store or for any percentage rent related to that new store.

No Bingo for You

Evans v. Waldrop, No. 2150342, 2016 WL 4260989 (Ala. Civ. App. Aug. 12, 2016). Tenant leased commercial space in Alabama. During the term, Tenant decided he wanted to sublet the premises to a potential subtenant that would operate an electronic bingo parlor.  The lease provided that, although Landlord’s written consent was required for any assignment or sublease, the Landlord could not unreasonably withhold such consent.  When approached by Tenant, Landlord initially indicated that he would consent to the proposed sublease.  However, Landlord then changed his mind, because he wanted to avoid “anything too ‘wild’” or ” any ‘carrying on’” at the premises.  In addition to Landlord’s own concerns, other tenants had indicated to Landlord that they did not want a bingo parlor in the project. After Landlord rejected Tenant’s proposed sublease, Tenant stopped paying rent and vacated the premises. Landlord then sued Tenant for breach of lease.  In defense, Tenant argued that he had not breached the lease because Landlord’s withholding of consent to the proposed sublease had been unreasonable.  On appeal, the court stated that in this type of dispute, the tenant has the “burden to show that a landlord has acted unreasonably.” The court then noted that “the legitimate factors landlords may consider in assessing reasonableness [include] . . . the financial responsibility of the proposed assignee or subtenant [and] . . . the compatibility of the tenant’s use with the uses of other tenants in the same shopping center or office building.”  Finally, the court observed that “[a] tenant has the burden of furnishing sufficient information about the proposed assignee to enable the landlord to determine whether it will consent to an assignment.”   In this instance, the court found that Tenant did not provide Landlord with adequate information regarding the proposed subtenant’s business or evidence that the proposed subtenant’s business would be sufficient to pay the required rent, as the proposed subtenant had never operated a business before, much less an electronic bingo parlor.  The court determined that the lack of the proposed subtenant’s business experience and the nature of the proposed use in combination with the preference of the other tenants in the building not to be adjacent to a bingo parlor, were collectively sufficient to justify Landlord’s reasonably withholding its consent to the proposed sublease.

Optionee Spared Losing its Option

Leiserv, LLC v. Summit Entertainment Center, LLC, et al., No. 15-CV-01289-PAB-KLM, 2016 WL 1046274 (D. Colo. Mar. 16, 2016).  Owner had  a bowling alley property in Colorado that was operated by Operator pursuant to an Operating Agreement. The Operating Agreement contained a purchase option for the benefit of Operator, which stated that upon termination of the Operating Agreement, Operator would have the right to purchase the bowling alley property from Owner for the fair market value of the property.  The Operating Agreement also provided a dispute resolution provision that required the parties to submit any disputes to non-binding mediation. Owner terminated the Operating Agreement, and, in response, Operating Company attempted to exercise its purchase option for the bowling alley property, which Owner refused to honor.  The parties then brought claims against each other for breach of contract, and Owner brought a summary judgment motion asking that the court declare Operator’s purchase option purchase unenforceable, asserting that the purchase option constituted only an agreement to agree and did not include material terms, including a purchaser price.  The Court found that an option agreement using the term “fair market value” to describe the purchase price, rather than a set purchaser price, does not render the provision unenforceable, so long as the option provides a sufficient mechanism to determine the fair market value.  Owner then argued that the purchase option  should be deemed unenforceable as merely an agreement to agree, as there was not an appropriate mechanism to establish the fair market value of the property.  However, the court found that the non-binding mediation required by the Operating Agreement’s dispute resolution provision was a sufficient mechanism that the parties had contractually agreed upon to resolve the fair market value question.  Finally, the court rejected the Owner’s argument that the purchase option was unenforceable because it was not supported by separate consideration, holding that that the purchase option was an integral component of the overall consideration for the Operating Agreement and thus sufficient to support the option right that was a component of the Operating Agreement. Accordingly, the court found in favor of the Operator and held that the purchase option in the Operating Agreement was enforceable.