The Notwithstanding Clause and the Unknown Defense

by Rebekah Fisher, Esq.; Fisher Matthews PLLC [email protected]

Editor’s Note: This article contains a case summary and analysis of a recent court decision that impacts retail leasing and lease administration. This summary focuses on the leasing issues covered and does not include detailed discussions or analysis of the procedural and peripheral issues in the case.

In Claire’s Boutique, Inc. v. Brownsburg Station Partners, LLC, 997 N.E.2d 1093 (Indiana 2013), the Indiana Appellate Court examined an operating co-tenancy provision contained in a shopping center lease. The shopping center consisted of two anchor retail spaces that were part of two multi-tenant buildings. The parties entered into a Lease for 1500 square feet of inline space for a 15 year term. The lease contained the following operating co-tenancy provision:

Section 2.06 Operating Co-Tenancy. Notwithstanding anything to the contrary contained in this Lease, in the event that the Shopping Center’s occupancy level falls below 70% of the non-department retail store tenants in Building A1 and A3 or either Kohl’s or Lowe’s open for business, Tenant shall pay percentage rent only (at the rate of 5% of gross sales) and Basic Annual Rent and all other charges to Tenant hereunder shall abate until such time as the occupancy level increases to over 70% of the non-department retail store tenants in Buildings A1 and A3 and at least Kohl’s and Lowe’s or any comparable replacement thereof in terms of size and quality is open for business. If the occupancy level remains below the level specified herein for the period of one year or more, Tenant shall have the option of terminating this Lease effective immediately.

The tenant decided to vacate the shopping center because of the store’s underperformance. The tenant removed its personal property and vacated the space without notice to landlord or to landlord’ onsite leasing agent. At the time tenant vacated the space, tenant was not aware of the co-tenancy violation. A week later, landlord sent a notice of default to tenant terminating the lease and the lease term and demanding payment of the accelerated balance of rent payments. Tenant did not respond to the notice or make any further payments of rent under the lease.

When landlord filed a complaint against tenant for breach of lease, tenant responded to the complaint with the assertion that it had an affirmative defense. Tenant stated that it had in fact terminated the lease as a result of landlord’s failure to meet the operating co-tenancy requirement. Tenant stated that the occupancy levels of the shopping center had been below 70% for more than one year and tenant therefore had the right to terminate the lease. The trial court ruled in favor of landlord and stated that the occupancy level of the shopping center should be calculated based on the percentage of gross leasable area occupied not the number of tenants alone and therefore tenant had breached the lease because more than 70% of the gross leasable area of the shopping center remained occupied, the trial court however denied landlord’s claim for consequential damages. Both landlord and tenant appealed.

On appeal, the court examined two primary issues: (i) did the trial court err in its construction of the operating co-tenancy provision as requiring occupancy based on gross leasable area; and (ii) when tenant vacated the premises was that vacation a permitted termination of the lease.

The trial court found the language of the operating co-tenancy to be ambiguous and adopted the landlord’s interpretation of the provision. Landlord argued that the provision only gave tenant the right to terminate when the occupancy level fell below 70% of the gross leasable area in the buildings in the shopping center. Tenant maintained that the lease unambiguously allowed termination when the occupancy level fell below 70% of the total possible tenants, not the gross leasable area.

The Appellate Court applied the plain meaning rule to interpret the operating co-tenancy lease provision. Here, the co-tenancy provision made no mention of gross leasable area or square footage. The plain language referred to “70% of the non-department retail store tenants in Buildings A1 and A3.” Therefore, the 70% rate clearly applied to the percentage of the tenants, not to the percentage of the gross leasable area. Landlord also argued that even though there was no reference to square footage or leasable area in the co-tenancy provisions, other provisions in the lease used the term occupancy when referring to square feet of occupied space. Since the language of the operating co-tenancy provision was clear and unambiguous, the court refused to look to other lease provisions to interpret or expand the meaning of the co-tenancy provision. The court stated that it was significant, if not dispositive, that the co-tenancy provision begins with the following introductory clause “Notwithstanding anything to the contrary contained in this Lease…” This clause qualified the operating co-tenancy provision and meant that, in spite of any other lease provisions, the operating co-tenancy provision is an independent provision that “sits squarely on its own bottom.” The use of this clause subordinates any other lease provision that may conflict with it and will render such provisions ineffective.

Landlord went on to also argue that the tenant’s interpretation of the co-tenancy provision was not reasonable, all reasonable parties would agree that occupancy levels in a co-tenancy context refer to square footage, not number of tenants. The court rejected this argument, citing that measuring occupancy levels by the number of tenants is a sound rationale, that a greater number and variety of tenants is more likely to attract more customers, increase foot traffic and generate larger sales. Calculating occupancy level in operating co-tenancy provisions based on number of tenants as opposed to gross leasable area is an industry recognized practice.

The next issue before the court was a question as to whether tenant’s conduct in vacating the premises satisfied the definition of termination under the operating co-tenancy provision. The parties did not argue as to the fact that tenant vacated the lease without notice before the end of the term and that the occupancy level of the shopping center was below the 70% threshold for at least one year. Landlord claimed that when tenant vacated the premises, it was not a permitted form of termination but it in fact was abandonment of the premises in violation of the lease. The court again looked at the plain language of the co-tenancy provisions “if the occupancy level remains below the level specified herein for the period of one year or more, tenant shall have the option of terminating this lease effective immediately.” The lease did not define termination or impose any other conditions or requirements for notice of termination by tenant. The court therefore concluded that tenant vacating the premises was a proper termination under the co-tenancy provision.

Landlord also argued that tenant was not permitted to raise the operating co-tenancy provision as a defense to liability for a tenant default under the lease after the fact because the occupancy level was not the reason for the closure of tenant’s store. Tenant had closed the store because it was a poor performing unit in tenant’s portfolio and landlord felt that tenant had fabricated its argument as to the co-tenancy failure as a reason for termination after landlord filed suit. The court dismissed this argument, citing the United States Supreme Court case College Point Boat Corp. v. United States, there the United States Supreme Court held “a party to a contract who is sued for its breach may ordinarily defend on the ground that there existed, at the time, a legal excuse for non-performance by him, although he was then ignorant of the fact. Tenant was entitled to assert the terms of the operating co-tenancy failure as a defense to landlord’s complaint even though tenant was not aware of that defense at the time it vacated the premises.