What happens when two parties, both knowledgeable in real estate and both advised by experienced attorneys, have signed a negotiated retail shopping center lease, and years later one of them doesn’t like the state of affairs?
It may not come as a surprise that the California Supreme Court, when presented with a dispute along these lines, responded with the judicial equivalent of “too bad—you live with your decisions.” (JJD-HOV Elk Grove v Jo-Ann Stores, S275843 (December 19, 2024).
The facts of the case are as follows: JJD-HOV Elk Grove (JJD) owned a shopping center in Elk Grove, California. In 2004 the fabric and craft retailer Jo-Ann Stores (Jo-Ann) leased 35,000 square feet of retail space in the center.
The lease contained a cotenancy provision whereby Jo-Ann would either pay “Fixed Minimum Rent” ($34,458 at the commencement of the lease term) or, if the co-tenancy provision (described below) was not satisfied for a period of six months, Jo-Ann would pay a likely lower “Substitute Rent" (calculated as 3.5% of the store’s gross sales less some agreed upon deductions).
The cotenancy provision in the lease provided that the Substitute Rent would be triggered if the landlord failed to lease space in the shopping center (i) to three “anchor tenants” (i.e., large retailers likely to attract shoppers to the mall), or (ii) to tenants comprising at least 60% of the shopping center’s gross leasable area (excluding the Jo-Ann space).
In addition, the anchor tenants had to be open for business. If the co-tenancy provision was not satisfied for six months, Jo-Ann had the right to either pay Substitute Rent or terminate its lease.
The cotenancy provision was the result of extended negotiations by the parties, each of whom was represented by counsel.
Jo-Ann briefly invoked the cotenancy clause in 2004 prior to the anchor tenants opening for business, and again in 2007 when one of the anchor tenants closed. JDD objected in 2007, but the issue was quickly settled after a new anchor tenant moved in.
The case presented to the Supreme Court began when Jo-Ann invoked the clause a third time in 2018 after two anchor tenants closed and the total retail occupancy at the center fell below 60%.
JDD sued Jo-Ann in Sacramento Superior Court, arguing that the cotenancy provision was unenforceable. It cited a 2015 court decision entitled Grand Prospect Partners, L.P. v Ross Dress for Less, Inc. (2015) 232 Cal.App.4th 1332, which held that a different type of cotenancy provision was an unenforceable penalty, not just an alternative way of calculating the rent due.
JDD claimed that the Grand Prospect precedent meant that Jo-Ann owed it nearly $640,000 (the difference between the Fixed Minimum Rent under the Lease and the Substitute Rent Jo-Ann had paid).
The Sacramento trial court ruled in favor of Jo-Ann, finding that the Grand Prospect case was factually different in that the landlord in that case did not own the anchor store required to be open in the cotenancy provision at issue and thus had no ability to rectify the situation by offering better lease terms/services to attract a new anchor tenant, and that the cotenancy provision in the Jo-Ann lease was simply an alternative rent structure and not a penalty as in the Grand Prospect case.
JDD appealed the trial court ruling, and the Court of Appeal affirmed the trial court’s decision. JDD then appealed to the California Supreme Court.
In its ruling, the Supreme Court pointed out that commercial real estate leases “are typically a result of extended negotiations between a landlord and tenant, who tend to be sophisticated and well-represented” by legal counsel, as were both JDD and Jo-Ann.
When a contract such as a lease has been fairly negotiated between knowledgeable parties, “it should be enforced as written and agreed upon by the parties.” It is the “duty of the court…to give effect to the contract as made, without regard to its wisdom or folly.”
Unlike in Grand Prospect, the cotenancy provision in JDD's lease with Jo-Ann “provides JDD a realistic choice between accepting lower rent or taking additional efforts to increase occupancy rates or secure replacement anchor tenants.”
JDD could have provided Jo-Ann with a higher level of service by taking whatever steps were necessary to attract and retain anchor tenants, offering inducements such as favorable lease terms, additional amenities, or renegotiating existing leases, and thus would have received the higher rental amount (i.e., the "Fixed Minimum Rent") from Jo-Ann.
Alternatively, JDD had the option of providing a reduced level of service, resulting in fewer anchor tenants or lower occupancy levels, and receiving a lower rental (i.e., Substitute Rent) from Jo-Ann.
In affirming the decision of the appellate court in favor of Jo-Ann, the court noted that “contracts exist to allocate risk between parties. Cotenancy provisions benefit both parties; they allow the landlord to court tenants, and they protect tenants should the landlord provide a reduced level of service.”
The court also noted that even if a cotenancy provision is disadvantageous to one of the parties to a lease, its inclusion is likely the result of one party acquiescing to less-desirable terms elsewhere in the lease. After all, a deal is a deal.
By Lynne S. Goldstein