JJD-HOV Elk Grove, LLC v. Jo-Ann Stores

Citation: Not availableDocket: C094190

Court: California Court of Appeal; June 28, 2022; California; State Appellate Court

Original Court Document: View Document

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The Court of Appeal of California addressed the enforceability of a co-tenancy provision in a retail lease between JJD-HOV Elk Grove, LLC (landlord) and Jo-Ann Stores, LLC (tenant). The lease required the shopping center to have either three anchor tenants or 60% of its space leased to avoid Jo-Ann paying "Substitute Rent." After two anchor tenants closed, Jo-Ann intended to pay Substitute Rent starting July 1, 2018. JJD contested this, arguing the provision was an unenforceable penalty based on the precedent set in *Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc.* The trial court ruled in favor of Jo-Ann, affirming that the co-tenancy provision was enforceable. The appellate court upheld the trial court’s decision, rejecting the *Grand Prospect* rule and stating that contracts should be enforced as written. The lease outlined that if the co-tenancy provision was unmet for six months, Jo-Ann could either continue paying Substitute Rent or terminate the lease. The lease specified Fixed Minimum Rent and Substitute Rent, with the latter being applicable when the co-tenancy requirements were not satisfied.

The lease was originally executed between JJD’s predecessor, Elk Grove Marketplace, LLC (EGM), and Jo-Ann’s predecessor, FCA of Ohio, Inc. JJD succeeded EGM in 2007, and Jo-Ann succeeded FCA in 2014. The evidence presented indicates that the co-tenancy provision was a topic of negotiation, with Jo-Ann initially proposing Substitute Rent terms that were later amended to require the greater of 3.5 percent of sales or $12,000 per month. The parties agreed that the percentage of gross leasable area required for co-tenancy would be set at 60 percent after discussions about various thresholds. The lease was amended post-execution to identify two anchor tenants and reduce their required square footage.

Jo-Ann invoked the co-tenancy provision twice before the current litigation, first paying Substitute Rent until all three anchor tenants were operational, and later disputing the applicability of the provision after the Sacramento Food Cooperative was replaced by Grocery Outlet. JJD sought declaratory relief regarding the triggering of the Substitute Rent provision following the closure of two anchor tenants, Sports Chalet and Toys R Us, which Jo-Ann claimed caused the shopping center's occupancy to fall below 60 percent, thus activating its right to pay Substitute Rent. Jo-Ann paid Substitute Rent from June 2018 until May 2020, when Scandinavian Designs opened, after which it resumed Fixed Minimum Rent payments.

JJD argues the co-tenancy provision is an unenforceable penalty and filed for a judicial declaration asserting that Jo-Ann must always pay Fixed Minimum Rent, claiming Jo-Ann owed $638,293 in rent as of January 5, 2021. While Jo-Ann does not dispute the amount owed, it contests the obligation itself and filed a cross-complaint to affirm the co-tenancy provision's validity. Both parties filed cross-motions for summary judgment, with the trial court ruling in favor of Jo-Ann.

Grand Prospect was deemed distinguishable, and JJD's reliance on it was found to be misplaced. The court clarified that the co-tenancy provision in the lease did not impose damages for breach of contract but rather established an alternative rent structure contingent upon specific events, such as reduced occupancy. The trial court upheld the enforceability of this co-tenancy provision. JJD subsequently filed a timely appeal.

In terms of standard of review, a party is entitled to summary judgment if there are no triable issues regarding material facts and the moving party is legally entitled to judgment. The appellate court reviews grants of summary judgment de novo, focusing on whether the undisputed facts justify judgment for the moving party, irrespective of the trial court's rationale. A determination of whether a contractual provision is unenforceable is a legal question for the trial court, which is also reviewed de novo on appeal. In this case, the trial court found all facts undisputed, with no opposing claims from either party.

Co-tenancy provisions in retail leases link a tenant's operational status to the presence of other tenants, especially anchor tenants, who drive customer traffic. These provisions are critical for the financial viability of shopping centers and typically include stipulations regarding required occupancy levels, landlord rights to rectify occupancy failures, and tenant remedies for breaches. The drafting of these provisions involves extensive negotiation between well-represented parties, reflecting the parties' bargaining strength and the desirability of the premises. There is no standard form for co-tenancy requirements, as they can vary significantly based on the agreement between the landlord and tenant.

Co-tenancy provisions in retail leases have historically been viewed as valid and enforceable by both parties and courts, with tenants often abating rent as a remedy for non-compliance. The Grand Prospect Partners case introduced a significant rule regarding the enforceability of such provisions, particularly in the context of penalties. In this case, a lease between a shopping center landlord and Ross Dress for Less included a co-tenancy provision that required Mervyn’s to be open for business when Ross's lease commenced; failure to do so allowed Ross to withhold rent and potentially terminate the lease if Mervyn's remained vacant for 12 months. The landlord sought a declaration that this provision was an unenforceable penalty, leading to a jury trial where the trial court struck down the provision as unconscionable and awarded damages to the landlord.

On appeal, the court found no grounds for unconscionability due to a lack of inequality in bargaining power. However, it analyzed whether the co-tenancy provision constituted an unenforceable penalty under California law, emphasizing that a penalty lacks a proportional relationship between the forfeiture and the actual damages from a breach. The court established a framework for evaluating whether a contractual condition is an unenforceable penalty by comparing the value of the forfeited property to the anticipated damages from non-compliance. The Grand Prospect ruling necessitated a detailed examination of the rent abatement and termination provisions for compliance with this standard.

The court upheld the enforceability of the termination provision in the lease, allowing Ross to terminate it 12 months after commencement. However, it deemed the rent abatement provision as an unenforceable penalty. The court determined that since Ross was not required to pay rent, the landlord forfeited the full monthly rent of approximately $39,500, with no anticipated harm to Ross, as the trial court found no expected damages from Mervyn's not opening on the lease's Commencement Date. The Grand Prospect court agreed with this assessment, noting an absence of reasonable relation between the forfeited rent and the anticipated harm.

In addressing the test for co-tenancy provisions as potential penalties, the court referenced Civil Code sections 1670 and 1671 but did not explicitly analyze them. Civil Code section 1671 validates provisions that liquidate damages unless proven unreasonable at the contract's inception. A liquidated damages provision that fails this test is classified as a penalty. The court clarified that the failure of Mervyn's to open did not constitute a breach of lease by the landlord. It also recognized that a contract provision dependent on conditions precedent could be deemed a penalty. The court suggested that the rent abatement provision was triggered by such conditions, equating the shopping center's occupancy by other tenants to an uncertain event necessary for the right to full rent. The Grand Prospect court emphasized the importance of substance over form, concluding that the co-tenancy provision functioned similarly to a liquidated damages provision, warranting evaluation under Civil Code section 1671's rules.

The court declines to adopt the Grand Prospect ruling that co-tenancy provisions, which reduce rent under specific conditions, constitute unenforceable penalties unless they are reasonably related to anticipated harm. This decision is based on the inapplicability of Civil Code section 1671, which governs liquidated damages for breach of contract, as there is no indication that reduced occupancy led to a breach of the agreement in this case. JJD's argument referencing Civil Code section 3275, which addresses forfeitures related to contractual penalties, is deemed insufficient as it was not effectively discussed or cited in the trial court. The court clarifies that while co-tenancy provisions could potentially be classified as unenforceable penalties under certain circumstances, this particular provision does not fall under the purview of section 1671 since it was not considered a breach of the lease. Conclusively, the court finds the co-tenancy provision valid and enforceable, emphasizing that the parties’ written contract should be upheld as it stands, without judicial alteration or interpretation beyond its explicit terms.

A contract's enforceability remains intact even if one party appears to receive an unfair advantage. Although JJD acknowledges the general rule that contracts are enforceable as written, it argues for exceptions, specifically referencing the rule in Grand Prospect, which is deemed inapplicable here. JJD contends that the court should not enforce the co-tenancy provision in the contract, but the court disagrees, citing Constellation-F, LLC v. World Trading 23, Inc. as a relevant case. 

In Constellation-F, a holdover rent provision in a commercial lease, which increased rent by 150% if the tenant stayed beyond the lease term, was ruled enforceable. The appellate court clarified that Civil Code section 1671, which addresses penalties for breach, did not apply because the provision established different rental rates rather than setting damages. Similarly, the trial court here viewed the lease’s co-tenancy provision as establishing two distinct rents—Fixed Minimum Rent and Substitute Rent—rather than determining damages, thus falling outside the purview of section 1671. 

Additionally, McGuire v. More-Gas Investments, LLC is referenced for its analogous principles, where a purchase agreement included contingencies related to neighboring lots' building restrictions and provided a refund if those conditions were unmet. The agreements in both cases illustrate that certain provisions can be enforceable without being categorized as penalties for breach of contract.

Plaintiffs sought an $80,000 refund, which the defendant refused, prompting a lawsuit. The defendant filed for summary judgment, claiming the refund was an unenforceable penalty rather than valid liquidated damages. The trial court sided with the defendant, but the appellate court reversed this decision. The court clarified that a contract provision might not solely be a liquidated damages clause; it could allow for alternative performance by the obligor. Such a provision does not impose damages and is not subject to the restrictions of Civil Code section 1671. 

Further, the court determined that the co-tenancy provision in the lease varied the rent owed based on the occupancy of the shopping center, distinguishing it from liquidated damages or penalties. If a specified number of anchor tenants were operational, fixed rent applied; otherwise, substitute rent based on a percentage of gross sales was owed. This reasoning was supported by a precedent case, Boca Park Marketplace Syndications Grp. LLC v. Ross Dress for Less, where a similar co-tenancy clause was upheld as a valid alternative rent provision. 

In Boca Park, the court highlighted that the lease did not mandate all tenants to be operational, thus avoiding a breach of contract. The parties had knowingly agreed to lower substitute rent, reflecting the diminished value of the lease space with fewer co-tenants. The court emphasized that both parties were sophisticated and had legal representation during negotiations, affirming that they understood and accepted the contract's provisions regarding varying rents.

Two rental rates were established based on occupancy levels in the shopping center, with a co-tenancy provision that could be met by either three anchor tenants or 60% of the space leased. If the co-tenancy provision was not fulfilled, Jo-Ann could pay Substitute Rent, defined as the greater of $12,000 or 3.5% of sales. Both parties actively negotiated these terms and demonstrated understanding of the co-tenancy provision. They acknowledged the risk of reduced occupancy, agreeing that Jo-Ann would pay Substitute Rent if this risk materialized. The agreement effectively allocated the risk of reduced occupancy to JJD, which would receive significantly lower rent under such circumstances. JJD has received the agreed-upon Substitute Rent, and there are no grounds to relieve JJD from its contractual obligations. The judgment is affirmed, and Jo-Ann is awarded costs on appeal.