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Write Lease Exclusivity Provisions Carefully to Avoid Conflicts With Tenants

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Write Lease Exclusivity Provisions Carefully to Avoid Conflicts With Tenants
by Carol C. Honigberg, JD, and Steven M. Nolan, JD

Exclusivity provisions in commercial real estate leases are quite common, especially for retail properties. They give particular tenants exclusive rights to operate certain businesses in shopping centers.

However, in order to avoid legal action, provisions should be drafted carefully so all excluded uses are clearly spelled out. In addition, landlords should not create problems between tenants by including conflicting provisions in individual leases. Two cases illustrate some of the problems that can arise from poorly written exclusivity provisions and act as reminders to be as specific and careful as possible when including them in leases.

The Need for Clarity Earlier this year, Rite Aid sued both its landlord and another tenant at Providence Square Shopping Center in Virginia Beach, Va., in Providence Square Associates v. G.D.F., Inc., claiming that both had violated an exclusivity agreement in its lease. Rite Aid's lease with Providence Square Associates, originally signed in 1977, stated that space in the shopping center would not be leased to any other drugstore, variety store, or photofinishing business.

In 1996, Hannaford Bros. Co. began negotiating a lease with Providence Square for space in the shopping center for a supermarket. The lease contained a prohibition against the operation of a pharmacy only to the extent that the Rite Aid lease prohibited as much. After executing the lease, Hannaford began constructing a supermarket that included a pharmacy. When Rite Aid's lawyer informed Providence Square that a pharmacy was being built in the supermarket, Providence Square attempted to negotiate an indemnification agreement with Hannaford, realizing it would be liable for a breach of Rite Aid's lease. The agreement, which Hannaford refused to sign, would have indemnified Providence Square for any costs arising from the breach of Rite Aid's exclusivity provisions.

The supermarket opened in June 1998 and housed both a full-service pharmacy and a drop box for photo processing. Its signs and advertisements proclaimed it a "food and drug superstore." The store's opening had an immediate and adverse effect on Rite Aid's business. Hannaford averaged about $30,000 per month in prescription drug sales, which is the sort of competition Rite Aid sought to avoid through the exclusivity provision in its lease. In protest, Rite Aid stopped paying its rent.

Providence Square sued both Hannaford and Rite Aid, alleging that its leases with them were being breached because Hannaford was operating a pharmacy and Rite Aid was withholding rent. Rite Aid countersued, alleging that Providence Square allowed Hannaford to operate the pharmacy and photo drop box in violation of Rite Aid's lease.

Rite Aid also sued Hannaford, claiming Hannaford breached its own lease with Providence Square, violated the restrictive covenant in Rite Aid's lease, and wrongfully induced Providence Square to breach its lease with Rite Aid. Hannaford's defense was that it was not a drugstore but a supermarket, which was not excluded under Rite Aid's provisions.

The 4th U.S. Circuit Court of Appeals held that Rite Aid's prohibition of another drugstore sought to avoid the competitive sale of prescription medicine in the shopping center. It said that a drugstore is no less a drugstore merely because it is incorporated into a supermarket. By looking at the substance of the activity restricted under the exclusivity provision and not the label given to the activity, the court found that Hannaford indeed violated the exclusivity provision in Rite Aid's lease. The case was remanded to a lower court for trial.

Avoid Conflicting Language An earlier case also shows the importance of considering existing exclusivity provisions when negotiating with new tenants. In Michaels Stores, Inc. v. Castle Ridge Plaza Associates, the U.S. District Court for the District of New Jersey allowed an existing shopping center tenant whose lease was being violated due to conflicting exclusivity provisions to intervene in a new tenant's lawsuit against the landlord.

In 1998, the arts and crafts store Michaels leased space in a shopping center in East Hanover, N.J., from Castle Ridge. Castle Ridge did business at the site under the name Linens 'n Things. The lease contained provisions prohibiting uses that conflicted with exclusive uses granted to other shopping center tenants, which included appliance, fabric, drug, greeting card, and convenience stores.

No mention was made of an arts and crafts store in Castle Ridge's lease, even though such a store was a tenant in the center. The store, Rag Shop, had a provision in its 1989 lease that no other arts and crafts store would be leased space in the center.

In accordance with lease requirements, Michaels notified the landlord of its intended use of the space as an arts and crafts store. The shopping center notified Michaels that because of the exclusivity provision in Rag Shop's lease, Michaels could not operate an arts and crafts store in the leased space and that any attempt to do so would violate its own lease.

Michaels went to court seeking a declaration that its intended use of the leased premises as an arts and crafts store was permitted under its lease. Michaels also sought an injunction prohibiting the landlord from interfering with its possession of the leased premises since its use was not prohibited in the lease.

Rag Shop asked the court's permission to intervene in the case to protect its position, claiming it had a direct interest in the outcome of the lawsuit. Allowing Michaels to operate an arts and crafts store would violate the exclusivity provision in Rag Shop's lease, thereby harming the store.

The court agreed with Rag Shop and allowed it to become a party in the case. It found that Rag Shop's interests were different from the landlord's - since a loss by the landlord would mean it had to allow Michaels to proceed with its plans, while Rag Shop would face undesired competition. The court found this sufficient reason to allow Rag Shop into the case, for which there is no record of a final decision.

These cases raise valid issues for landlords to consider when including exclusivity provisions in leases. The more specific an exclusion can be written, the less the court can read into it. A properly drafted provision leaves little doubt about what use is excluded, lessening the uncertainty for both landlord and tenant.

It also is in a landlord's best interest to ensure that the exclusivity provisions in various tenants' leases complement - not contradict - one another. Conflicting exclusivity provisions may leave the landlord caught in the middle of two unhappy tenants, which could bring lawsuits from both parties.

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Carol C. Honigberg, JD, is a partner in the real estate group at Reed, Smith, Hazel, & Thomas LLP in Falls Church, Va. Contact her at (703) 641-4220 or chonigberg@rssm.com. Timothy L. Gorzycki is a summer associate with the firm.

The discussion of legal issues in this column is for informational purposes only. Results may vary depending on state laws and individual circumstances.

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