Legal Briefs

Pay Attention to Specific Lease Terms to Avoid Litigation

Although they are among the most common legal documents in commercial real estate, leases often are items of contention due to misunderstanding of terms or unspecific wording. As the following cases illustrate, landlords and tenants must pay close attention to detail when drafting or signing leases or letters of intent to protect their interests.

Equitable Relief? In Utah Coal and Lumber Restaurant, Inc., v. Outdoor Endeavors Unlimited , decided last November, the Supreme Court of Utah considered the issue of equitable relief regarding a tenant that failed to exercise its option to renew a lease on time.

The landlord, Utah Coal and Lumber Restaurant, owns a historic commercial building in Park City, Utah, that it leased to Outdoor Endeavors, doing business as White Pine Touring. White Pine invested a substantial amount of money in permanent improvements to the building, intending to utilize all available renewals to amortize the improvements, which Utah Coal knew.

The five-year lease contained three five-year renewal options. To exercise a renewal, White Pine was required to give notice in writing not more than 120 days and not less than 60 days before the expiration date of the current lease term.

Due to unforeseen circumstances, White Pine failed to provide the requisite notice of intent to renew during the window of opportunity. However, after receiving a letter from Utah Coal's counsel advising that the lease would terminate, White Pine immediately sent a response exercising its renewal option, but it was received 11 days after the window closed. Utah Coal then sought to renegotiate the lease on more favorable terms, which White Pine declined, and Utah Coal brought suit. The trial court found White Pine's failure to notify in time to be a justifiable mistake and applied the equitable excuse doctrine, which excuses non-compliance with specific terms of an agreement.

Utah Coal appealed to the Utah Supreme Court, which concluded that if failure to exercise a renewal option on time is the result of fraud, misrepresentation, duress, undue influence, mistake, or landlord's waiver of its right to receive notice, equitable relief should apply. Yet it also stated that strict compliance with the lease terms is the general rule, and a tenant should not be excused from its own negligence, inadvertence, or neglect. The court concluded that an exception allowing equitable relief any time the delay in notifying is slight, the landlord's loss is small, and the tenant would suffer a hardship comes close to gutting the rule of strict compliance. Therefore, it found that White Pine's failure to notify on time was the result of its own negligence and that the equitable relief doctrine should not apply.

Continuous Operation Dispute In Rouse-Randhurst Shopping Center v. J.C. Penney , the U.S. District Court for the Northern District of Illinois considered how a covenant of continuous operation relates to a tenant's decision not to renew a lease term.

The lease in question was for an anchor tenant in a shopping center in Mt. Prospect, Ill., and contained two amendments relevant to the dispute. First was a 1981 amendment establishing a new termination date of June 30, 2001, that granted four renewal options of five years each and added a covenant to continuously operate a department store on the premises until June 30, 1996. The second amendment added in 1989 extended the covenant of continuous operation until June 2005.

J.C. Penney assumed the lease from the previous department store in 1990 and soon concluded that the location was not profitable. It notified the landlord, Rouse-Randhurst Shopping Center, that it intended to cease operations at the end of original term, which it did. Rouse then brought an action for breach of the covenant to continuously operate.

J.C. Penney argued that the operating covenant and the lease term were in conflict and that the covenant should be reformed to expire coterminously with the lease. Rouse argued that J.C. Penney agreed to continuously operate pursuant to the covenant, which it could have done by renewing the lease term or by holding over and continuing to operate the store without a lease extension.

The court noted that the covenant to operate and the lease term were at no time coterminous, nor did they need to be. The court concluded that the lease was clear and unambiguous and that J.C. Penney breached its covenant to continuously operate a department store on the premises by ceasing operations in June 2001, for which Rouse was entitled to damages.

Inadequate Letter of Intent OfficeMax, Inc., v. Sapp , decided by the U.S. District Court in the Middle District of Georgia, examines the question of whether letters of intent are binding contracts.

In 1998, Mr. Sapp began development of a shopping center on approximately 12 acres of land in Tifton, Ga. He entered negotiations to build and lease space to OfficeMax, and each party signed a letter of intent that contemplated a 15-year term with four renewal options for the lease of 23,500 square feet, with the configuration subject to the tenant's review. A proposed site plan was included, which also was subject to tenant's review.

The letter of intent, prepared by the tenant, also included a nonshop clause that prevented the landlord from initiating or pursuing discussions with third parties relating to the lease of the referenced premises. OfficeMax's attorneys prepared several drafts of a lease and ultimately sent execution counterparts to Sapp.

However, Sapp also had been negotiating with Staples, an OfficeMax competitor, and eventually signed a lease for the same space with them. OfficeMax brought an action for breach of an agreement to lease, breach of contract, and damages, asserting that the letter of intent was an agreement to lease.

The court noted that an agreement to lease might be enforceable in Georgia, but only if all the essential lease terms are contained in the agreement. In this case, the court found that many essential terms were not resolved, in particular the use restrictions the tenant sought to impose on the rest of the center, which were not discussed in the letter of intent but were the subject of significant discussion and negotiation. The court further found that the nonshop clause was not enforceable because it had no definite term and it did not describe adequately the property subject to the clause. Because OfficeMax reserved the right to review the configuration of the premises and the site plan, the court concluded that the location was subject to change and the description therefore was inadequate. The court found that OfficeMax had no contract or agreement to enforce, and Sapp had no liability or obligations to OfficeMax.

Thoughts to Consider While a number of cases side with the trial court in the White Pine case, the majority view seems to be that lease terms are construed strictly and equitable relief from failure to timely renew only is available in instances of fraud, misrepresentation, or similar circumstances. It is far safer for tenants to comply strictly with the terms of any renewal options.

J.C. Penney learned the expensive lesson that terminating a lease does not necessarily terminate the tenant's obligations. Independent covenants can continue to be enforced, irrespective of termination.

Finally, the OfficeMax case reminds landlords and tenants that letters of intent typically are not binding, nor are they meant to be. If parties want a letter of intent to be binding and enforceable, they must establish all essential business terms with specificity and make clear that all parties intend for the agreement to be enforceable. Absent a clear expression of intent, courts likely will look for reasons not to enforce. 

Carol C. Honigberg, JD

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. 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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