Legal Briefs

Recapture Clauses Help Landlords Retain Control of Properties

A ssignment and recapture clauses often are debated during negotiation of commercial real estate leases, and the relationship between the two is intertwined. In deciding whether to consent to assignments of tenants' leasehold interests, landlords frequently are required by law or contract to act reasonably — a subjective matter. Therefore, to increase their control over tenants' assignments of leased premises, landlords often insist on the inclusion of recapture clauses.

Assignment/Recapture Relationship Every lease will contain an assignment clause, which will determine when and how a tenant may assign or sublet its leasehold. Typically, a landlord will want all assignments and subleases to be subject to its prior approval and will want the ability to disapprove for any reason. Landlords often are willing to compromise and allow some flexibility in assignment clauses, but they often reserve the right to invoke a recapture clause if an assignment or sublease is requested.

A recapture clause permits a landlord to terminate the entire lease or a portion of it for the proposed assigned space. By giving control of occupancy to landlords, such clauses ensure that they receive all enhanced value of leased property.

Perhaps the most important issue with respect to recapture clauses is what serves as the triggering device. Although any number of events can trigger a landlord's right to recapture property, they frequently are activated by a tenant requesting assignment of a lease. Not focusing on this can result in dire consequences for the tenant.

A recapture clause allows the landlord to be somewhat arbitrary in its consent to the assignment. A contract stating that a landlord must be reasonable in consenting to an assignment may require a court's interpretation of the term reasonable, an uncertain result at best. Landlords can create an exit strategy and sidestep this issue by providing a mechanism to recapture the property without being held to a reasonableness standard.

A Case in Point Willow Oaks Association v. Food Lion, Inc., decided at the end of 2000, demonstrates the effects of not identifying the triggering mechanism of a recapture clause. In this case, the 4th U.S. Circuit Court of Appeals determined that a recapture clause in a commercial real estate lease operated autonomously of the lease's default provisions; thus, the landlord was not required to provide 30 days' notice of default to the tenant.

Super Fresh, a supermarket chain operated by the Great Atlantic and Pacific Tea Co., and Willow Oaks, a shopping center owner, entered into a lease where Super Fresh agreed to operate a grocery store in a shopping center in Newport News, Va., owned by Willow Oaks. In December 1998, after various events led Willow Oaks to believe that Super Fresh intended to shut down its store (which occurred the following month), Willow Oaks began negotiations with Food Lion, another supermarket chain, for a new lease of the space. 

Unknown to Willow Oaks, however, Food Lion simultaneously was negotiating directly with Super Fresh for an assignment of the chain's rights under the original lease. On February 19, 1999, Super Fresh and Food Lion entered into a purchase and sale agreement conveying to Food Lion all of Super Fresh's rights.

Three weeks later, Super Fresh requested Willow Oaks' consent to the assignment of the lease to Food Lion. The shopping center owner did not consent and terminated the lease.

Willow Oaks then filed a court action seeking a declaratory judgment that it possessed and properly exercised its right to terminate the lease and that the termination extinguished all of Super Fresh's rights under the lease.

In making a determination, the court scrutinized the lease's recapture provision language, which stated that if Super Fresh ceased operating its business for more than 60 days for any reason other than causes beyond its control, Willow Oaks could terminate the lease and recapture the space. Since Super Fresh had been closed for 79 days due to its inability to operate profitably — a factor within Super Fresh's control — Willow Oaks informed Super Fresh that it had elected to invoke the recapture clause and was terminating the lease. 

The court established that Super Fresh's failure to continue operations did not constitute a default but served as the mechanism by which Willow Oaks could exercise its right to recapture the premises. The court held that the lease's default provisions did not apply to the landlord's right to recapture; therefore, Willow Oaks was not bound to provide the stated 30 days' notice of default prior to termination of the lease. 

The court noted that if Super Fresh had reopened its store or begun Food Lion's proposed remodeling of the space while awaiting Willow Oaks' consent to assign, Willow Oaks would not have been able to recapture the premises, as operations would not have ceased as required to trigger the recapture. The issue then would have centered on whether the landlord's consent to assignment was unreasonably withheld in violation of the lease provision. Had this been the case, Super Fresh probably would have prevailed, as Willow Oaks would have had difficulty arguing the reasonableness of its refusal, due to its own prior negotiations with Food Lion. In any event, Super Fresh could have taken affirmative measures to prevent Willow Oaks from recapturing the property.

Protecting Rights When reviewing commercial real estate leases containing a recapture clause, both landlords and tenants should make certain that the lease sets forth the circumstances upon which the recapture will become effective. Special attention should be given to those portions of the recapture provision that are specific to the triggering event. For instance, if a tenant's request to transfer property triggers the right to recapture, the provision should identify the percentage of space, if any, the tenant is permitted to sublet without activating the recapture

Since recapture clauses give landlords the right to take back property, tenants should review the language carefully. Tenants must make sure that they have no further liability if the landlord exercises its recapture right. Otherwise the tenant may be exposed to continuing liability during the remainder of the lease term. Additionally, the recapture provision should require a landlord to provide notice of its intent to recapture the space, and if possible, to allow the tenant to withdraw its request for consent if the landlord invokes the recapture provision in response. If the tenant has the bargaining position to get such withdrawal right, the tenant needs to insert specifically crafted language for protection.

Carol C. Honigberg, JD, and Janie L. Rhoads

Carol C. Honigberg, JD, is a partner and Janie L. Rhoads is a law clerk in the real estate group at Reed Smith LLP in Falls Church, Va. Contact them at (703) 641-4220 or chonigberg@reedsmith.com and (703) 641-4295 or jrhoads@reedsmith.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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