California’s Supreme Court Weighs in on the Validity of Retail Co-Tenancy Clauses

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California’s Supreme Court Weighs in on the Validity of Retail Co-Tenancy Clauses

Co-tenancy clauses have long been standard in retail real estate leases. These provisions allow tenants to pay reduced rent or, in some cases, terminate their lease if anchor tenants in the shopping center vacate or declare bankruptcy. The rationale is that anchor tenants drive significant foot traffic, and their absence diminishes the value of surrounding retail spaces. In California, previous court decisions had questioned the fairness and enforceability of co-tenancy clauses. However, a recent dispute between Jo-Ann Stores and its landlord escalated to the California Supreme Court, which ruled that earlier rulings might not universally apply.

The Court distinguished this case from prior decisions, emphasizing that co-tenancy provisions are often the result of negotiations between sophisticated parties and should be enforced as written. Previous court decisions, notably Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. (2015), questioned the fairness and enforceability of certain co-tenancy clauses. In that case, the court ruled that a rent abatement provision was an unenforceable penalty, as it lacked evidence that the penalties were proportionate to the damages suffered.

The recent dispute between Jo-Ann Stores, LLC, and its landlord, JJD-HOV Elk Grove, LLC, escalated to the California Supreme Court, which provided clarity on this issue. In this case, after two anchor tenants closed, Jo-Ann began paying a reduced "substitute rent" as stipulated in their lease's co-tenancy provision. The landlord challenged this arrangement, referencing the Grand Prospect decision to argue that the co-tenancy clause was unenforceable.

The reasons given for the ruling at the time was that there was no evidence of actual damages suffered by Ross and that the penalty of complete rent abatement was unreasonable. One of the key aspects of a co-tenancy clause is that the damages can’t be punitive so Ross being able to continue to operate without paying any of the $39,500 per month rent that was due was excessive in the court’s eyes. The lease structure used by Jo-Ann Stores was viewed not as a penalty but as a negotiated term that adjusted rent based on the shopping center's economic conditions, aligning with the contractual intent of both parties.

This ruling has significant implications for commercial leases in California and potentially nationwide. It reinforces the enforceability of co-tenancy clauses that adjust rent based on specific contingencies, provided these terms are clearly defined and reflect the parties' intentions. Landlords and tenants may need to revisit and possibly revise lease agreements to ensure that co-tenancy provisions are structured in a manner consistent with this decision, potentially favoring alternatives like sales-based rental rates over fixed reductions tied to anchor tenant occupancy. The case also highlights how slight variations in details can produce very different outcomes when it comes to contract law. As most seasoned real estate professionals know, just because something is in a contract doesn’t necessarily mean that it will stand up in court.

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