PHILADELPHIA—An arbitration panel's recent decision has reaffirmed the business expectations of national retailers who have long relied on co-tenancy clauses to avoid collateral damage when a shopping center anchor store goes out of business. In a time of changing market conditions, this sends a message to landlords that they ignore these agreed upon protections at their peril.

A panel of three arbitrators from the American Arbitration Association in June enforced a co-tenancy clause against a Pennsylvania landlord, awarding retailer Ross Dress for Less $1.9 million in damages, including attorneys' fees. The award, confirmed by the Eastern District of Pennsylvania in September, reflects the longstanding belief among real estate professionals that co-tenancy clauses are alive and well.

A common provision of shopping center leases, co-tenancy clauses are designed to protect tenants' business interests by providing a rent reduction or lease termination if anchor stores cease operations. They are based on the premise that successful shopping centers usually have a complementary tenant mix, strong anchor tenants and high occupancy rates. A major store closure means less foot traffic for the remaining tenants.

The dispute at the center of the arbitration panel's ruling began in 2011, when Ross discovered it was overpaying its rent at the Lycoming Crossing shopping center. Ross argued that the shopping center's owner, VIWY, had failed to satisfy the conditions for full rent when one of three anchor tenants, Circuit City, closed in 2009. The landlord could have satisfied this condition with another similar store, but it did not, and the landlord continued to bill Ross as if full rent were due.

The landlord refused to acknowledge the reduced occupancy period resulting from the Circuit City closure and refused Ross' demand for a rent refund for the overpaid rent. VIWY ultimately terminated Ross's lease without acknowledging Ross' right to pay reduced rent, and Ross filed a complaint in federal court alleging breach of lease in January 2012, two months after vacating its space. The case was ultimately sent to arbitration.

To justify its actions, VIWY relied on an outlier intermediate appellate decision from California in a separate dispute involving Ross that favored the landlord, Grand Prospect Partners, and surprised many in the real estate industry. Under the unique facts of that case—which involved a landlord's promise that a large department store would open on adjacent property that the landlord did not control—the California court found that the rent abatement provision of the co-tenancy clause acted as an “unenforceable penalty” because the value of the money or property given up was not reasonably related to the harm that the condition was anticipated to be caused.

In the Pennsylvania arbitration, the Panel was not swayed by the Grand Prospect decision. The Panel recognized the significant capital that anchor tenants invest in their stores and found that “[a]nchor tenants' importance to the success of the shopping center gives them bargaining power to include lease provisions that motivate a successful mix of co-tenants and remedies in the event of unmet expectations.” It concluded that the co-tenancy provision did not constitute a penalty because the amount of rent reduction is the product of negotiation and likely reflects the “developer's success at attracting a strong tenant mix for the relevant demographic.”

Many commentators in 2015 speculated that the Grand Prospect ruling would lead courts to take a narrow view of co-tenancy clauses in commercial lease agreements. Yet our research shows that no other court has followed suit — a trend further supported by the arbitration Panel's decision favoring Ross.

The Panel's decision and subsequent confirmation by the Eastern District of Pennsylvania teaches that the rationale in the Grand Prospect case is unique and does not reflect the long-standing reliance among real estate professionals that co-tenancy clauses are commonly employed to accomplish important commercial considerations.

Matthew A. White is a partner in Ballard Spahr LLP's litigation department. He may be contacted at whitema@ballardspahr.com. The views expressed here are the author's own.

Instant Insights /

Landlords Ignore Co-Tenancy Clauses at Their Peril

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