V O L . 3 1 I S S U E 3International Council of Shopping Centers, Inc.1221 Avenue of the Americas, 41st floor, New York, NY 10020-1099Phone (646) 728-3800

F A L L / W I N T E R 2 0 1 1

Shopping Center Legal UpdateThe legal journal of the shopping center industry

In Depth

What Must a Retail Debtor Do to Timely Assume a

Shopping Center Lease Under Bankruptcy Code

§ 365(d)(4)? ________________________________________2

Zoning Contingency Clause: The Tipsy Coachman

Saved the Tenant; Sober Drafting Might Have

Helped the Landlord ________________________________5

Multi-location Retail Store Not ‘Appropriate’

for Union Bargaining ________________________________8

Landlords’ Implied Covenant to Maintain and

Attract Customers __________________________________10

Finders Keepers: Federal and State Regulation

of Unlicensed Real Estate ‘Brokers’ and ‘Finders’ ______12

Massachusetts SJC Opinion Imposes Non-Waivable

Statutory Duty on Commercial Landlords to

Repair Unsafe Conditions __________________________15

Cases ________________________________________________18

Radius Restrictions ____________________________________18

Tenant Estoppel Certificates ____________________________18

Landlord’s Duty to Mitigate __________________________19

Duty of Care__________________________________________20

From Canada

Rights of Landlords in Bankruptcy—May Be More

Than Expected ____________________________________22

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In Depth

What Must a Retail Debtor Do to Timely Assume a Shopping CenterLease Under Bankruptcy Code § 365(d)(4)?

Brian D. Huben*Katten Muchin Rosenman LLPLos Angeles, CA

IntroductionThe Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “2005 Act”) brought significant changes to a numberof sections of the United States Bankruptcy Code. Among many of the sections of the Bankruptcy Code, Congress focused oneliminating past abuses relating to the period of time within which a debtor/tenant may assume, assume and assign, or rejecta lease of non-residential real property under 11 U.S.C. § 365(d)(4).1 Prior to passage of the 2005 Act, as long as a retail debtorcould establish “cause” (a term not defined by the Bankruptcy Code) for an extension of time under § 365(d)(4), bankruptcycourts granted multiple extensions of time that, in some cases, stretched on for years. Following prolonged debate, Congressmandated a maximum period of 210 days after an order for relief is entered following a bankruptcy petition for a debtor/ten-ant to assume a non-residential real property lease. But what, exactly, must a retail debtor do to assume a shopping centerlease? Despite the plain language of the statute, two schools of thought have emerged: (1) that a debtor need only file itsmotion to assume before the 210th day of the case; (2) that the bankruptcy court’s lease assumption order must be entered bythe 210th day of the case. An analysis of the legislative history of the 2005 Act, the language of § 365(d)(4), and several relatedsections of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure support the conclusion that the debtor needsto have a lease assumption order in hand (or on the docket) to avoid having the lease deemed rejected and being forced tosurrender possession to the landlord.

The StatuteThe 2005 Act substantially revised § 365(d)(4) “to reduce the time in which a trustee [or debtor-in-possession] may assume orreject a real property lease and to give greater rights to real property lessors.”2

Section 365(d)(4) currently reads as follows:

(A) Subject to subparagraph (B), an unexpired lease of nonresidential real property under which the debtor is thelessee shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property tothe lessor, if the trustee does not assume or reject the unexpired lease by the earlier of—

(i) the date that is 120 days after the date of the order for relief; or(ii) the date of the entry of an order confirming a plan.

(B)(i) The court may extend the period determined under subparagraph (A), prior to the expiration of the 120-dayperiod, for 90 days on the motion of the trustee or lessor for cause.

Shopping Center Legal Update is published by the Legal Department of the International Council of Shopping Centers, Inc., 1221 Avenue of the Americas, 41stfloor, New York, NY 10020-1099; David Henry, Chairman; Michael P. Kercheval, President & CEO; Gregory Peterson, General Counsel.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding thatthe publisher is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of acompetent professional should be sought.

Editor-in-Chief: Stephanie McEvily, Esq.

Spring Issue Editors: Thomas Barbuti, Whiteford, Taylor & Preston LLP, Baltimore, MD, http://www.wtplaw.com; Mitchell S. Block, DeLeon & Washburn, P.C.,Austin, TX, http://www.dwlawtx.com; Lara E. Rycyk, DJM Realty Services, Melville, NY, http://www.djmrealty.com; Mindy Sherman, Perkins Coie, Chicago, IL, http://www.perkinscoie.com; Joshua Stein, Joshua Stein PLLC, New York, NY, http://www.joshuastein.com; Natalie Vukovich, Daoust Vukovich LLP, Toronto,Ontario, Canada, http://www.dv-law.com; Lisa Winnick, Rite Aid Corp., Camp Hill, PA, http://www.riteaid.com; Daniel K. Wright, Tucker, Elllis & West,Cleveland, OH, http://www.tuckerellis.com

Summer Issue Editors: Elizabeth H. Belkin, Belkin Law Offices, Chicago, IL, http://www.belkinlawoffices.com; Fredric L. Carsley, De Grandpré Chait LLP,Montreal, Canada, http://www.dgclex.com; Kevin Groarke, Sonnenschein, Nath & Rosenthal, New York, NY, http://www.sonnenschein.com; Brian D. Huben,Katten Muchin Rosenman, Los Angeles, CA, http://www.kattenlaw.com; George J. Kroculick, Duane Morris LLP, Philadelphia, PA,http://www.duanemorris.com; John H. Lewis, Holland & Knight, LLP, Jacksonville, FL, john.lewis@hklaw.com; Eric Rapkin, Akerman Senterfitt, Ft. Lauderdale,FL, http://www.akerman.com

Fall/Winter Issue Editors: J. Yost Conner, Jr., Patton Boggs LLP, Washington, DC, http://www.pattonboggs.com; Tami Daniel, Whiteford, Taylor & Preston LLP,Baltimore, MD, http://www.wtplaw.com; Gary Kessler, Kessler Collins, Dallas, TX, http://www.kesslercollins.com; Colleen M. Leonard, Holland & Knight, LLP,Washington, DC, http://www.hklaw.com; Karen O’Malley, Goulston & Storrs, Boston, MA, http://www.goulstonstorrs.com; Blair A. Rebane, Borden LadnerGervais LLP, Vancouver, Canada, http://www.blgcanada.com; Matthew P. Seeberger, Cox, Castle & Nicholson, Los Angeles, CA, http://www.coxcastle.com

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(ii) If the court grants an extension under clause (i), the court may grant a subsequent extension only uponprior written consent of the lessor in each instance. § 365(d)(4).

The 210-Day Deadline—It’s a Bright Line, Not Just a SuggestionThe intent of, and the purpose behind, the current version of § 365(d)(4) was set out very clearly by Congress before the 2005Act became law.

Sec. 404. Executory and Contracts and Unexpired Leases. Subsection (a) of section 404 of the Act amends section365(d)(4) of the Bankruptcy Code to establish a firm, bright line deadline by which an unexpired lease of non-residential real property must be assumed or rejected. If such lease is not assumed or rejected by such dead-line, then such lease shall be deemed rejected, and the trustee shall immediately surrender such property tothe lessor. Section 404(a) permits a bankruptcy trustee to assume or reject a lease on a date which is the earlier ofthe date of confirmation of a plan or the date which is 120 days after the date of the order for relief. An extensionof time may be granted, within the 120 day period, for an additional 90 days, for cause, upon motion of thetrustee or lessor. Any subsequent extension can only be granted by the judge upon the prior written consent ofthe lessor either by the lessor’s motion for an extension or on motion of the trustee, provided that the trustee hasthe prior written approval of the lessor. This provision is designed to remove the bankruptcy judge’s discretionto grant extensions of the time for the retail debtor to decide whether to assume or reject a lease after a maxi-mum possible period of 210 days from the time of entry of the order of relief. Beyond that maximum period,the judge has no authority to grant further time unless the lessor has agreed in writing to the extension.H.R.Rep. No. 109-31(I), at 8687 (2005) (emphasis added).

Prior to the 2005 Act, and consistent with the absence of a bright line test for when a lease must be assumed (orassumed and assigned), courts in some jurisdictions held that merely filing a motion to assume (or assume and assign) a leasesatisfied the requirement that a lease be “assumed” for purposes of § 365(d)(4). However, since the 2005 Act became law, thatrationale no longer withstands scrutiny.

As a preliminary matter, § 365(d)(4) speaks to the consequences of a debtor (or trustee’s) failure to “assume” the lease.A non-residential real property lease cannot be assumed unless a debtor moves to assume the lease under § 365, and the bank-ruptcy court grants the motion and enters an order. See § 365, and Fed.R.Bankr.Proc. 6006, 9013, and 9014. Many courts haveheld that assumption under § 365 cannot be accomplished by implication or the unilateral acts of the debtor. See, e.g., In reEnron, 300 B.R. 201, 214 (Bankr. S.D.N.Y. 2003) and In re Kelly Lyn Franchise Co., 26 B.R. 441, 445 (Bankr. M.D. Tenn. 1983)(rejecting the notion that assumption could be implied from the debtor’s conduct). Indeed, assumption under § 365 requiresthe express approval of the court. See Lindsey v. Dept. of Labor (In re Harris Management Co., Inc.), 791 F.2d 1412, 1414 (9th Cir.1986), and In re Whitcomb & Keller Mortgage Co., 715 F.2d 375, 380 (7th Cir. 1983). See also, In re House of Deals of Broward, Inc.,67 B.R. 23, 25 (Bankr. E.D.N.Y. 1986) (the term “assumption” contemplates not only the debtor in possession making a motionto assume, but also the court granting such a motion). The filing of a lease assumption motion on or before the 210th day ofthe case, with a hearing on the lease assumption motion coming after the 210th day of the case, is merely an artifice to extendthe time to assume a lease beyond the 210-day deadline without the landlord’s consent—a practice the 2005 Act was clearlydesigned to stop.

In those instances where a retail debtor wants or needs more than 210 days to decide whether it will assume or assumeand assign its nonresidential real property leases, § 365(d)(4) provides the debtor with a mechanism to obtain a further exten-sion with the prior written consent of the landlord. See § 365(d)(4)(B)(ii). In a number of large Chapter 11 retail bankruptcycases since 2005 (e.g., Mervyn’s, Circuit City, Blockbuster, Borders), the retail debtors approached shopping center landlordsearly in the reorganization process to negotiate an extension of time to assume leases beyond the 210-day deadline. Not sur-prisingly, those debtors did not rely upon the filing of a lease assumption motion to obtain a de facto extension beyond the210th day of their cases. In those cases, clearly such a strategy would not have been worth the risk. Indeed, all of the dead-lines imposed by the former and current versions of § 365 were designed by Congress to be punitive. See Debartolo PropertiesManagement, Inc. v. Devan, 194 B.R. 46, 52 (Bankr. D. Md. 1996) (§ 365(d)(4) encourages debtors to make a prompt decisionabout their leases and punishes debtors who fail to timely act). In In re Tubular Technologies, LLC, 348 B.R. 699 (Bankr. D. S.C.2006), the Chapter 11 debtor filed a motion to extend the time to assume or reject a non-residential real property lease on the112th day of the case, but a hearing was not held until the 144th day of the case. The bankruptcy court denied the debtor’smotion, noting that the unambiguous language of § 365(d)(4) “clearly provides that if any extension is desired, Debtor mustobtain the extension by an order entered within the 120 day period proscribed.” In re Tubular Technologies, LLC, 348 B.R. at708.

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It seems unlikely that Congress intended to treat a retail debtor’s failure to obtain a lease assumption order prior to the210-day deadline any less severely than a retail debtor’s failure to comply with the 120-day deadline to obtain the single 90-day extension of time under § 365(d)(4)(b)(i).

Congress was also keenly aware of the hardship that the 210-day deadline could create for a retail debtor. Before the2005 Act, early assumption of a shopping center lease followed by a subsequent “rejection” created a potentially crippling lia-bility for the debtor—all of the rent due under the lease for the remainder of the term was elevated to the level of an adminis-trative priority claim, essentially moving the landlord close to the front of the proverbial line of creditors and positioning theclaim for payment in full. See Nostas Assocs. v. Costich (In re Klein Sleep Products Inc.), 78 F.3d 18 (2nd Cir. 1996) (rejection ofassumed lease gave rise to debt entitled to administrative priority because the entire liability resulting from the breach of anassumed lease was deemed a cost of administering the estate). While § 365(d)(4) imposes the hard 210-day deadline forassumption of a shopping center lease, another part of the 2005 Act limits the debtor’s liability in the event a lease is assumedand later rejected. In such a scenario, the debtor’s liability is capped under § 503(b)(7) to two years’ worth of rent and chargesunder the lease.

SummaryAt this point, the 2005 Act has been in effect for less than six years. Some bankruptcy courts may have already opined onwhether a debtor must have its lease assumption order entered before the 210-day deadline in order to avoid automatic rejec-tion of a shopping center lease, but the Bankruptcy Appellate Panels and Circuit Courts have yet to provide any guidance onthe issue. Time will no doubt yield clarity on the matter; until then, debtors and their counsel are likely best served by toeingthe bright line drawn by Congress in the 2005 Act.

*BRIAN D. HUBEN, a Member of this newsletter’s Board of Editors, is a Partner in the Los Angeles, CA, office of KattenMuchin Rosenman LLP. His practice focuses on the representation of shopping center owners, developers and managers ascreditors in retail tenant bankruptcies, and in litigation in state and federal courts.

1Unless otherwise noted, subsequent references to a “Section” are to the United States Bankruptcy Code, 11 U.S.C. §§ 101, et seq.

2Collier on Bankruptcy (15th ed. Rev. 2009) § 365.LH[2][g] at pp. 365–112.

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Zoning Contingency Clause: The Tipsy Coachman Saved the Tenant;Sober Drafting Might Have Helped the Landlord

Eric D. Rapkin*Akerman SenterfittFt. Lauderdale, FL

Carrie Ann Wozniak** Akerman SenterfittOrlando, FL

[I]n some circumstances, even though a trial court’s ruling is based on improper reasoning, the ruling will be upheldif there is any theory or principle of law in the record which would support the ruling. This longstanding principleof appellate law, sometimes referred to as the “tipsy coachman” doctrine, allows an appellate court to affirm a trialcourt that reaches the right result but for the wrong reasons….1

A recent Florida appellate case (successfully argued on appeal by Ms. Wozniak, one of the authors) upheld the tenant’sright to terminate a commercial lease agreement due to the failure of a zoning contingency in the lease. The case is interestingto practitioners for a number of reasons, not the least of which is that the tenant prevailed at the trial court; the landlordappealed; and although the appellate court held that the trial court’s holding was wrong, the trial court’s judgment for thetenant was nonetheless affirmed on other grounds.

The facts of 1700 Rinehart, LLC v. Advance America, Cash Advance Centers, Etc., 51 So. 3d 535 (Fla. 5th DCA 2010), are rela-tively straightforward. In May 2007 the parties entered into a lease agreement in which the sole permitted use was a cashadvance store. The parties knew that such use might not be permitted by the city; in August 2007, several months after thelease was signed, the parties amended the lease, making the tenant responsible for confirming that the tenant’s use was com-patible with zoning. The amendment contained the following termination provision:

In the event Tenant, after using best efforts, is unable to obtain all permits and approvals necessary for Tenant toopen and operate its business in the Premises within ninety (90) days from the mutual execution of this Lease,Tenant shall have the right, upon written notice to Landlord, to terminate the Lease, in which event all rents anddeposits paid to Landlord shall be refunded to Tenant provided, however, that Landlord shall have the right onbehalf of Tenant to attempt to obtain all permits and approvals for Tenant and if Landlord is unsuccessful, thenTenant shall have the right to terminate the Lease.

The tenant promptly submitted applications to the city for the necessary permits; in January 2008, more than 90 daysafter the lease amendment was executed, the city denied the tenant’s application. The following day, the tenant sent a noticeto the landlord, terminating the lease under the 90-day termination provision. The landlord responded that the tenant hadfailed to terminate within 90 days of executing the lease, as it claimed was required, and denied the tenant’s right to termi-nate the lease and receive a refund of its security deposit. The landlord then sued the tenant and guarantor for unpaid rent,including accelerated rent through the lease’s five-year initial term.

On cross-motions for summary judgment, the trial court ruled that the lease was void for “want of consideration” or“frustration of purpose” because the space could not be used for its only intended purpose. Further, the trial court rejectedthe tenant’s argument that it properly terminated the lease pursuant to the 90-day termination provision.

The appellate court found this ruling to be legally incorrect, as well as the trial court’s ruling that the tenant could notrely on the 90-day termination provision; but, relying on the tipsy coachman rule, the appellate court affirmed the trial court,holding that the tenant properly terminated the lease under the 90-day termination provision.

The appellate court quickly explained that the lack of consideration doctrine had no application in this case because“the particular potential obstacle was not only foreseen by the parties, but as to which they specifically bargained, with therisks of its occurrence divided by and between the parties in the agreement itself.” In 1700 Rinehart, the parties specificallyinserted a provision allowing the tenant to terminate the lease if it was unable to use the property for the permitted use.

Instead, the appellate court analyzed the 90-day termination provision and the tenant’s actions, and held that the tenantproperly and timely invoked the termination provision—even though the termination did not occur for nearly five monthsafter the execution of the lease amendment. The court held that despite the tenant’s clear use of its best efforts, the tenant wasunable to open and operate its business within 90 days after the execution of the lease amendment. The landlord’s argument(with which the trial court agreed) was that the termination notice was ineffective because it did not occur within the 90-dayperiod. The appellate court, however, held that the “clear language” of the lease amendment shows that the 90-day periodrefers to the tenant’s ability to lawfully conduct its business on the premises—and not to the tenant’s ability to terminate thelease.

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The court cited language from a number of other cases in which the parties clearly expressed a time limitation on a ter-mination right, including United Artists Theatre Circuit, Inc. v. Sun Plaza Enterprise Corp., 1998 WL 938732 (E.D.N.Y. 1998). (“Ifthe Tenant will not be considered as a bankable Tenant by any lending institution and/or the Landlord will not be able tosecure a construction loan based on this Lease, and, in that event, the Landlord shall have the right, only within the period of 90days after the execution of this Lease, to cancel this Lease, provided the Landlord used his best efforts to secure financing.”) [e.s.];Commonwealth v. Vartran, 733 A. 2d 1258, 1260 (Penn. 1999) (“If within 60 days from the execution of this Lease Tenant has notreceived such resolutions, enactments or other approvals as Tenant, in its sole opinion, deems appropriate, Tenant shall havethe right, exercised n [sic] writing not later than five business days after the end of such 60 day period, to terminate this Lease bywritten notice to Landlord . . .”) [e.s.]; and Grossman v. Sharp Air Freight Servs., Inc., 1994 WL 902889 (Mass. Sup. 1994) (“If,notwithstanding such diligent efforts, [Sharp] is unable to obtain such approval on or before sixty (60) days following the exe-cution of this lease, [Sharp] shall have the option to terminate this lease; provided, however, that such option shall be exercised (ifat all) by notice to [the Grossmans] not later than seventy (70) days following the date of execution of this lease.”). Indeed, inreviewing the language in the termination rights in these other cases, the 1700 Rinehart court stated that “[t]he contrastbetween the contract terms in these cases and this one is decisive.” [e.s.]

Contrary to the landlord’s argument that this interpretation would mean that there is no time limit whatsoever on thetenant’s right to terminate the lease, the court stated that the law is clear in Florida and elsewhere that when a contract failsto specify a particular period, the law implies a reasonable time under the circumstances. Moreover, in this specific instance,the tenant’s zoning application was still pending on the 90th day, so the tenant would have had to abandon its reasonableefforts to secure the ability to use the premises. The court stated that it would not infer that the parties to the lease intendedsuch a “self-defeating result.”

Practical ImplicationsWhat are some practical implications for lease negotiators regarding a retail tenant’s intended use of the premises?

Of primary importance is the need for due diligence. As opposed to a multitenant office building, where a new user canoften be comfortable that general office use is permissible under applicable land use laws, retail tenants cannot be assuredthat their specific use is permissible simply because their use will be in a shopping center housing other retail tenants. It isincumbent on tenant’s counsel to be certain that the tenant’s intended use is permissible, and if not, what would need to beaccomplished to allow the tenant’s intended use. Similarly for the landlord: While it is normally the tenant’s responsibility toconfirm the compatibility of a tenant’s use with applicable zoning, the landlord is typically in a better position than the tenantat the outset of negotiations to know what is and is not permissible at the property. If the landlord knows that the tenant’suse is not permissible without some type of zoning approval, the landlord would be prudent to advise the tenant, rather thansimply remaining silent. For negotiations in which the tenant has bargaining strength, the tenant will often ask for a represen-tation in the lease that the tenant’s use is permissible under applicable zoning.

If the intended use is not permissible under zoning, a contingency for governmental approvals for the tenant’s useneeds to be included in the lease.

First, the parties need to address whose responsibility it will be to obtain the governmental approvals. More often thannot, it will be the tenant’s responsibility, although lease negotiators will often also include a requirement for the landlord (atno cost to the landlord) to cooperate with the tenant in pursuing such approvals.

In addition, the zoning contingency should define what efforts are required to be undertaken. In 1700 Rinehart, the tenant was required to use “best efforts” to obtain the necessary permits and approvals. Lease

negotiators would be cautioned to research the governing state law to determine what would be involved in a party’s duty touse best efforts. The parties probably intend that the tenant is required to use reasonable diligence, as opposed to beingrequired to make every conceivable effort—even if it means bankrupting the tenant. But even if “best efforts” is determinedto be synonymous with reasonable diligence, the parties could disagree about what exactly would be required. For example,if the tenant promptly files all required applications and diligently pursues the approval process, but the application isdenied, would best efforts require the tenant to pursue a zoning appeals process? Most drafters typically insert the effortsstandard without much definition. Perhaps care should be taken in defining with a bit more precision what steps are requiredto be taken in order to meet the efforts standard, and conversely what steps would not be required to be pursued. For a dis-cussion on the concept of best efforts, see Kenneth A. Adams, Understanding “Best Efforts” And Its Variants (Including DraftingRecommendations), The Practical Lawyer, August 2004, 11.

The time frame set forth in a zoning contingency clause can help determine the parameters for what can and cannot beaccomplished. For example, in the 1700 Rinehart case, the tenant had 90 days to obtain all necessary permits and approvals. Ifonly the initial application process would be expected to take 90 days, then it is unlikely that the parties could have intendedthat the tenant’s best efforts included pursuing an appeal from a denial of the application.

Lease drafters should include two distinct time frames: (1) the time period within which the contingency is to be satis-fied; (2) the time period within which the lease can be terminated, should the contingency not be satisfied within the firsttime period. As noted in the 1700 Rinehart case, when a contract fails to specify a particular period, the law typically implies areasonable time under the circumstances. Neither party should have to rely on what a court might determine to be a reason-able time to terminate a lease for failure of a contingency.

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In conclusion, although the tenant’s termination right was saved by the tipsy coachman, the landlord may have hada better chance to prevail on its claims, had it undertaken a bit more “sober” drafting and negotiating of the lease.

*ERIC D. RAPKIN is a Shareholder in Akerman Senterfitt’s Fort Lauderdale office and a member of this newsletter’s EditorialBoard. erapkin@akerman.com.

**CARRIE ANN WOZNIAK is an Associate in Akerman Senterfitt’s Orlando office. cwozniak@akerman.com

1Robertson v. State, 829 So. 2d 901, 906-07 (Fla. 2002).

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Multi-location Retail Store Not ‘Appropriate’ for Union Bargaining

Edward F. Harold*Fisher & Phillips LLP New Orleans, LA

The National Labor Relations Board (“NLRB” or “Board”) recently held that a proposed bargaining unit of 32 Connecticutstores of Sleepy’s Inc. (“Sleepy’s”) was not an appropriate multi-location bargaining unit. The decision, by board members,Leibman and Schaumber, provides insight into how a retailer’s operations can impact the scope of a bargaining unit, shouldorganizing efforts take place.

The Board RulesSleepy’s Inc. is a bedding retailer, with approximately 700 stores, located primarily in the Northeast. Each store is generallystaffed by only one employee each workday. Union organizing efforts took place at many Sleepy’s locations in Connecticut.After the ordinary administrative process, the Board’s regional director certified a proposed bargaining unit of 32 stores andapproximately 62 employees.

The primary basis for the regional director’s decision was his conclusion that this was a “distinct Employer-designatedgeographical grouping of stores, all of which are under the direct supervision of [the same regional manager].” The employerappealed this decision to the Board in Washington, D.C., which overturned the regional director’s decision.

The Board addressed the issue using its “community of interest analysis,” developed for multi-location units that are“more than a single location, but less than chain wide in scope.” The overarching concern of the test is to identify whether theset of employees in the proposed unit has interests that are distinct from the employees at the locations excluded from theunit. The important factors include:

similarity of employee skills, duties and working conditions; functional integration of business operations,including employee interchange; centralized control of management, supervision and labor relations; whether thepetitioned-for unit conforms to an administrative function or organizational grouping of the employer’s opera-tions; geographic cohesiveness and proximity; and collective-bargaining history.

Similar, But Not Similar EnoughSleepy’s store operations were not unusual. The stores were divided into five markets, each led by a regional vice president.Each market was divided into regions led by regional managers responsible for between 30 and 35 stores. The regional man-agers each had district managers working under them, who were responsible for subsets of stores within the regional man-ager’s area of responsibility. The 32 stores in the unit in question were in the employer’s New England market, whichincluded approximately 156 stores.

While only one employee was generally on duty in each store, the stores were connected through electronic communi-cations. An employee in one store could review the inventory of all the stores. Customers could purchase a product from onestore and pick it up from a store in a different locale. All store employees throughout the company were governed by thesame employment policies and practices. The regional vice president not only made hiring and promotion decisions, but alsoparticipated in employee disciplinary matters, including termination.

The employees at the 32 locations in the proposed unit were identical in terms of skills and duties. The stores were geo-graphically similar, within 60 miles of each other. The main distinguishing characteristic of these stores was that—at least forawhile—they were under the supervision of the same regional manager.

The Board held that the similarities were not enough to conclude that the Connecticut unit stores’ employees had acommon interest that was distinct from the interests of the excluded stores’ employees. In particular, there was no distinctionbetween the employees of these stores and the employees of the other stores in the same market.

The regional vice president, not the regional manager, was primarily responsible for employment decisions. Someexcluded stores in the same market were actually geographically closer to some of the stores comprising the petitioned-forunit. Additionally, while the employees assigned to these stores generally did not work in other stores, employees from out-side the unit also worked in the stores in the unit about 50 percent of the time; many of them were floaters, who were notassigned to a specific store.

Most importantly, the Board found that the regional director erred in concluding that the grouping of the 32Connecticut stores was the product of the employer’s administrative structure. The Board noted that the designation of theunit used by the regional director in his decision, R-37, actually referred to a specific regional manager—not to a distinctgrouping of stores. The assignments of stores to regional managers was very fluid, changing as stores opened and closed andas regional managers came and went. Thus, the grouping of stores under the moniker R-37 had changed numerous timessince the unit decision. As such, the Board concluded that this group was not an appropriate bargaining unit.

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The Board did not go so far as to hold, as the employer requested, that no subset of the stores smaller than the NewEngland market could be an appropriate unit. It suggested, although without any analysis, that perhaps all of the Sleepy’sstores located in Connecticut could be an appropriate bargaining unit.

What This Means for Retail EmployersWhen a union seeks to represent employees at a single location, the Board reasons that such a single-store unit is “presump-tively appropriate.” But if the union seeks to represent a certain group of stores, but less than the entire company, there aremultiple factors in play. Consequently, it is possible for either the union or the employer to argue that the unit should belarger or smaller than what was petitioned for. While the positions of both the union and the employer will vary with thefacts of a case, the employer will usually argue for a larger unit (more difficult to organize) while the union will argue for asmaller one (easier to organize). In this case, Sleepy’s argued that no unit smaller than the entire New England region wasappropriate. The Board did not rule on that argument; rather it sent the case back to its regional director for further actionregarding whether any unit smaller than New England might be appropriate.

Preventing a union organizing effort will rarely be the prime concern when a retailer sets up its operational structure.In fact, any restructuring that was designed to hinder union organizing would carry no weight when unit decisions are beingmade, and could even be unlawful. On the other hand, many legitimate factors are utilized in the assessment of an appropri-ate unit, and most of them also are factors that drive operational decisions. For example, geographic proximity is a significantconcern so that district and regional managers can spend more time in their stores and less time on the road.

Maintaining consistency in the application of company-wide employment policies and practices requires centralizedoversight. A company’s need for a management structure that is efficient in hiring, training, promoting, disciplining and ter-minating employees can dictate the level of management where these kinds of decisions take place. Management stabilityover groups of stores will likely be of greater importance to retailers with a small number of large stores than for retailerswith a large number of smaller stores.

Conventional wisdom suggests that the more different locations are included in a collective bargaining unit, the moredifficult will be the union’s job of winning representation. The employer’s goal in the Sleepy’s case was to increase the num-ber of locations in the unit.

However, the Sleepy’s decision does not indicate that retailers should rush to make structural management changesthat will avoid union organizing. Rather, it is a reminder to consider how a retailer’s management structure could affect thescope of potential bargaining units.

While management structure is a significant factor in the Board’s unit determinations, it is hardly a good union-avoid-ance strategy. If a company is structured in a way to suggest that only large multi-location units are appropriate, unions willlikely focus on organizing individual stores. Preventing union organizing at this level may best be handled through storemanager training. Where it is more likely that a few large stores in a geographic area would be targeted as a unit, avoidanceefforts may be directed at implementing pro-employee policies; keeping communications open, honest and free flowing; andmaking sure that wages and benefits are competitive for the industry and locale.

*EDWARD F. HAROLD is a Partner of the national labor and employment law firm of Fisher & Phillips LLP in New Orleans,and he chairs the firm’s Retail Industry Practice Group. He can be reached at eharold@laborlawyers.com; (504) 592–3801.

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Landlords’ Implied Covenant to Maintain and Attract Customers

J. Yost Conner, Jr.* Patton BoggsWashington, DC

Some retail landlords may be surprised to learn that even if a lease is silent on the point, the landlord has an implied duty notonly to maintain a shopping center in good condition but also in a condition that will attract customers to the shopping centerfor the benefit of the tenants.

In an unpublished opinion, the Appellate Division of the New Jersey Superior Court upheld a lower court’s ruling thata landlord whose tenant was required to sell “quality jewelry” is subject to an implied covenant to maintain the shoppingcenter in “a good condition to assist its tenants in selling their wares and goods …. Wallington Plaza, LLC v. Taher, N. A-4122-09T1 (N.J. Super. App. Div. Jul. 7, 2011). In almost every circumstance, a landlord and a tenant naturally wish to maintaingood customer traffic at a shopping center; they have the opportunity, up-front, to negotiate bilateral maintenance and opera-tion standards as well as other changed condition contingencies. The imposition of this implied covenant that the parties didnot negotiate opens an intriguing area in landlord-tenant disputes. Future cases might well test how far the duty to attractcustomers actually extends; therefore, the profession would do well to continue a dialog on the issue. Practitioners should beresponsive to this in drafting retail leases.

In Wallington Plaza, the landlord and tenant had signed a 10-year lease for a 1,400 sq. ft. inline space in a neighborhoodstrip shopping center. The lease required the tenant to sell “quality jewelry” (i.e., jewelry containing precious metals and/orprecious gems or minerals) and to operate in a “first class and reputable manner.” At trial, Taher, who was both the principalshareholder of the retail business and a guarantor under the lease, testified that when executing the lease in 1998, he believedthat the shopping center was a “first class place to conduct business.” Although the court’s opinion is not definitive on thepoint, the lease appears not to have imposed an explicit duty on the landlord to maintain the shopping center in any particu-lar condition. Over the course of years, the shopping center fell into disrepair: Its parking lot crumbled; weeds became ram-pant; and many of the shopping center’s 14 tenants—including both of its anchors, a 25,000 square foot A&P grocery storeand a 20,000 sq. ft. Rite-Aid pharmacy—vacated the premises, leaving the vast majority of the shopping center’s leasable areaempty. The trial court characterized the condition of the shopping center as “deplorable.”

Faced with a dramatic reduction in revenue, the tenant vacated the premises in October 2008, six months prior to expi-ration of the lease, and stopped paying rent. The landlord sued Taher, as guarantor, for unpaid rent for the last six months ofthe lease term. Taher counterclaimed, asserting that the landlord’s failure to maintain the shopping center constituted abreach of the lease. The trial court, focusing on the tenant’s explicit obligation to operate its store in a particular manner,ruled that the landlord also had an obligation to maintain the shopping center in a first-class manner and “a responsibility …to keep the premises in a reasonable condition as a tenant would expect, if he had to operate in a first-class business to makerespective customers welcome.” Id. The appellate court described the landlord’s obligation as a duty “to maintain the shop-ping center in a good condition to assist its tenants in selling their wares and goods.” Id. Although the trial court held that thetenant had breached the lease by abandoning the premises and stopping payment of rent, the court also found that the land-lord had breached its implied maintenance covenant and applied the landlord’s breach in mitigation of the damages duefrom Taher.

Now that the Wallington Plaza court has enunciated this implied duty for landlords, it is worth considering what otheractions a landlord might be required to take—or refrain from taking—“to assist its tenants in selling their wares.” In the threeyears since Taher’s business left Wallington Plaza, the center appears to have rounded a corner. One of the anchor spaces isnow occupied by a discount supermarket. While the second anchor space remains empty, a broker is marketing it as either asingle-tenant or a multi-tenant space. See http://www.rkf.com (view marketing materials for Wallington Plaza). Several ofthe inline spaces are occupied, now hosting a dry-cleaner, branch bank, vitamin store, nail salon, wine and liquor store, smallelectronics store, and specialty clothing store. A new pad site in the now-renovated parking lot will be the new home of thecurrent inline branch bank.

An implied covenant to maintain a shopping center in a reasonable condition shorn of any other requirement is proba-bly a good idea. It makes negotiating the lease more efficient for both parties, and it establishes a minimum baseline stan-dard. However, elevating a reasonable maintenance standard to “first class” standard, and mandating that a landlord assistits tenants in selling their wares, tests each of the apparent improvements at Wallington Plaza. These improvements appear tobe positive developments for the shopping center; under the Wallington Plaza standard, though, it is not clear whether thecourt would view them so positively. It is also possible that the landlord might have fared no differently, even if these devel-opments had all occurred prior to 2008, yet Taher’s business had still experienced a slowdown and he had still abandonedthe shopping center.

When Taher’s business first opened in Wallington Plaza, a Great Atlantic & Pacific Tea Company operated an A&Psupermarket in one of the anchor spaces; now, its discount brand, Food Basics, operates in that space. While a well-operated

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discount supermarket such as Food Basics might well satisfy either a reasonableness or first-class standard, it most certainlyattracts a different demographic from that attracted by the original A&P grocery store. This different demographic may beeither more or less likely to purchase quality jewelry from an independent retailer. Should that be among the court’s consid-erations in cases similar to Wallington Plaza?

If so, could the court also reasonably conclude that a landlord has an obligation to backfill vacant supermarket spacewith a high-end fresh grocer, based on the theory that a retailer’s generally more affluent demographic might be more likelyto purchase quality jewelry? Should the landlord have tried to sign a mass-market clothing retailer for the space that is nowoccupied by a niche retailer, based on the theory that having a more diverse body of shoppers at the shopping center wouldbenefit the jeweler? If a landlord’s duties extend to assisting its tenants in selling their wares, does that encompass all tenantsin the aggregate or does it mean each particular tenant? If it refers to each individual tenant, there may be irresolvable con-flicts. For example, does placing a building on a pad site in the parking lot violate the landlord’s implied covenant if the newbuilding blocks the view of an independent inline tenant from the street?

Suppose a landlord has a fully occupied and well-maintained shopping center. However, a tenant believes that thelandlord is not properly marketing the shopping center. Might a court conclude that the landlord has violated its duty toattract traffic and assist tenants in selling their wares and might that court force the landlord to increase its advertisingbudget?

In light of the result in Wallington Plaza, it is worth wondering whether the court fully considered all of the factors thatmight have been in play at the shopping center. In particular, the events surrounding Wallington Plaza were playing outsimultaneously with the United States slipping into its worst recession since the Great Depression. See Bob Willis, U.S.Recession Worst Since Great Depression, Revised Data Show: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNivTjr852TI (Aug. 1, 2009). This put enormous pressure on both shopping centers and retailers, as consumers scaled back ontheir spending—thereby sending extraordinary numbers of businesses into failure. That might have contributed to both thetenant’s loss of business and the landlord’s inability to keep retailers open in a small shopping center in a competitive market.If that was the case, it is difficult to understand how the landlord could possibly have satisfied the standard announced bythe court.

Practitioners’ LessonsNone of this suggests that the court erred in Wallington Plaza. A lease that imposes a manner of operation on a tenant shouldinclude a minimal manner of operation that is required of the landlord. However, in announcing a standard that seems to gobeyond simply requiring that landlords maintain shopping centers reasonably, the court tacitly reminds practitioners thatwhat we draft will matter. It is “vogue” in some parts of the profession today to say that leasing is merely commodity work.But it is not. Leases cannot simply be cloned. Nor does a lease exist only in a moment in time. Leases have a life. Practitionersare obligated to envision that life and to advise clients on how to anticipate changes and lay the groundwork for reacting tothem in clients’ interests.

Best practices might have compelled the Wallington Plaza lease to set out the landlord’s maintenance standard for theshopping center rather than remaining completely silent. Had there been a standard, the tenant might have had an earlierremedy. The lease also appears to have lacked other tools that tenants sometimes use to leverage changes or even get out ofbad leases. For example, although the tenant was subject to a continuous operation provision, there appears not to have beena co-tenancy provision in the lease. The tenant appears to have been obligated to a fixed base rent without a fallback to a per-centage-rent-only provision in the event of reductions in revenue or other changed conditions. The tenant did not enjoy akick-out right tied to revenue or other conditions, and the lease appears not to have imposed a particular marketing obliga-tion on the landlord. All of these tools might have been useful, had they existed.

For good reason, Wallington Plaza has generated discussion among practitioners. See, e.g., Ira Measly, Does a LandlordHave an Implied Duty to Maintain a Shopping Center? http://www.retailrealestatelaw.com (also, see Sept. 8, 2011, blog entrywith practitioner responses). Discussions should continue vigorously, and practitioners should educate their clients about theimportance of thorough review and thoughtful negotiation of every lease, lest they face changed circumstances that put themin front of a judge years down the road.

*J. YOST CONNER is the Group Leader of Patton Boggs’s Real Estate and Construction practice and is a member of the firm’sRecruitment Committee. With 25 years in development, construction and the practice of law, he merges practical experiencein real estate development, design and construction with legal acumen to assist developers, owners and tenants in recogniz-ing, avoiding and resolving problems in commercial real estate transactions and construction projects—including real prop-erty acquisition, disposition and workouts, leasing, development, contracting, exchanges, privatization, and finance.

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Finders Keepers: Federal and State Regulation of Unlicensed Real Estate‘Brokers’ and ‘Finders ’

Gary S. Kessler*Philip G. McNicholas**Kessler Collins PCDallas, TX

IntroductionIn the United States, each state is responsible for regulating its domestic real estate market. To protect the best interests ofconsumers in the real estate markets, all states require real estate brokers to be trained and licensed. All of the states alsomaintain regulatory bodies to monitor real estate transactions and to prevent brokering by unlicensed individuals. A relatedissue for state regulatory bodies with a less obvious solution is whether to permit unlicensed individuals simply to introducepotential parties to real estate transactions. These individuals, known as “finders,” are hired to bring parties together so thatthe parties may negotiate their own purchase contract or lease. In states where finders are legal, an individual without a realestate license can be compensated for organizing a real estate transaction so long as that individual’s involvement is restrictedto conform with state guidelines. The difference between a “finder” and a “broker” frequently depends on whether addi-tional authority—that is, the power to negotiate—has been given.

The federal government has tangentially interceded in this area by regulating the compensation of unlicensed individu-als for referring potential clients to licensed brokers. The Real Estate Settlement Procedures Act (“RESPA”) prevents most typesof reimbursement to unlicensed individuals for referring business to licensed real estate brokers relating to real estate settle-ment services. However, RESPA’s authority is limited to situations in which a licensed broker ultimately mediates the transac-tion, whereas finders join parties so that they can reach an agreement without a broker. It therefore falls upon the states todecide whether to prohibit or permit real estate finders.

States have taken varied positions on the approval of unlicensed real estate finders. A recent New York appellate court’sruling, which reversed the lower court’s decision to distinguish between the legality of unlicensed brokers and finders, hasbrought this debate into light. Some states view the sanctioning of unlicensed finders as providing an easy way for individu-als to sidestep real estate licensing requirements; these states have enacted restrictive legislation as a way to deter prospectiveunlicensed finders. Other states believe that finders offer a different service from real estate brokers and decrease costs forconsumers by adding competitors for real estate clients.

First, this article will consider RESPA’s regulation of unlicensed individuals as intermediaries in real estate transactions.Then, the authors will summarize the present legislation of unlicensed brokers and finders in California, Texas and Ohio. Therecent New York State appellate court’s reversal in Futersak v. Perl will then be reviewed, along with New York’s changedstance toward real estate finder’s fee agreements. Finally, the authors will discuss the significance of Futersak and its potentialimpact on other states.

Federal Legislation—RESPAIn 1974, Congress passed RESPA, which provides in relevant part that:

No person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreementor understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involv-ing a federally related mortgage loan shall be referred to any person.1

In other words, RESPA prohibits the payment of any consideration in exchange for the referral of business to licensed realestate brokers relating to a real estate settlement, so long as a federally related mortgage loan is involved.2 A broker cannotpay any consideration to an unlicensed individual for referrals, even if such consideration was legal under state law.

RESPA only regulates referrals relating to settlement services, which essentially means that the business is meant for alicensed broker. “Settlement services” are defined as any service provided in connection with a real estate settlement includ-ing, but not limited to, title searches; title examinations; the provision of title certificates; title insurance; services rendered byan attorney; the preparation of documents; property surveys; the rendering of credit reports or appraisals; pest and fungusinspections; services rendered by a real estate agent or broker; the origination of a federally related mortgage loan (including,but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of loans); handling ofthe processing; and closing or settlement.

In a nutshell, RESPA regulates real estate transactions in which a licensed broker is ultimately the facilitator. However,states must independently decide whether to intervene when a finder is used in place of a broker.

State Legislation—CaliforniaAccording to California law, a licensed real estate broker can only compensate another licensed broker or a licensed salesper-son who is employed by the broker for real estate services. Unlicensed brokering is not permitted. Even if someone has

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earned a percentage of commission, it is illegal to compensate an unlicensed individual if he or she performed real estateservices while unlicensed.

On the contrary, there is no prohibition against “finders” under California law so long as the finder does not performany services requiring a real estate license. California has a specific finder’s fee exemption that can apply if the finder’s activ-ity is limited to the introduction of the parties and if the finder is not involved in any role in the negotiations. As such,assuming that a real estate finder is careful to limit his or her activity to introducing potential parties, a compensation agree-ment could be enforceable in California.

Payment to an individual who is employed by the broker to perform acts not requiring a real estate license is also legal.However, it is illegal for a broker to employ or compensate an unlicensed individual for acts that do require a real estate license.If an unlicensed employee crosses the line and performs services requiring a license, it would be considered a violation, andthe broker and employee could face civil and criminal penalties in California.

State Legislation—TexasIn Texas, a licensed broker cannot:

pay a commission to or otherwise compensate a person directly or indirectly for performing an act of a brokerunless the person is a license holder or a real estate broker licensed in another state who does not conduct in thisstate any of the negotiations for which the commission or other compensation is paid.3

A broker is defined broadly to include an individual who “aids or offers or attempts to aid in locating or obtaining real estatefor purchase or lease”; “procures or assists in procuring a prospect to effect the sale, exchange, or lease of real estate”; and“procures or assists in procuring property to effect the sale, exchange, or lease of real estate.”4 Accordingly, both unlicensedbrokers and unlicensed finders are banned in Texas.

Also, Texas expands upon RESPA’s influence by specifying that a licensed broker in Texas who offers to or actuallypays cash to an unlicensed person for a referral is subject to disciplinary action under Texas state law.5 The individual makingthe referral and receiving cash compensation would be considered an unlicensed person who is engaged in the business ofreal estate brokering; that person could face civil penalties and criminal charges.6 There is one exception, however: gifts ofmerchandise with a retail value of $50 or less are not considered valuable consideration.7

State Legislation—OhioOhio law prohibits payments to unlicensed individuals who perform brokering duties. To receive any compensation for refer-ring a prospective real estate client—including the referral of a buyer, seller, landlord or tenant—an individual must belicensed either as an Ohio real estate broker or a real estate salesperson.

Ohio Revised Code § 4735.01 lists acts that require a real estate license if performed for a fee. For example, a real estatelicense is needed by anyone who “directs or assists in the procuring of prospects or the negotiation of any transaction …which does or is calculated to result in the sale, exchange, leasing or renting of any real estate.” Hence, similar to Texas law,Ohio defines the acts of brokers to encompass finders, and requires both activities to be licensed.

Under Ohio Administrative Code § 1301:5-5-06, an exception to § 4735.01 exists in that an Ohio broker can pay a refer-ral fee to a broker who is licensed in another state and refers prospects to the Ohio broker. The out-of-state broker who refersbusiness to a broker licensed in Ohio can only perform those acts that do not require possession of an Ohio real estate brokerlicense, with an exception for commercial transactions. That is, under Ohio Revised Code § 4735.022, out-of-state brokers canperform acts that would usually require an Ohio license on commercial property, so long as they work with a licensed Ohiobroker and meet certain other requirements.

Violation of § 4735.01 results in a first-degree misdemeanor and fines of up to $1,000 per day during the violation.Licensed brokers and agents who compensate unlicensed individuals could also be subject to penalties.

Recent Case Law—Futersak v. Perl (New York)In a recent case, the courts had to interpret New York State’s unlicensed broker statute as either prohibiting or permittingfinder’s fees. See Futersak v. Perl, 2011 NY Slip Op 04629, Decided on May 31, 2011, a case originating in the Supreme Court forNassau County in New York State and eventually appealed to the Appellate Division, Second Department, of the SupremeCourt of New York. These decisions inevitably redefined the breadth of New York’s regulation of its real estate market.

Futersak filed a lawsuit, claiming that he and Perl had entered into a valid written agreement whereby Futersak wouldmerely introduce Perl to a prospective seller of real estate and that he would retain a 15% interest in any subsequent purchaseby Perl. After Perl purchased the real estate and refused to pay, Futersak pursued a breach of contract claim against Perl, whodefended against the suit by arguing that Futersak was barred from recovery by New York Real Property Law § 442-d as anunlicensed broker. In pertinent part, § 442-d reads as follows:

[n]o person… shall bring or maintain an action in any court of [New York] for the recovery of compensation forservices rendered … in the buying, selling, exchanging, leasing, renting or negotiating a loan upon any real estatewithout alleging and proving that such person was a duly licensed real estate broker or real estate salesman onthe date when the cause of action arose.

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The Supreme Court for Nassau County took into consideration opposing motions for summary judgment, and ruledthat there was a difference between brokers and finders, based on the quality and quantity of service, and that an individualserving solely as a finder could be compensated without violating § 442-d. The court, therefore, ruled that Futersak had avalid contractual right to be paid for introducing Perl to the seller; Futersak’s prima facie case for breach of contract was estab-lished, and Futersak was granted his motion for summary judgment.

On appeal, the Appellate Division of the Supreme Court of New York also considered Real Property § 442-d, but con-cluded that “this prohibition applies even if the services rendered are characterized as those of a ‘finder.’ ” The court ruledthat Futersak was barred from recovery because he was an unlicensed finder, reversed Futersak’s summary judgment andgranted summary judgment for Perl.

SignificanceThe New York appellate court’s ruling in Futersak increased regulation of New York real estate transactions. The Futersak deci-sion disables an unlicensed broker or finder in New York State from obtaining legally enforceable contract rights.

The court’s decision may reduce the confidence New Yorkers have that their contracted-for rights will be enforced andmay increase broker fees due to decreased competition. However, New York’s real estate market will improve, hopefully, forconsumers because deals will be proctored by trained and licensed individuals.

As for nationwide impact, regulatory bodies in other states will certainly (1) observe the effects of the Futersak appellatereversal in New York State and (2) judge whether New York’s real estate market is safer and fairer for consumers or if brokerfees increase because of less competition from finders. In either case, it is likely that other states will respond to Futersak byeither increasing regulation or sanctioning finders. Only time will tell. However, state laws and court rulings should bechecked routinely for changes.

*GARY S. KESSLER is the President of Kessler Collins PC and regularly handles real estate issues.

**PHILIP G. MCNICHOLAS is an Associate of Kessler Collins P.C.

1 RESPA.2 Most loans meet the “federally related” standard that includes loans made by federally insured lenders as well as loansintended to be sold to a federal institution such as Fannie Mae or Freddie Mac.3 TRELA § 1101.651(a).4 TRELA § 1101.002(1)(A)(vii) – (ix).5 TRELA § 1101.652(b)(11) & (26).6 TRELA § 1101.351(a).7 Rule 535.20(a).

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Massachusetts SJC Opinion Imposes Non-Waivable Statutory Dutyon Commercial Landlords to Repair Unsafe Conditions

Laura D’Amato*Karen O’Malley**Megan Watts***Goulston & Storrs, P.C.Boston, MA

Earlier this year, the Massachusetts Supreme Judicial Court held that a decades-old statute imposing a duty to repair unsafeconditions applies to commercial landlords, and that such duty cannot be waived by contract. The decision, Bishop v. TESRealty Trust, 459 Mass. 9 (2011), further extends protections once thought to be reserved for residential tenants and, whenlooked at in the context of several other recent Massachusetts cases, suggests a trend toward the regulation of commercialtenancies in Massachusetts.

Bishop v. TES Realty TrustIn this case, a commercial tenant sought damages for a personal injury she sustained as a result of a leaking roof. The tenant,who had previously provided written notice to the landlord about the leaking roof, claimed that the leaking roof was an“unsafe condition,” and, therefore, subject to Mass. Gen. Laws c. 186, § 19. This statute requires a landlord to “exercise rea-sonable care” to correct an “unsafe condition, not caused by the tenant, his invitee, or any one occupying through or underthe tenant,” when a tenant has provided written notice to the landlord of the unsafe condition. If the landlord fails to correctthe duly-noticed unsafe condition within a “reasonable time,” a tenant or any other person rightfully on the premises who isinjured as a result of the condition may sue the landlord for damages. This duty may not be waived by contract, and any pro-vision that attempts to do so is “void and unenforceable.”

M.G.L. c. 186, § 19 has been regularly applied to residential landlords. Prior to Bishop, however, the court had notaddressed whether this statutory obligation also applied to commercial landlords. Although the law does not exempt com-mercial landlords on its face, parties to commercial leases have long operated as if that were the case. The Bishop court foundthat there was nothing in the plain language of the statute or the legislative history to suggest that it did not apply to com-mercial landlords. Thus, the court held that commercial landlords could be found liable under the statute and that the obliga-tions imposed by the statute could not be waived. It is worth noting that in addition to direct action by a tenant against thelandlord, the statute has been interpreted to require the landlord to reimburse a tenant who has settled a claim of an individ-ual injured as a result of the failure to repair the unsafe condition.

Although the duty imposed on a landlord as a result of this decision cannot be waived, the decision does not invalidatelease provisions that impose a duty to repair on the tenant. The Bishop court noted that with respect to a lease that places theduty to repair on the tenant, the costs of any such repairs could be billed to the tenant. Therefore, if a landlord undertakesrepairs after notice from the tenant of an “unsafe condition,” the landlord will still be able to obtain reimbursement from thetenant.

Nevertheless, the holding in Bishop imposes on landlords’ liabilities to third parties, which landlords previously wouldnot have expected. Under the common law, in the commercial lease context, if a tenant agreed to be responsible for repairs(e.g., within the tenant’s premises), then the landlord would not have liability to third parties arising from the tenant’s failureto perform those responsibilities. After Bishop, a tenant can change the landlord’s exposure to third parties by sending thelandlord notice of a dangerous condition that the tenant should have cured. Accordingly, commercial landlords inMassachusetts should consider including terms in their leases such as:

• A landlord self-help right allowing the landlord the right to cure tenant defaults, including the failure to per-form necessary repairs, and charge the tenant for the cure costs; and

• A landlord right of access to inspect the tenant’s premises to determine whether dangerous conditions exist.

The following is a sample provision that incorporates both of these concepts:

The Landlord and its designees shall have the right to enter upon the demised premises at all reasonable hoursfor the purpose of inspecting or making repairs to the same or exhibiting the same to prospective purchasers andlenders. If repairs are required to be made by the Tenant pursuant to the terms hereof or if the Tenant is requiredto perform any other obligation under this lease, the Landlord may demand that the Tenant make such repairs orperform such obligation forthwith, and if the Tenant refuses or neglects to commence such repairs or performanceand complete the same with reasonable dispatch, after such demand, the Landlord may (but shall not be requiredto) make or cause such repairs or performance to be done and shall not be responsible to the Tenant for any loss

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or damage that may accrue to its stock or business by reason thereof. If the Landlord makes or causes suchrepairs or performance to be done, or endeavors so to do, the Tenant agrees that it will forthwith, on demand,pay to the Landlord the cost thus incurred, and if the Tenant shall default in such payment, the Landlord shallhave the remedies provided in Section _____ hereof.

Additionally, in drafting a commercial lease, a landlord (and its legal counsel) should also be conscientious to require its ten-ants to obtain commercial liability insurance in sufficient amounts naming landlord and its managing agent as additionalinsured parties.

While these provisions, which are common in a commercial lease, will not excuse landlords from their statutory obliga-tions, they should help clarify the parties’ respective rights and obligations, including tenants’ financial obligations, as thelaw in this area continues to evolve.

The Trend Toward Increased Regulation of Commercial Tenancies The Massachusetts SJC Court has issued several decisions in recent years, which depart from the traditional expectation thatparties to a commercial lease will be free to negotiate the terms of their agreement without interference from government reg-ulation or public policy concerns. These cases suggest a move away from emphasizing commercial parties’ freedom to con-tract toward increased consumer protectionism, where the commercial tenant is the consumer.

2002: Wesson v. Leone Enterprises, Inc.Here, the Massachusetts Supreme Judicial Court “abandon[ed] the common-law rule of independent covenants in commer-cial leases,” finding instead “in favor of the modern rule of mutually-dependent covenants as reflected in the Restatement(Second) of Property (Landlord and Tenant) § 7.1 (1977).” 437 Mass. 708 (2002). By holding that covenants within a commer-cial lease are mutually dependent, the court established that, “[e]xcept to the extent the parties … validly agree otherwise,” atenant could be relieved of certain obligations under a lease (e.g., the obligation to pay rent) due to the failure of the landlordto fulfill its obligations under the lease (e.g., the obligation to provide a dry space and minimal heating). The Wesson court’sanalysis was tied to a shift in perspective—from viewing the commercial lease as a conveyance of land to viewing it as a con-tract for possession of property. As a result of the rule, Massachusetts commercial tenants had new, non-negotiated leverageunder existing commercial leases and were able to exercise rights not previously tied to the provisions of their leases.

In response to the holding of Wesson, in order to limit a tenant’s right to abate rent or terminate its lease, a landlordshould consider incorporating language into its commercial lease forms such as:

In no event shall Tenant have the right to terminate or cancel this lease as a result of any default by Landlord orbreach by Landlord of its covenants or any warranties or promises under this lease, except in the case of an actualwrongful eviction of Tenant from the demised premises or a constructive eviction of the Tenant resulting from abreach or default by Landlord that renders the premises untenantable for the purposes for which it was rented.

A more tenant-friendly lease might include language that more closely resembles the following:

The Landlord shall in no event be in default in the performance of any of its obligations hereunder unless anduntil the Landlord shall have failed to perform such obligations within thirty (30) days or such additional time asis reasonably required to correct any such default after notice by the Tenant to the Landlord properly specifyingwherein the Landlord has failed to perform any such obligation. If Landlord shall fail to perform any covenant,term or condition of this lease upon Landlord’s part to be performed, Tenant may not terminate this lease andTenant’s sole remedies shall be money damages and injunctive relief, except in the case of (a) a substantial breachor default by Landlord of its obligations under this lease which materially and adversely affects the Tenant’s abil-ity to conduct business from the demised premises and for which Tenant has no other remedy under this lease orin equity, or (b) a wrongful eviction of Tenant from the demised premises (constructive or actual) by Landlord.

2010: Norfolk & Dedham Mutual Fire Ins. Co. v. MorrisonThe SJC ruled in Norfolk & Dedham Mutual Fire Ins. Co. v. Morrison, 456 Mass. 463 (2010) that M.G.L. c. 186, § 15, under whichlease provisions that require a tenant to indemnify the landlord or release the landlord from liability for the landlord’s ownnegligence are void, was applicable to commercial leases.1 In so holding, the court looked at the plain language of the statutewhich, like the statute at issue in Bishop, did not distinguish between residential and commercial leases. The 2010 holding wasnot altogether surprising among Massachusetts practitioners. It was commonly assumed that the statute would apply to resi-dential and commercial leases alike. Nevertheless, the holding required increased attention by commercial landlords, specifi-cally with respect to the relationship between waivers of subrogation and self-insurance provisions. A typical waiver of sub-rogation in a commercial lease waives each party’s rights to seek remedies against the other party, to the extent that a claim iscovered by insurance, and requires the insurance companies of each party to provide similar waivers; in other words, if aclaim is covered by insurance, then any further recovery is waived.

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After Norfolk & Dedham Mutual Fire Ins. Co., a commercial lease that (i) provides for a waiver of subrogation by the ten-ant and (ii) allows a tenant to self- insure now places the landlord in danger of being liable to the tenant for a claim due to thelandlord’s own negligence, regardless of the waiver of subrogation. The landlord is at risk because, to the extent that the ten-ant plays the role of both tenant and insurer (by self-insuring), a waiver of subrogation could be interpreted as a release bythe tenant of the landlord from liability for the landlord’s own negligence because the tenant, as insurer, agreed not to pursueany further recovery under the waiver of subrogation. Such an agreement could be deemed void in Massachusetts becausethe applicable statute protects the tenant and does not distinguish between the tenant as lessee and the tenant as insurer.2

The combination of Wesson, Norfolk & Dedham Mutual Fire Ins. Co., and now Bishop, suggests a trend toward increasedprotection of tenants under commercial leases in Massachusetts. These protections, particularly the duty to repair, may comeas a surprise to out-of-state landlords, who may be used to states that impose no additional duties upon a commercial land-lord, or that impose only a more limited form of duty based upon the implied warranty of habitability/suitability.

Among such states, California, Florida, Minnesota and New York all maintain that commercial landlords have no obli-gation to maintain or repair leased premises absent express covenants, although their reasoning varies. In California, thefocus has been primarily on the relatively equal bargaining power between commercial tenants and landlords (in contrastwith the dynamic between residential tenants and landlords),3 whereas both Minnesota and New York case law emphasizes acommercial tenant’s control over the property.4 Some states have, however, adopted the concept of an implied warranty forcommercial leases. For example, Texas has recognized an implied warranty of suitability in commercial leases since 1988.5

This warranty, may, however, be waived by express lease language,6 and it cannot give rise to a tenant’s personal injury claimon its own.7 New Jersey also recognizes an implied warranty of fitness for commercial leases,8 but New Jersey courts do notview the warranty as creating an affirmative duty for a landlord to make repairs; instead the warranty provides a defense tonon-payment for a tenant.9 Moreover, a breach of the implied warranty does not, by itself, provide a tenant with a cause ofaction for personal injury.10

While providing some protection for commercial tenants, none of the states surveyed appears to go as far asMassachusetts. As a result of Bishop, commercial landlords in Massachusetts (and their legal counsel) will need to revisit theirleases and consider including provisions such as a landlord self-help right and right of access to permit the landlord toinspect the tenant’s premises to determine whether dangerous conditions exist; to cure tenant defaults, including the failureto perform necessary repairs; and to charge the tenant for the cure costs. Insurance provisions also should be reviewed inlight of both Bishop (to provide for sufficient commercial liability coverage of the landlord and its managing agent) andNorfolk (to provide for coverage of claims resulting from the landlord’s negligence). Although these provisions cannot excuseMassachusetts landlords from their statutory obligations, they should help clarify the parties’ respective rights and obliga-tions as the law of commercial tenancies continues to evolve.

*LAURA D’AMATO is a Director in Goulston & Storrs’s Litigation and Employment groups. She represents corporate and indi-vidual clients in a variety of forums, including state and federal court and administrative proceedings.

**KAREN O’MALLEY is a Director in Goulston & Storrs’s Real Estate group. She brings 13 years of experience in real estate toclients in the areas of acquisition, permitting, financing and leasing of all types of commercial properties.

***MEGAN WATTS is an Associate in Goulston & Storrs’s Real Estate group.

1 For a more in-depth discussion of Norfolk & Dedham Mutual Fire Ins. Co., see O’Malley, Karen, and Morrissey, Erin E.,“Recent State Supreme Court Decision Has Significant Implications for Indemnity and Insurance Clauses in CommercialLeases.” Shopping Center Legal Update. Fall/Winter 2010.2 For suggested language, see Id.3 Glenn R. Sewell Sheet Metal, Inc. v. Loverde, 451 P.2d 721 (Cal. 1969). 4 See Raftery v. Toys “r” Us, Inc., 2007 U.S. Dist. LEXIS 44157 (S.D.N.Y. 2007) and Johnson v. Miller, 388 N.W.2d 26, 27–28 (Minn.App. 1986).5 Davidow v. Inwood North Professional Group – Phase I, 747 S.W.2d 373, 377 (Tex. 1988).6 Gym-N-I Playgounds, Inc. v. Snider, 220 S.W.3d 905 (Tex. 2007).7 See Housing Auth. of Beaumont v. Landrio, 269 S.W.3d 735, 748–49 (Tex. App. 2008); Porter v. Lumberman’s Investment Corp., 606S.W.2d 715, 717 (Tex. Civ. App. 1980). Though these cases dealt with the analogous implied warranty of habitability in resi-dential leases, Texas courts have not disturbed the rule in the commercial lease context.8 Reste Realty Corp. v. Cooper, 251 A.2d 444 (N.J. 1968); Gamble v. Connolly, 943 A.2d 202, 208 (N.J. Super. Ct. App. Div. 2007).9 See Marini v. Ireland, 265 A.2d 526 (N.J. 1970) and Reste Realty, supra.10 Patton v. Texas Co., 80 A.2d 231 (N.J. Super. Ct. App. Div. 1951).

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Cases

Colleen M. Leonard*Holland & Knight, LLPWashington, DC

Radius RestrictionsIn Almeda Mall, L.P. v. Shoe Show, Inc., 649 F.3d 389 (2011), a shopping center landlord in Houston, TX, learned the hard waythat by failing to craft a radius restriction narrowly, the landlord would end up in court trying to enforce the weak provisionby debating diction, parsing language and arguing over synonyms.

Almeda Mall, L.P. (“Landlord”) leased space in a shopping center to Shoe Show, Inc. (“Tenant”) for the retail sale ofshoes. Tenant’s trade name under the lease (was “The Shoe Dept.”). The Shoe Dept. lease provided for a radius restrictionthat expressly prohibited Tenant from operating another business under the same trade name (i.e., The Shoe Dept.) or under a“substantially similar trade name,” within 2 miles of the shopping center. Four years later, Tenant opened a retail shoe store400 feet away from the Landlord’s shopping center and operated the new store under the trade name “Shoe Show.”

Tenant’s lease also provided Tenant with an early termination right in the event Tenant’s annual gross sales did notmeet a minimum threshold. The termination right was exercisable by Tenant, provided that Tenant was not in default at thetime of its exercise. About a year after Shoe Show opened, Tenant exercised its early termination right. Landlord rejectedTenant’s exercise of the right, maintaining that Tenant was in default for violating the radius restriction by opening and oper-ating the second store under a substantially similar trade name as “The Shoe Dept.” Landlord asserted that as a result of thealleged default, Tenant had no right to an early termination of the lease. When Tenant nonetheless vacated the premises andceased paying rent, Landlord filed a complaint in federal court for Tenant’s breach of the lease.

The district court agreed with Landlord that the two trade names were substantially similar and granted Landlordsummary judgment based on Tenant’s breach of the lease. On appeal, the Fifth Circuit Court of Appeals reversed the deci-sion, finding the two trade names to not be substantially similar and, therefore, finding that Tenant was not in default underthe lease based on its opening of the second store.

The appellate court first noted what Tenant’s lease did not provide for: (i) Tenant was not prohibited from operating acompeting shoe store within the 2-mi. radius; (ii) Tenant was not prohibited from using a trade name with the word “shoe” init; and (iii) Tenant was not prohibited from using the trade name “Shoe Show,” despite such trade name being one of just afew trade names widely used by Tenant. The court maintained that Landlord failed to be clear and direct about that whichthe provision was intended to protect against (i.e., a rival shoe store operated by Tenant nearby), and the court declined toreward Landlord by drawing what might appear to be a logical conclusion that the trade names were substantially similarmerely because they both contained the word “shoe.” Instead the court, relying on Cleveland Opera Co. v Cleveland Civic OperaAssociation, 22 Ohio App. 400, 154 N.E. 352, 353 (1926), utilized a two-step test to determine whether the Tenant’s trade nameswere substantially similar.

Step One required that the court consider geographical or descriptive terms non-determinative as to substantial similar-ity since such terms generally do not describe the actual business entity but rather describe the nature of the operation. Inapplying Step One, the court maintained that the term “shoe” was generic and described the merchandise sold by Tenant, butdid not point to the identity of the proprietor (which a trade name purports to do). The court explained that if Landlord’sintent was to prohibit Tenant from operating another shoe business, Landlord should have expressly prohibited Tenant fromoperating another business under a trade name with the word “shoe” in it.

After disregarding the term “shoe” in its determination of whether the trade names were substantially similar, the courtemployed Step Two—determination of whether the other words in the name “result in apparent or obvious confusion.” Thecourt determined that “Dept.” and “Show” were not synonyms, and, if anything “imply two functionally different types ofestablishments.” Furthermore, the court asserted that the words were different in pronunciation, structure, appearance andverbal translation. The court concluded that the trade names were not substantially similar. The court held that Tenant didnot violate the radius restriction and trade-name provisions of Tenant’s lease by opening a second store under the trade-name“Shoe Show,” and Tenant was not prohibited from exercising its early termination right because of such acts.

The Shoe Show case certainly highlights the importance of clearly and directly fashioning a lease provision so that theintended result is specified in the lease, rather than relying on indirect methods to obtain the intended result and risking anunsuccessful outcome.

Tenant Estoppel CertificatesThe Court of Appeals of Georgia recently decided a case that demonstrates how critical it is for a tenant who certifies certainfacts and statements in an estoppel certificate to be certain that tenant has thoughtfully considered the accuracy and potentialimpact of those certified statements.

In Office Depot, Inc. v. District at Howell Mill, LLC, 309 Ga.App. 525 (2011), the appellate court upheld the trial court’sdecision that estopped Office Depot, Inc. (“Office Depot”) from claiming that a breach of its lease existed after Office Depotsigned an estoppel certificate certifying that “[t]o Tenant’s knowledge, Landlord is not in default in the performance or obser-

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vance of any of its obligations under any terms or provisions of the Lease.” In 2005, Office Depot entered into a shopping center lease with The District at Howell Mill, LLC (the “District”), for cer-

tain retail premises in Atlanta, GA. Under Office Depot’s lease, the District was prohibited from leasing premises in the shop-ping center to a tenant whose “primary business” at the time of execution is “the sale, leasing, distribution or displayof…school supplies.” A year and a half later, the District leased space in the center to The School Box, with a use provisionthat permitted the tenant to use the premises for:

[t]he display and sale at retail of educational supplies for school and home, including, but not limited to studentworkbook, teacher resource books, home school curriculum, children’s literature, teaching materials in all sub-jects, classroom decorations, educational toys and games, art and crafts supplies, school supplies, children’smusic and videos, software, classroom furniture, inspirational teaching materials and other products usually pur-chased by schools, teachers and parents of school age children, and for no other use.

Thereafter, in April 2007, ELPF Howell Mill LLC (“ELPF” and together with the District, the “Landlord”) desired topurchase a majority interest in the shopping center from the District, and as part of its due diligence, among other things, metwith representatives from both Office Depot and The School Box to discuss any existing problems with their respective leasesor with the District, visited the stores, reviewed The School Box lease, and obtained an estoppel certificate from Office Depot,which stated that Landlord was not in default under the lease as of such date.

In none of ELPF’s conversations with Office Depot representatives did Office Depot state that there were any Landlordviolations of the Office Depot lease. ELPF proceeded to purchase the interest in the shopping center. Office Depot notified theDistrict six months later that Landlord’s lease with The School Box violated Office Depot’s exclusive use provision, whichprovision permitted Office Depot to pay alternative rent if Landlord had not cured the breach within 60 days of notice toLandlord of the breach. The notice stated that Office Depot would commence paying alternative rent upon the expiration ofthe 60-day period if the breach was not cured. Office Depot’s exclusive use provision also gave Office Depot the right to ter-minate if, after six months of paying alternative rent to Landlord, the default was not cured. When Landlord did nothing tocure the alleged breach in the allotted time, Office Depot commenced paying alternative rent.

The following year, Office Depot sought a declaratory judgment that Landlord breached Office Depot’s exclusive useprovision. Landlord counterclaimed and sought summary judgment claiming that Office Depot was estopped from assertinga breach claim following its delivery of an estoppel certificate stating otherwise. When the trial court sided with Landlordand granted summary judgment, Office Depot appealed.

The appellate court upheld the trial court’s holding that the 2007 estoppel certificate precluded Office Depot’s claim forbreach of the lease, and the court countered Office Depot’s argument that ELPF relied on the estoppel certificate, and OfficeDepot’s alternative argument that ELPF’s reliance was not reasonable.

Office Depot then argued that it should be entitled to terminate the lease because the exclusive use provision providedOffice Depot with a right to terminate the Lease if the breach was not cured within six months of Tenant’s assertion ofLandlord’s violation. Office Depot argued that regardless of whether there was a Landlord violation, the language gaveOffice Depot the right to terminate if the violation was not cured within six months of the assertion of the violation. The courtdisagreed with Office Depot’s argument and held that the language granted Office Depot with a remedy only if there was abreach. Without a breach, there is no reason for a remedy.

As every tenant knows, an exclusive use provision is an extremely valuable tenant tool. The Court of Appeals ofGeorgia reinforced the importance that a party to an estoppel certificate needs to be thoughtful and thorough when executingthe certificate or agreeing to a lease modification including estoppel language to avoid losing valuable rights as a result ofcarelessness.

Landlord’s Duty to Mitigate A tenant negotiating a lease will typically want the lease assignment provision to require that the landlord will not unreason-ably withhold its consent in the event that the tenant requests the landlord’s approval of an assignment or sublease. Thatsame tenant will also generally insist that if the landlord terminates the lease because of a tenant breach, the landlord shouldmitigate its damages and make efforts to re-let the space. Ultimately, a tenant is looking for the landlord to act reasonably ormake reasonable efforts on both such occasions. Oftentimes, these two scenarios, and the efforts a landlord is required tomake as a result of such scenarios, are confused.

In Brennan Associates v. OBGYN Specialty Group, P.C., 127 Conn.App 746 (2011), a case recently decided by the AppellateCourt of Connecticut, the court clarified these two separate scenarios and the efforts a landlord must exert to satisfy its dutyor obligation.

The plaintiff, Brennan Associates (“Landlord”), was the owner of a shopping center in Trumbull, CT. Landlord leasedspace in the shopping center to OBGYN Specialty Group, P.C. (“OBGYN”) to be used for “the practice of medicine, obstetricsand gynecology.” The lease was scheduled to expire in September 2007. In 2004, OBGYN vacated the premises in order tomove to a larger space elsewhere, but continued to pay rent to Landlord. The lease provided that OBGYN could not assign orsublease its leasehold interest without Landlord’s consent, which “consent shall not be unreasonably withheld.”

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OBGYN made efforts to find a replacement tenant, and in December 2005, delivered a proposal to transfer the lease to atanning salon for the remainder of the lease in accordance with the terms and conditions of the lease. The tanning salon pro-posal, however, also requested a three-year renewal at a negotiated higher rental rate, and an option to renew for an addi-tional five years. Landlord never agreed to the tanning salon proposal but instead counter-offered to the tanning salon for afive-year lease at a higher rental rate. The parties never reached a deal.

In February 2006, OBGYN ceased paying rent, and in April 2006, Landlord delivered a notice to quit to OBGYN.OBGYN surrendered the premises a week later, and Landlord brought suit for OBGYN’s failure to pay rent and other chargesunder the lease. OBGYN filed a special defense, asserting that OBGYN was relieved of its performance under the leasebecause Landlord unreasonably withheld its consent to assignment amounting to a material breach.

The lower court found that while Landlord took reasonable steps to re-let the premises after delivering the notice toquit to OBGYN in April 2006, the Landlord’s refusal to accept an assignment or sublease to the tanning salon in December2005 constituted a failure by Landlord to mitigate its damages, which stopped OBGYN’s liability and exonerated OBGYNfrom liability as to the sums owed under the lease. The appellate court carefully considered the issue and reversed.

The appellate court began by addressing the issue of whether Landlord had a duty to mitigate its damages and, assum-ing the duty existed, at what point the obligation arose. The court cited well-established case law providing that, inConnecticut, the obligation of a landlord to mitigate damages arises only if the landlord manifests its intent to terminate thelease based on a breach of the lease by the tenant; and in such event, a landlord must only make reasonable efforts to mini-mize the damages. The court maintained that, in the instant case, Landlord’s duty to mitigate arose upon Landlord’s manifes-tation of an intent to terminate—Landlord’s delivery of the notice to quit to OBGYN in April 2006. Since the lower courtalready concluded that Landlord’s actions after April 2006 demonstrated reasonable efforts to re-let and satisfied Landlord’sduty to mitigate after such date, the appellate court turned to the issue of whether Landlord breached its obligation onanother basis.

The question before the appellate court was whether Landlord’s failure to approve of the tanning salon as a replace-ment tenant was a breach of Landlord’s obligations under the lease. The court determined that the tanning salon proposalwas not a proposal to sublease or assign the lease on the terms and conditions of the lease. Instead, the court characterized theproposal as a proposal for a new lease with a longer term, an option to renew and a change in use. Thus, the assignment andsublease provision of the lease did not apply to this scenario; instead Landlord was mitigating its damages by negotiatingwith the tanning salon tenant. The court maintained that Landlord had the full right to negotiate the terms of a proposed newlease and counter offer based on terms that Landlord finds more desirable and had no obligation to accept the tanning salon’sproposal without considering Landlord’s own interest. The court concluded that Landlord was not unreasonable for consid-ering the economic benefit of a longer lease and counter offering to the tanning salon to this effect. The tanning salon’s failureto accept Landlord’s counter offer does not make Landlord liable for a failure to mitigate damages. The court reversed thelower court’s decision and held that Landlord satisfied its duty to mitigate its damages. Furthermore, because the assignmentand sublease provision was never implicated, there was no need to consider whether Landlord unreasonably disapproved ofan assignment or sublease to the tanning salon.

Ultimately, the court unscrambled the duty to mitigate from the obligation that Landlord not unreasonably withhold itsconsent to an assignment. The decision rested upon the characterization of the tanning salon proposal, suggesting that wherea proposal to sublease or assign to a replacement tenant is a proposal to materially change the terms of a lease, the landlord isnot bound by any lease requirements regarding an assignment or sublease. This case begs the question of the efficacy ofrequiring that a Landlord not unreasonably withhold its consent to an assignment and sublease provision, since a proposal totransfer the lease that includes a change in a material term could invite a challenge as to whether the proposal might beviewed by the court as a proposal to assign or sublease, or whether the proposal is viewed as a proposal for a new lease.

Duty of CareA retail tenant entering into a lease has a number of palpable motivations for wanting to define clearly and unambiguouslythe location and scope of its leased premises. For example, base rent and operating expenses are typically calculated, basedupon the square footage of the leased premises. It is also important to the tenant to define the physical parameters of thepremises because it is the premises only to which the tenant has exclusive use under the lease. Tenant will want to specifyexactly which area the tenant is obligated to repair and maintain. On the flip side, the tenant will also want to delineateclearly in its lease any surrounding or adjacent area that does not comprise the leased premises, so as to avoid being subject toa duty of care toward invitees with respect to property not within the tenant’s control.

The Supreme Court of Idaho, in McDevitt v. Sportsman’s Warehouse, Inc., 151 Idaho 280 (2011), recently clarified that atenant in a multi-tenant shopping center does not owe its invitees a duty to keep the adjacent sidewalk free of hazards, or towarn its invitees about any such hazards, provided that the tenant did not cause the hazard itself.

In McDevitt, the plaintiff tripped and fell on a recessed irrigation box on the sidewalk outside of Sportsman’sWarehouse (“Sportsman’s”) located in a shopping center in Twin Falls, ID. The plaintiff filed suit in district court seeking per-sonal injury damages against Sportsman’s, Canyon Park, L.L.C. (“Landlord”), and various other ownership and propertymanagement entities. Each of the defendants, except for Sportsman’s, was dismissed from the complaint pursuant to a settle-ment agreement. Sportsman’s, however, filed for summary judgment, arguing that the plaintiff failed to provide sufficient

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evidence that Sportsman’s had a duty to the plaintiff to maintain the sidewalk in a safe and hazard-free manner, or to warnthe plaintiff of any unsafe conditions in the sidewalk. The district court granted Sportsman’s summary judgment on the duty-of-care issue. When the plaintiff appealed, the appellate court affirmed.

The appellate court recited existing case law that established the following rules of law: (i) a tenant has a duty to keepits premises reasonably safe; (ii) a tenant has a duty to keep reasonably safe the area over which it has control; and (iii) absenta contractual obligation or a controlling statute, a tenant in a multi-tenant shopping mall does not have control over the com-mon areas and, therefore, does not have a duty to keep them safe for invitees.

The court affirmed the district court’s holding that Sportsman’s did not owe the plaintiff a duty to keep the adjacentsidewalk free of the recessed irrigation box or to warn the plaintiff about the dangerous condition. The court’s holding restedon evidence that Sportsman’s lease unambiguously did not include the adjacent sidewalk as part of the leased premises (thecourt citing deposition evidence that the leased premises only extended within the exterior walls of the building defined inthe lease). As to the control issue, the court found that the lease was clear that Sportsman’s was required to obtain Landlord’sconsent if Tenant desired to use the sidewalk area as a temporary extension of the leased premises, or to alter or change thesidewalk, and that Landlord had the duty to maintain the sidewalk area. Furthermore, Sportsman’s produced evidence thatLandlord had contracted with a management company to manage and maintain the common areas. It was clear to the courtthat Landlord, not Sportsman’s, retained control of the sidewalk area.

McDevitt supports the principle that a lease should clearly delineate the demised premises in order for the tenant (andthe landlord) to understand unambiguously the scope of their respective obligations on- and off-premises.

*COLLEEN M. LEONARD is an Associate, practicing commercial real estate in the Washington, D.C., office of Holland & Knight,LLP.

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From Canada

Rights of Landlords in Bankruptcy—May Be More Than Expected

Blair A. Rebane*Borden Ladner Gervais LLPVancouver, BC

On October 26, 2010, the British Columbia Court of Appeal (the “Court”) released its decision in Canadian Petcetera LimitedPartnership v. 2876 R Holdings Ltd., 2010 BCCA 469 [Petcetera], an important case that addressed the rights of a landlord to ter-minate a lease after a tenant has filed a notice of intention under the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (the“Act”). In its decision, the Court interpreted §§ 65.1 and 69(1) of the Act and concluded that those provisions do not prevent alandlord from terminating a lease for non-payment of rent due after the filing of a notice of intention. This decision is animportant one for landlords to take note of, as it may allow them to terminate undesirable leases with insolvent tenants fol-lowing the filing of a notice of intention, provided that those tenants had breached the lease in some manner prior to the fil-ing of the notice of intention, or failed to pay rent following the filing of the notice of intention.

In Petcetera, a lease was entered into between the appellants, 2876 R Holdings Ltd. and Arnold Silber (collectively, the“Landlord”), and the respondent, Petco Animal Supplies, Inc. (the “Lease”). The tenant’s interest in the Lease was assigned toCanadian Petcetera Limited Partnership (“Petcetera”). Petcetera was far from punctual in its payment of the monthly rentunder the Lease. It failed to pay the rent by the due date in 23 of the 24 months in the years 2007 and 2008, and in each of thefirst three months in 2009.

The majority of leases contain default clauses. Some leases allow for monetary defaults to be cured by a tenant afternotice of default is given by a landlord, while other leases permit their termination after default without giving the tenantopportunity to cure the default. In Petcetera, the Lease contained a hybrid provision, which gave the tenant the opportunity tocure a default unless there was a history of tardy payments. In May 2008, the Landlord wrote to Petcetera, pointing out thatunder that provision of the Lease, it was entitled to repossess the premises without notice in the event of a future default as aresult of the tardy payments. However, no further steps were taken in that regard until Petcetera entered bankruptcy pro-ceedings.

On March 20, 2009, Petcetera filed a notice of intention to make a proposal under § 50.4(1) of the Act. By letter datedMarch 24, 2009, the Landlord demanded immediate payment of $14,379.94, representing the pro rata rent for the period ofMarch 21 to March 31, 2009, which had not yet been paid. This amount remained unpaid into April 2009. The cheque for therent due on April 1, 2009, was mailed by Petcetera on March 30, 2009, but was not received by the Landlord until April 2,2009. On the morning of April 2, 2009, before the April rent cheque was received, the landlord delivered a notice of termina-tion to the leased premises. The notice recited the default of Petcetera in failing to pay the pro rata rent for the period fromMarch 21 to 31, 2009, and the rent due on April 1, 2009. It stated that no notice of default was required under the Lease byvirtue of Petcetera’s failure to make the rent payments for January, February and March 2009 on their due dates. TheLandlord changed the locks and took possession of the premises.

On April 21, 2009, Petcetera commenced an action against the Landlord, seeking a declaration that the purported termi-nation of the Lease was invalid or, alternatively, an order to relieve it from the forfeiture of the lease. That action involved theinterpretation of §§ 65.1 and 69(1) of the Act, the relevant portions of which are as follows:

65.1 (1) If a notice of intention or a proposal has been filed in respect of an insolvent person, no person may terminate oramend any agreement, including a security agreement, with the insolvent person, or claim an accelerated payment, or a for-feiture of the term, under any agreement, including a security agreement, with the insolvent person, by reason only that

(a) the insolvent person is insolvent; or(b) a notice of intention or a proposal has been filed in respect of the insolvent person.

(2) Where the agreement referred to in subsection (1) is a lease or a licensing agreement, subsection (1) shall be read asincluding the following paragraph:

(c) the insolvent person has not paid rent or royalties, as the case may be, or other payments of a similar nature, inrespect of a period preceding the filing of

(i) the notice of intention, if one was filed, or (ii) the proposal, if no notice of intention was filed.

(3) Where a notice of intention or a proposal has been filed in respect of an insolvent person, no public utility may discon-tinue service to that insolvent person by reason only that

(a) the insolvent person is insolvent;

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(b) a notice of intention or a proposal has been filed in respect of the insolvent person; or(c) the insolvent person has not paid for services rendered, or material provided, before the filing of

(i) the notice of intention, if one was filed, or(ii) the proposal, if no notice of intention was filed.

(4) Nothing in subsections (1) to (3) shall be construed(a) as prohibiting a person from requiring immediate payment for goods, services, use of leased or licensed property orother valuable consideration provided after the filing of

(i) the notice of intention, if one was filed, or(ii) the proposal, if no notice of intention was filed;

(b) as requiring the further advance of money or credit…

(5) Any provision in an agreement that has the effect of providing for, or permitting, anything that, in substance, is contraryto subsections (1) to (3) is of no force or effect.

(6) The court may, on application by a party to an agreement or by a public utility, declare that subsections (1) to (3) do notapply, or apply only to the extent declared by the court, where the applicant satisfies the court that the operation of those sub-sections would likely cause it significant financial hardship.[…]69. (1) Subject to subsections (2) and (3) and sections 69.4, 69.5 and 69.6, on the filing of a notice of intention under sec-tion 50.4 by an insolvent person,

(a) no creditor has any remedy against the insolvent person or the insolvent person’s property, or shall commence or con-tinue any action, execution or other proceedings, for the recovery of a claim provable in bankruptcy . . . until the filing ofa proposal under subsection 62(1) in respect of the insolvent person or the bankruptcy of the insolvent person.

Section 69(1) of the Act states that once a notice of intention has been filed, no creditor has any remedy against theinsolvent person and they are stayed from commencing or continuing any action, execution or other proceeding for the“recovery of a claim provable in bankruptcy.” The Court noted that the purpose of that section is to avoid a multiplicity ofproceedings and to prevent any single unsecured creditor from obtaining priority over any other unsecured creditor by bring-ing an action and executing a judgment against the debtor.

Where the debtor is a tenant, § 65.1 of the Act prevents a landlord from terminating the lease by reason only that thetenant has not paid rent in respect of the period preceding the filing of the notice of intention. The substance of that provision,according to the Court, is to prevent landlords from basing their entitlement to terminate on non-payment of rent in respect ofthe period preceding the filing of the notice of intention. The Court explained that the combined purpose of §§ 65.1 and 69(1)is to maintain the status quo among creditors at the time of the filing of a notice of intention and to preserve the debtor’sassets during the reorganization process.

The Court found that the language of § 65.1 only prevents the termination of a lease in cases where the only default giv-ing rise to the entitlement to terminate is non-payment of rent in respect of the period preceding the filing of the notice ofintention. However, the Court held that § 65.1 does not preclude a landlord from terminating a lease for default in payment ofrent occurring after the date of filing. Similarly, the Court noted that § 69(1) is limited to remedies for the recovery of “claimsprovable in bankruptcy” and does not apply to the termination of leases for default after filing of a notice of intention. TheCourt noted that while the termination of the lease is an exercise of a remedy, it is not the exercise of a remedy for the recov-ery of a claim provable in bankruptcy.

The Court’s analysis in Petcetera strongly suggests that other non-financial defaults occurring before or after the date of fil-ing of a notice of intention could entitle a landlord to terminate a lease. The stay in § 65.1 appears to have been limited by theCourt to cases where the landlord wishes to terminate exclusively on the basis of rent arrears at the time of the filing of the noticeintention. Similarly, the stay in § 69(1) seems to exclude non-financial defaults such as assigning or subletting without leave of thelandlord, changing the use of the premises or breaching restrictive covenants, since none of these defaults would give rise to aclaim provable in bankruptcy. As a result, if landlords want to ensure that they retain the ability to terminate a lease after the filingof a notice of intention, it will be crucial that they maintain information of any of these types of default.

The Court’s decision in Petcetera is significant because it clarifies the scope of the stays set out in §§ 65.1 and 69(1) of theAct, and confirms that, in certain circumstances, landlords will retain the right to terminate a lease after a notice of intentionhas been filed. However, it is important to note that the principles set out in this case are very broad. Any landlord planningto terminate a lease should carefully review the specific provisions of the lease since any steps taken to enforce rights mustcomply with the provisions of the lease and not otherwise affect any rights of a tenant in bankruptcy.

*BLAIR REBANE is a Partner at the Vancouver office of Borden Ladner Gervais LLP. He is the National Leader of the Franchiseand Distribution Group, and has extensive experience with advising franchisors in all types of franchise matters. In addition,he practices in the area of construction and contract law. His clients include a number of Canada’s largest franchisors, manu-facturers and those involved at all levels of the construction industry.

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