Thrift Store Wasn’t ‘Qualified Replacement’ for Retail Tenant

Facts: A shopping center tenant signed a 10-year lease with a five-year extension option. Under the lease, the tenant had the right to renegotiate the terms of the extension period, including the rental rate. At the time that the tenant signed the lease, the center included several large tenants, including a national clothing department store. The department store was named a “key tenant” in the lease, which included cotenancy provisions obligating the owner to replace key tenants with “replacement tenants” that are substantially similar to the key tenant and to abate or reduce rent during the time that a key tenant’s space remains vacant. The lease also stated that the cotenancy provision would not be changed, modified, or added to except in writing signed by the owner and tenant.

When the department store vacated its space, the owner replaced it with a thrift store. The tenant began paying reduced rent, claiming that the thrift store didn’t qualify as a replacement tenant similar to the department store, so its cotenancy right had been violated. But the tenant still wanted to extend its lease.

In a series of emails between the tenant’s real estate manager and the owner’s attorney negotiating an extension of the lease, the tenant asserted that it wanted the then-current cotenancy violation provisions in the lease to stay in effect—meaning that the tenant would continue to pay reduced rent until a replacement tenant replaced the thrift store. The tenant later informed the owner that it would leave the center. But the owner claimed that the email communications constituted a valid and enforceable modification of the lease—an extension—which the tenant would breach if it moved out. The owner sued the tenant, arguing that the lease had been extended and that, under the terms of the extension, the tenant was required to resume paying base rent, not the reduced rent. 

Decision: A Tennessee court ruled in favor of the tenant.

Reasoning: When making its decision, the court had to take into account whether: (1) the email communications between the tenant and owner constituted a valid and enforceable modification of the lease; and (2) the thrift store was a qualified replacement for the anchor tenant, which would determine whether the owner had violated the cotenancy provision.

The court determined that the email communications weren’t a valid, enforceable agreement to modify the lease for two reasons. First, neither the manager nor the attorney had actual authority to accept offers or acceptances of any lease proposals; the scope of their roles in the negotiating process was to relay information from the owner and tenant regarding proposed terms. Second, the owner and tenant rejected some of the terms in every email proposal that was offered to each another, instead offering its own new and different terms. The court noted that “a proposal to accept, or an acceptance, upon terms varying from those offered, is a rejection of the offer and puts an end to the negotiation unless the party who made the original offer renews it, or agrees to the modifications suggested.” Here, neither party ever agreed to the exact terms that were offered by the other party. The emails were labeled “Proposed Modification Option” and weren’t signed by both parties, which was required under the lease for the tenant and owner to reach a final agreement on the terms of a lease modification they would be bound to.

The court also determined that the thrift store wasn’t a proper replacement for the department store under the lease. The lease required that the qualified replacement tenant must be substantially similar to the anchor tenant with respect to the: (1) quality, type, and mix of merchandise; (2) price points of merchandise; (3) type of customer; and (4) number of stores.

The court noted that the thrift store sold primarily "gently used" items, whereas the department store sold new, defect-free merchandise. The department store also had a greater mix of clothes and household items than the thrift store. And the price range at the two stores was substantially different: The thrift store’s price points were 80 percent to 99 percent below the prices of the department store. Also, the type of customer at the thrift store was substantially different from the customer at the department store, who would be willing to pay five to 20 times the amount on new merchandise compared to what a thrift store customer would be willing to spend on items at the thrift store. Finally, with respect to the number of stores, the thrift store had always had more stores than the department store.

The court decided that the tenant wasn’t required to stay at the center, but that if it did continue to operate at the center it would be entitled to pay reduced rent because of the cotenancy failure.

• Hickory Grove, LLC v. Rack Room Shoes, Inc., May 2012