Revisiting Inquiry Notice

The trial court granted summary judgment to First American Bank, finding that First American Bank had no actual or constructive notice of the restrictions contained in the Lease, and that further investigation would have placed 'too great a burden' on First American Bank based on the attenuated connection between the leased premises and the outparcel. The appellate court reversed, holding that First American Bank had knowledge of facts sufficient to put it on inquiry notice of the Lease. In remanding the case for further proceedings, the appellate court emphasized that First American Bank had knowledge that the outparcel was burdened by reciprocal easements and that the outparcel was located adjacent to a shopping center. According to the appellate court, these circumstances were sufficient to require further inquiry as to the probable easement rights of shopping center tenants.

Flawed Analysis

The appellate court's analysis seems flawed in several respects. First, the appellate court suggests that conventional reliance on title insurance is insufficient when assessing potential easement rights and restrictions in a shopping center context. This suggestion is inconsistent with industry custom and practice. The lease restrictions at issue were not contained in any recorded document or otherwise directly in the chain of title with respect to the outparcel. The original memorandum of lease was not recorded against the outparcel. If the easement rights and restrictions had been so material to the lease transaction, they should have been expressly set forth in the original memorandum of lease, and the parties should have ensured that the memorandum of lease was recorded against the outparcel, and not just against the adjacent shopping center property.

Admittedly, Murray's was not a party to the original lease transaction, but as between a bona fide purchaser and a party seeking enforcement of an implied property restriction, equity should not favor the party who could have most easily avoided the issue, namely a tenant. Here, that would translate into recording a proper memorandum of lease or other document of record against the outparcel. This was not done. At the very least, equity should not impose liability on the party who did not create the issue, namely a bona fide purchaser. The appellate court dismissed this logic and instead elected to focus on the existence of the reciprocal easement agreement which, as amended, contained a reference to the lease as a permitted title exception ' which reference, when taken together with the existence of the reciprocal easements, presumably was sufficient to place a prudent person on notice of the potential additional easement rights and restrictions.

At best, the appellate court's rationale ' such as it was ' leaves the unanswered questions: Should the existence of reciprocal easements lead to any other conclusion, such as the existence of exclusive agreements, use restrictions, sign prohibitions, view corridor prohibitions, or the like? Should a buyer assume that any such restrictions exist even if they cannot be gleaned from the public record or are not contained in the deed of conveyance?

The answer should be apparent ' a resounding 'no.' However, the logic implied by the appellate court takes a different direction and belies common sense, thereby creating new uncertainty as to the meaning of covenants running with the land. Consequently, shopping center owners and outlot buyers should each pay close attention to the appellate court's analysis and plan appropriately.

Conclusion

From the shopping center owner's perspective, Murray's Discount Auto highlights the need for an effective tracking system of all non-record grants and restrictions that may be contained in leases and related project agreements and the need to memorialize such rights and restrictions to ensure that they properly burden the intended property. Any outlot sale transaction should be documented in such a manner that the relevant rights and restrictions of shopping center tenants are adequately disclosed and protected, preferably by deed or other recordable instrument. As an alternative, the shopping center owner may entertain structuring lease provisions that would sever the outparcel from the balance of the shopping center upon conveyance, not just for cost recovery and related accounting matters, but for all intents and purposes. However, such a provision would undermine the intent of the parties in originally creating the easement rights and restrictions.

From the outlot purchaser's perspective, there are a number of important lessons to be taken from Murray's Discount Auto. First and foremost, the outlot buyer should require the shopping center seller to make appropriate representations and warranties as to the existence of any unrecorded restrictions which would bind the outparcel, material or otherwise. By requiring such representations and warranties, the outparcel buyer should be able to flush out any potential troublesome issues. The title insurer should also require similar disclosure. Second and similarly, to the extent any memorandum of lease or reciprocal easement agreement appears of record with respect to any shopping center property, the outlot buyer should diligently examine the same and related documents to satisfy itself of any potential easement rights and restrictions. Third, the purchase and sale documentation should adequately provide for review and approval procedures for any proposed improvements to be constructed by the outparcel buyer. In this manner, any potential surprise or uncertainty can be avoided or resolved during the due diligence process, and not post-closing.

It is hoped that Murray's Discount Auto represents an anomaly in the established doctrine of inquiry notice. However, the implication of Murray's Discount Auto cannot be minimized. When purchasing an outlot or other property adjacent to a shopping center project, the buyer would be well advised to make pointed inquiries as to non-record matters, including leases and reciprocal easement and like agreements, and the shopping center owner should ensure that these matters are adequately disclosed. Failing to do so may result in unintended and disruptive consequences, which may be easily avoided with appropriate counsel and due diligence.

D. Albert Daspin practices with Daspin & Aument LLP in Chicago, representing national and regional developers in acquisition, entitlement, construction, financing, leasing, build-to-suit, sale, and related development matters. His development practice spans office, retail, industrial, and residential property types.

A recent Illinois Appellate Court decision should lead to increased underwriting and due diligence inquiries by purchasers (and title insurers) of shopping center outparcels (that is smaller parcels at the center's perimeter that the shopping center owner intends to sell or lease for high-traffic uses) and may redefine appropriate inquiry notice throughout the retail industry. In Murray's Discount Auto Stores, Inc. v. USRP Texas, L.P. and First American Bank, Case No. 1-02-3434, the Appel-late Court of Illinois, First Judicial District, held that the purchaser of a shopping center outparcel had knowledge of facts sufficient to put it on inquiry notice as to the existence of a no-build restriction contained in an unrecorded lease at adjacent shopping center property. In so doing, the appellate court sent a loud and clear message that shopping center easement rights and restrictions will be exalted at the expense of buyers who fail to take additional due diligence inquires that may be warranted under the circumstances.

In Murray's Discount Auto, plaintiff Murray's Discount Auto Stores, Inc. ('Murray's'), succeeded to the interest of Trak Auto Corporation, as tenant, pursuant to a lease agreement dated November 1995 (the 'Lease') between the original shopping center developer and Trak Auto Corporation, a memorandum of which was recorded against the shopping center property in June 1996. A lease assignment and assumption was executed in connection with the bankruptcy of Trak Auto Corporation and was approved by the bankruptcy court in January 2002. The Lease included a so-called no-build restriction pursuant to which 'no buildings, kiosks or building type structures' were to be constructed within the designated 'Protected Area.' Subsequent to the initial demise of the leased premises, the shopping center property was conveyed on two separate occasions, the last of which occurred in 1999. Sandwiched between the separate sale transactions, the shopping center owner conveyed an outparcel to American Chartered Bank and, as part of such outparcel sale transaction, the parties entered into a reciprocal easement agreement pursuant to which certain reciprocal easement grants and rights were established. In July 2001, American Chartered Bank conveyed the outparcel to First American Bank, and as part of such transaction, the parties amended the original reciprocal easement agreement.

The outparcel was located at the corner of the shopping center adjacent to the leased premises. Shortly after Murray's took possession of the leased premises, First American Bank commenced construction of a branch banking facility on the outparcel. Murray's filed suit to enjoin construction based upon interference with the easement rights in the common areas demised pursuant to the Lease, specifically claiming that First American Bank constructed a retaining wall that entered a portion of the Protected Area in violation of the Lease and that First American Bank intentionally interfered with Murray's easement rights.

The trial court granted summary judgment to First American Bank, finding that First American Bank had no actual or constructive notice of the restrictions contained in the Lease, and that further investigation would have placed 'too great a burden' on First American Bank based on the attenuated connection between the leased premises and the outparcel. The appellate court reversed, holding that First American Bank had knowledge of facts sufficient to put it on inquiry notice of the Lease. In remanding the case for further proceedings, the appellate court emphasized that First American Bank had knowledge that the outparcel was burdened by reciprocal easements and that the outparcel was located adjacent to a shopping center. According to the appellate court, these circumstances were sufficient to require further inquiry as to the probable easement rights of shopping center tenants.

Flawed Analysis

The appellate court's analysis seems flawed in several respects. First, the appellate court suggests that conventional reliance on title insurance is insufficient when assessing potential easement rights and restrictions in a shopping center context. This suggestion is inconsistent with industry custom and practice. The lease restrictions at issue were not contained in any recorded document or otherwise directly in the chain of title with respect to the outparcel. The original memorandum of lease was not recorded against the outparcel. If the easement rights and restrictions had been so material to the lease transaction, they should have been expressly set forth in the original memorandum of lease, and the parties should have ensured that the memorandum of lease was recorded against the outparcel, and not just against the adjacent shopping center property.

Admittedly, Murray's was not a party to the original lease transaction, but as between a bona fide purchaser and a party seeking enforcement of an implied property restriction, equity should not favor the party who could have most easily avoided the issue, namely a tenant. Here, that would translate into recording a proper memorandum of lease or other document of record against the outparcel. This was not done. At the very least, equity should not impose liability on the party who did not create the issue, namely a bona fide purchaser. The appellate court dismissed this logic and instead elected to focus on the existence of the reciprocal easement agreement which, as amended, contained a reference to the lease as a permitted title exception ' which reference, when taken together with the existence of the reciprocal easements, presumably was sufficient to place a prudent person on notice of the potential additional easement rights and restrictions.

At best, the appellate court's rationale ' such as it was ' leaves the unanswered questions: Should the existence of reciprocal easements lead to any other conclusion, such as the existence of exclusive agreements, use restrictions, sign prohibitions, view corridor prohibitions, or the like? Should a buyer assume that any such restrictions exist even if they cannot be gleaned from the public record or are not contained in the deed of conveyance?

The answer should be apparent ' a resounding 'no.' However, the logic implied by the appellate court takes a different direction and belies common sense, thereby creating new uncertainty as to the meaning of covenants running with the land. Consequently, shopping center owners and outlot buyers should each pay close attention to the appellate court's analysis and plan appropriately.

Conclusion

From the shopping center owner's perspective, Murray's Discount Auto highlights the need for an effective tracking system of all non-record grants and restrictions that may be contained in leases and related project agreements and the need to memorialize such rights and restrictions to ensure that they properly burden the intended property. Any outlot sale transaction should be documented in such a manner that the relevant rights and restrictions of shopping center tenants are adequately disclosed and protected, preferably by deed or other recordable instrument. As an alternative, the shopping center owner may entertain structuring lease provisions that would sever the outparcel from the balance of the shopping center upon conveyance, not just for cost recovery and related accounting matters, but for all intents and purposes. However, such a provision would undermine the intent of the parties in originally creating the easement rights and restrictions.

From the outlot purchaser's perspective, there are a number of important lessons to be taken from Murray's Discount Auto. First and foremost, the outlot buyer should require the shopping center seller to make appropriate representations and warranties as to the existence of any unrecorded restrictions which would bind the outparcel, material or otherwise. By requiring such representations and warranties, the outparcel buyer should be able to flush out any potential troublesome issues. The title insurer should also require similar disclosure. Second and similarly, to the extent any memorandum of lease or reciprocal easement agreement appears of record with respect to any shopping center property, the outlot buyer should diligently examine the same and related documents to satisfy itself of any potential easement rights and restrictions. Third, the purchase and sale documentation should adequately provide for review and approval procedures for any proposed improvements to be constructed by the outparcel buyer. In this manner, any potential surprise or uncertainty can be avoided or resolved during the due diligence process, and not post-closing.

It is hoped that Murray's Discount Auto represents an anomaly in the established doctrine of inquiry notice. However, the implication of Murray's Discount Auto cannot be minimized. When purchasing an outlot or other property adjacent to a shopping center project, the buyer would be well advised to make pointed inquiries as to non-record matters, including leases and reciprocal easement and like agreements, and the shopping center owner should ensure that these matters are adequately disclosed. Failing to do so may result in unintended and disruptive consequences, which may be easily avoided with appropriate counsel and due diligence.

D. Albert Daspin practices with Daspin & Aument LLP in Chicago, representing national and regional developers in acquisition, entitlement, construction, financing, leasing, build-to-suit, sale, and related development matters. His development practice spans office, retail, industrial, and residential property types.