<b><i>In the Spotlight:</i></b> How to Protect Against a Lawsuit By the Beneficiary of an Exclusive

An exclusive-use provision is one of the landlord's least favorite provisions in the lease, because it limits the landlord's right to lease other space in its shopping center, and usually carries a penalty ' rent reduction and a right to terminate the lease are the most common ' in the event that the exclusive is violated. Accordingly, a landlord generally tries to limit an exclusive use provision as much as it can. Two common ways to limit an exclusive use provision are: 1) to grant a conditional remedy rather than make a covenant; and 2) to make a personal covenant rather than a real covenant. Both of these approaches should ensure that a tenant will not be entitled to sue a co-tenant over a violation of the tenant's exclusive.

Condition Versus Covenant

The best way for a landlord to limit an exclusive is to offer a tenant limited remedies if a co-tenant operates a competing business rather than to agree (covenant) that the landlord will not allow a co-tenant to sell particular goods or services. In this scenario, the landlord agrees that if (i.e., the condition) a co-tenant sells certain competing goods or services, and if (ah, another condition) the original tenant demonstrates a loss of sales, then the original tenant has a limited remedy: Reduce fixed rent, pay a percentage of sales in lieu of fixed rent and, finally, perhaps terminate the lease after a sustained period of reduced sales.

In this type of provision, the landlord has not really promised to do anything that, if violated, could become a breach of the lease. Accordingly, the tenant has no right to sue the landlord or the co-tenant for damages, and has no equitable remedies.

Personal Covenant Versus Real Covenant

If the landlord does not have enough leverage to limit the “exclusive” to a conditional remedy, then the next best thing is to make it a “personal” covenant rather than a “real” covenant. What's the distinction between the two? A personal covenant is an agreement that the landlord has personally made for the benefit of the tenant. Accordingly, the tenant cannot enforce it against other tenants or occupants of the shopping center. A personal covenant might be worded: “Landlord covenants that it will not lease any property located within the shopping center for use as a shoe store.”

If the landlord later leases property in the shopping center to a different tenant for use as a shoe store, then the beneficiary of the shoe store exclusive can claim that the landlord has violated its covenant. It cannot, however, sue the co-tenant, because the co-tenant did not promise it would not sell shoes; rather, only the landlord covenanted that it would not lease property for the sale of shoes.

On the other hand, a real covenant is a property interest that affects the land instead of simply the landlord. As Tanya D. Marsh and Stefan Szwarc note in the article, “Transforming Lease Covenants into Real Covenants: Lessons from Winn-Dixie v. Dolgencorp,” which appeared in Volume 29, No. 5 of Probate & Property magazine, real covenants differ from personal covenants in: 1) how they are interpreted; 2) which remedies are available for a breach; and 3) who is burdened by, and benefits from, the covenant. For purposes of this article, the last of these differences is the most significant, because a real covenant often (but not always ' state law varies on this point) runs with the land, and may be binding upon co-tenants of a shopping center.

In order for the shoe store exclusive to be a real covenant, it would have to be worded more like this: “Landlord covenants that no portion of the shopping center (except the demised premises) will be used for the sale of shoes. This covenant shall be binding upon the successors and assigns of the parties and shall run with the land.”

Also, the covenant should be included in a memorandum of lease or other document of record to put other tenants on notice of the limitation.

So far, this sounds pretty easy, right? The distinction is between the landlord agreeing what the landlord shall not do versus the landlord agreeing that certain things shall not happen in the shopping center. It feels similar to the distinction between a limited warranty deed, which protects a purchaser against the seller's actions while in title, versus a general warranty deed, which protects a purchaser against all items that affect title.

The problem, as Marsh and Szwarc point out, is that courts sometimes gloss over the distinction between personal and real covenants, effectively transforming a personal covenant into a real covenant. In order to guard against such transformation, landlords might add the following language at the end of a personal covenant: “Such covenant shall not run with the land, and shall not be binding upon other tenants or occupants of the shopping center.”

Lawsuits by Co-tenants

What if a landlord has made a real covenant to one tenant, and after a co-tenant begins to operate in violation of the real covenant, the original tenant sues the co-tenant? At first blush, it would seem that a landlord would prefer that a tenant sue a co-tenant of the shopping center rather than exercise its right to pay reduced rent or pursue other remedies under the lease. Hasn't the landlord dodged a bullet?

Maybe not. The landlord may wish to prevent the beneficiary from pursuing the co-tenant because that lawsuit may result in an injunction that prevents the co-tenant from operating in the shopping center. A closure may be problematic for a number of reasons. If the closed business occupies a prominent position in the shopping center, the closure may make it difficult for the landlord to attract new tenants to the shopping center. The closure may also trigger another tenant's right to pay reduced rent pursuant to its co-tenancy provision. Finally, a closed tenant cannot generate the gross sales that are necessary for the tenant to hit its breakpoint and trigger any obligation to pay percentage rent.

Additionally, the landlord could just end up being a party to multiple lawsuits. First, the beneficiary's lease may also contain a covenant of quiet enjoyment pursuant to which the landlord agrees that the tenant will enjoy the demised premises without interference from the landlord or anyone claiming by, through or under the landlord. Despite the limited remedies for a violation of the tenant's exclusive, the tenant may still be able to sue the landlord for damages or equitable remedies under the quiet enjoyment provision.

And if the co-tenant is sued by the beneficiary but believes it is not at fault, it could bring the landlord into that lawsuit or sue the landlord separately to recover its losses (for example, due to a court-ordered closure). It's possible that the landlord never told the co-tenant about this exclusive, maybe by oversight, or maybe because the co-tenant's lease had a limited permitted-use clause that the landlord believed didn't permit the co-tenant to sell shoes. If the co-tenant was not told of the exclusive, or if it has a different interpretation of its lease, landlord could find itself sued not only by the beneficiary of the exclusive, but also by the co-tenant who has been sued for a violation for which it does not believe it is responsible.

To avoid these results, the landlord should expressly prohibit the beneficiary of an exclusive from suing co-tenants in the shopping center by: 1) indicating that the rights of the beneficiary set forth in the exclusive provision ' which rights should not include “all other rights at law or in equity” ' are the beneficiary's sole and exclusive remedies in the event of a violation of the exclusive; 2) making it clear that the exclusive does not run with the land; or 3) adding language along these lines:

In no event shall Tenant be entitled to seek any damages or other relief from, or bring any cause of action against, any other tenant or occupant of the shopping center for any alleged or actual violation of this paragraph.

Next month, we will look at the issue of exclusives from the perspective of co-tenants.

Ruth Schoenmeyer is of counsel to Chicago's Pircher, Nichols & Meeks.