Grand Prospect Partners v. Ross Dress for Less, Inc.

Filed 1/12/15
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIFTH APPELLATE DISTRICT
GRAND PROSPECT PARTNERS, L.P.,
F067327
Plaintiff, Cross-Defendant and Respondent,
(Super. Ct. No. VCU237296)
v.
OPINION
ROSS DRESS FOR LESS, INC. et al.,
Defendants, Cross-Complainants and
Appellants.
APPEAL from a judgment of the Superior Court of Tulare County. Paul A.
Vortmann, Judge.
Arnold & Porter, Sean M. SeLegue, Jerome B. Falk, Jr., Jeremy McLaughlin;
Bartko, Zankel, Bunzel & Miller, Benjamin K. Riley, Simon R. Goodfellow; Dowling
Aaron, Donald R. Fischbach and Steven M. Vartabedian for Defendants, Cross-
Complainants and Appellants.
Bingham McCutchen, Stephen Zovickian and Robert A. Brundage; Caswell Bell
& Hillison, Robert K. Hillison and Kimberly L. Mayhew for Plaintiff, Cross-Defendant
and Respondent.
Caldwell Leslie & Proctor, Christopher G. Caldwell, Michael D. Roth and Albert
Giang for California Retailers Association, The Gap, Inc., Bed Bath & Beyond Inc.,
H&M Hennes & Mauritz L.P., Petco Animal Supplies, Inc., and VF Outdoor, Inc. as
Amicus Curiae on behalf of Defendants, Cross-Complaints and Appellants.
-ooOoo-
This appeal addresses whether cotenancy provisions1 in a lease for retail space in a
shopping center are unconscionable or unreasonable penalties and, thus, not binding on
the landlord. The enforceability of cotenancy provisions has not been discussed in an
opinion published by a California appellate court. This opinion does not establish a
categorical rule of law holding cotenancy provisions always, or never, are enforceable.
Instead, it illustrates that the determination whether a cotenancy provision is
unconscionable or an unreasonable penalty depends heavily on the facts proven in a
particular case. Here, the facts show the provisions were not unconscionable and only the
rent abatement provision operated as an unreasonable penalty.
Grand Prospect Partners, L.P. (Grand Prospect), the owner and operator of the
Porterville Marketplace shopping center, filed this action to challenge the enforceability
of provisions in its commercial lease with Ross Dress For Less, Inc. (Ross). The
provisions conditioned Ross’s obligation to open a store and pay rent on Mervyn’s
operating a store in the shopping center on the commencement date of the lease, and also
granted Ross the option to terminate the lease if Mervyn’s ceased operations and was not
replaced by an acceptable retailer within 12 months.
The opening cotenancy condition was not satisfied because Mervyn’s filed for
bankruptcy and closed its store in 2008. As authorized by the lease, Ross took possession
of the space, never opened for business, never paid rent, and terminated the lease after the
12-month cure period expired.
Grand Prospect claims Ross was obligated to pay rent for the full 10-year term of
the lease because the provisions authorizing rent abatement and termination were
unconscionable or, alternatively, an unreasonable penalty and thus unenforceable. The
1 Lease provisions that require other stores in a shopping center to be occupied by
operating businesses generally are referred to as cotenancy requirements or conditions.
(See 1 Retail Leasing: Drafting and Negotiating the Lease (Cont.Ed.Bar 2013) ch. 7, pp.
7-1 to 7-29 (Retail Leasing).)
2.
trial court agreed with both theories, found Ross had breached the lease by failing to pay
rent and terminating the lease, and directed the jury to determine the amount of damages
resulting from each breach. The jury awarded $672,100 for unpaid rent and
approximately $3.1 million in other damages caused by the termination.
Ross appealed, contending the cotenancy provisions in the lease were not
procedurally and substantively unconscionable and were not an unreasonable penalty.
As to unconscionability, which requires proof of both procedural and substantive
unconscionability, we conclude the evidence establishes there was no procedural
unconscionability. The parties were sophisticated and experienced in the negotiation of
commercial leases for retail space, their negotiations involved several drafts of the letter
of intent and subsequent lease, and Grand Prospect’s decision to approach Ross first
about renting the space was a free and unpressured choice. Ross’s insistency on
cotenancy provisions during negotiations did not make the lease a contract of adhesion or
otherwise deprive Grand Prospect of a meaningful choice.
As to unreasonable penalties, the rent abatement and termination provisions must
be examined separately because they involve separate consequences triggered by
different (albeit partially overlapping) conditions. As a general rule, a contractual
provision is an unenforceable penalty under California law if the value of the property
forfeited under the provision bears no reasonable relationship to the range of harm
anticipated to be caused if the provision is not satisfied.
Here, the trial court’s determination that the rent abatement provision constituted
an unreasonable penalty is supported by its findings of fact that (1) Ross did not
anticipate it would suffer any damages from Mervyn’s not being open on the lease’s
commencement date and (2) the value of rent forfeited under the provision was
approximately $39,500 per month. There is no reasonable relationship between $0 of
anticipated harm and the forfeiture of $39,500 in rent per month and, therefore, the trial
court correctly concluded the rent abatement provision was an unenforceable penalty.
3.
As to the lease termination provision, California courts have adopted a specific
rule that holds no forfeiture results from terminating a commercial lease based upon the
occurrence of contingencies that (1) are agreed upon by sophisticated parties and (2) have
no relation to any act or default of the parties. These facts are present in this case and,
therefore, the rule compels the conclusion that the termination provision did not
constitute a forfeiture. Because no forfeiture occurred as a result of the termination, the
termination provision did not create an unreasonable penalty.
We therefore modify the judgment to award damages only for unpaid rent.
FACTS
The Parties
Ross is the nation’s largest retailer of off-price apparel and home fashion. The
trial court found Ross had more than 259 stores in California and more than 1,000 stores
nationwide. In 2008, Ross’s annual sales totaled more than $6.4 billion.
Grand Prospect is a California limited partnership. Its sole asset is a shopping
center named the Porterville Marketplace, located in Porterville, California.
Grand Prospect is managed by David H. Paynter, its sole general partner. Paynter
received a bachelor’s degree in business administration, majoring in finance. At the time
of trial, he had over 33 years of experience in real estate. In 1998, Paynter formed his
current company, Paynter Realty and Investments, which is based in Tustin, California.
Paynter Realty and Investments is involved in both development of shopping centers and
managing those properties. Paynter testified that he had been partners in developing over
60 shopping centers and that Paynter Realty and Investments currently owned and
operated seven shopping centers. Two of those shopping centers (Clovis and Visalia)
leased space to Ross.
Grand Prospect’s sole limited partner is John F. Marshall, who is a 50 percent
owner. Marshall is a commercial real estate broker who received a college degree in
business administration in 1974. Marshall started working in real estate in 1976, moved
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exclusively to commercial real estate in 1979, and started his own real estate company in
2001. His company specialized in selling and leasing shopping centers. Marshall met
Paynter in 1983 when the both were working on a shopping center project in Turlock.
Marshall was familiar with Ross, having acted as its broker in numerous lease
transactions between 2002 and 2011.
The Negotiations
In 2005, a former grocery store building became available at the Porterville
Marketplace and Marshall contacted Ross to see if Ross would be interested in the
location. In October 2005, Marshall (acting as Grand Prospect’s broker) showed Mike
Seiler of Ross the site and several other locations in Porterville. Seiler worked with
Marshall to prepare a letter of intent, which was similar to the one used for a store in a
Clovis shopping center managed by Paynter. Seiler, not Marshall, was responsible for
the letter’s contents. After making changes, Seiler emailed the letter of intent to Marshall
and directed him to forward it to Paynter.
The first version of the letter of intent presented to Paynter was dated October 20,
2005, set the initial term of the lease at 10 years with minimum rent for the first five
years at $10.50 per square foot with an increase to $11.00 for the second five years. The
letter of intent provided four five-year renewal options, each with a $0.50 increase in
rent. The letter of intent also contained cotenancy provisions that required, at
commencement and throughout the full term of the lease, 70 percent of the leasable floor
area in the center be occupied by retail tenants, including Target and Mervyn’s occupying
87,000 and 76,000 square feet, respectively.
The negotiations of the letter of intent were delayed when Paynter learned Target
was considering moving out of the shopping center. Eventually, Target decided to stay in
Porterville Marketplace and expand its store. As a result, Paynter delivered his revisions
to the letter of intent to Ross in the spring of 2007.
5.
After further negotiations, the final letter of intent, dated July 11, 2007, was signed
by the parties. The minimum rent was $13.25 for the first 10 years and $14.00 for the
first option period with $0.50 increases for each of the three remaining option periods.
The calculation of the 70 percent occupancy requirement stated that it would exclude
Ross “and Target as to the Commencement Date to be further negotiated in the lease,
from the numerator and denominator .…” Target was required to occupy 126,000 square
feet on the commencement date and during the term of the lease; Mervyn’s 76,000 square
feet.
With the nonbinding letter of intent in place, the parties began negotiating the
lease for 30,316 square feet of space in the Porterville Marketplace.
On April 4, 2008, the lease for a Ross store at Porterville Marketplace was
executed on behalf of Ross by James Fassio, executive vice president, and Gregg
McGillis, group vice president of real estate (the Lease). Four days later, Paynter signed
the Lease on behalf of Grand Prospect.
The terms of the Lease’s cotenancy provisions required Mervyn’s to be operating
its business in 76,000 square feet on the commencement date of the Lease.2 Other
aspects of the cotenancy provisions are described in part I.B, post.
Actions Under the Lease
In early July 2008, Grand Prospect notified Ross the construction work on the
store had been completed and Ross, if it chose, could take delivery early.3 Jack Toth,
then Ross’s director of real estate responsible for the San Joaquin Valley, responded with
an email stating Ross intended to take delivery on February 9, 2009, as stated in the lease.
2 Grand Prospect was not Mervyn’s landlord because Mervyn’s owned its building
in the shopping center. Therefore, Grand Prospect had no control over whether Mervyn’s
continued to operate in the shopping center. After Mervyn’s closed its store, Grand
Prospect purchased the building and subsequently leased most of the space to Kohl’s
Department Stores.
3 The construction of the Ross tenant improvements cost Grand Prospect more than
$2.3 million.
6.
In late July 2008, Mervyn’s filed for reorganization under federal bankruptcy law.
In October 2008, the bankruptcy case was converted to a liquidation under chapter 7 of
the Bankruptcy Code. The Mervyn’s store in the Porterville Marketplace closed on
December 31, 2008.
In October 2008, Paynter became aware that Mervyn’s was going to close its
stores and, as a result, Grand Prospect could not meet the opening cotenancy requirement
in Lease. Paynter contacted Toth and told him about Mervyn’s liquidation. On October
24, 2008, Toth sent Paynter an email asserting: “We negotiated hard for the Mervyn’s
co-tenancy because it makes a huge difference to us financially. Without Mervyn’s, we
will open very soft and it will take much longer for Ross to get established in
Porterville.” Toth made two proposals for amending the Lease. Under the first, Ross
would pay two percent of sales as rent and, once a suitable replacement tenant was found,
would go back to full rent. Under the second proposal, the requirement for Mervyn’s as a
cotenant would be eliminated and Ross would pay a fixed rent of $10.00 per square foot
for the initial term (versus $13.25).
The parties were unable to negotiate a modification of the Lease. On February 6,
2009, Ross advised Grand Prospect that it accepted delivery of the store as the Lease
required, “subject to all its rights under the Lease, including the Required Co-Tenancy
provisions of Section 6.1.3.” The February 9, 2009, delivery date meant that the
commencement date of the Lease was May 10, 2009.4
On May 10, 2009, neither Mervyn’s nor a replacement anchor tenant was open for
business in the Porterville Marketplace. Relying on the cotenancy provisions in the
Lease, Ross opted not open a store or pay rent.
In January 2010, Grand Prospect notified Ross that it had entered into a lease with
Kohl’s Department Stores to occupy 24,000 square feet of the Mervyn’s 76,000 square
4 The Lease defined the commencement date as 90 days following the delivery date.
7.
feet space. Ross regarded Kohl’s as an acceptable replacement for Mervyn’s, but
concluded the lease between Grand Prospect and Kohl’s did not cure the cotenancy
failure because (1) Kohl’s had not leased the required 76,000 square feet and (2) Kohl’s
was not scheduled to open within the 12-month cure period.
On January 21, 2010, Ross advised Grand Prospect that it would terminate the
Lease 30 days after the expiration of the 12-month period.
In May 2010, one year after the commencement date, Ross provided Grand
Prospect with formal notice that it was terminating the Lease because the reduced
occupancy had remained in effect for 12 consecutive months.
Grand Prospect leased the Ross space to Famous Footwear (6,000 square feet) and
Marshalls of California, LLC (24,316 square feet) in 2011. These businesses opened and
began paying rent in July and March of 2012, respectively. These leases also contained
cotenancy requirements.
PROCEEDINGS
In April 2010, before Ross terminated the Lease, Grand Prospect filed a complaint
against Ross for declaratory relief, breach of contract and unjust enrichment. Grand
Prospect requested (1) a judicial declaration that the cotenancy provisions were
unenforceable and (2) money damages for unpaid rent, future rent and expenditures on
tenant improvements.
In June 2010, Ross filed a cross-complaint against Grand Prospect, seeking a
judicial declaration of the parties’ rights and duties under the Lease.
In November 2012, a jury trial began. On the 13th day of the jury trial, December
17, 2012, the trial court issued an oral ruling on the issues that had been reserved for the
court. It determined the cotenancy provisions were unconscionable and were an
unenforceable penalty and struck those provisions from the lease. By striking the
cotenancy provisions from the lease, the court found that Ross had breached the lease by
8.
failing to pay rent and terminating the lease. The court rejected Grand Prospect’s cause
of action for unjust enrichment.
The jury was then instructed on two issues related to damages. First, the jury was
directed to determine the amount that would reasonably compensate Grand Prospect for
Ross’s failure to pay rent and its termination of the lease. Second, the jury was directed
to determine the amount of damages, if any, Grand Prospect could have avoided with
reasonable efforts and expenditures.
The special verdict form submitted to the jury required findings as to four items of
damages. The first item addressed the worth of the unpaid rent that had been earned at
the time of termination. The jury found this amount was $672,100. The jury’s findings
on the three other damage items, relating to the termination of the Lease, brought Grand
Prospect’s total damages to $3,785,714.86.
After the trial court decided Grand Prospect’s contested motion for attorney fees
and denied Ross’s motion for a new trial, it entered an amended judgment of
$4,701,990.83 in favor of Grand Prospect, which included an award of approximately
$916,275 in attorney fees and costs.
Ross timely appealed.
DISCUSSION
I. COTENANCY PROVISIONS
A. Overview
Cotenancy requirements are included in retail leases for the benefit of the tenant.
They generally require other stores in the shopping center to be occupied by operating
businesses. (1 Retail Leasing, supra, § 7.1, p. 7-2.) Their purpose is to assure the tenant
that “(1) there is a critical mass of key tenants or occupants as well as a sufficient
population of other retailers that have opened for business or will concurrently open
when the tenant is required or intends to open, and (2) there is a satisfactory level of
occupancy by these tenants or occupants during the term of the lease after the tenant has
9.
opened.” (1 Retail Leasing, supra, § 7.2, p. 7-2.) Cotenancy provisions usually are
found only in retail leases. (Ibid.)
Cotenancy provisions can be categorized as opening cotenancy requirements and
operating cotenancy requirements. (1 Retail Leasing, supra, § 7.4, p. 7-4.) “Opening
cotenancy requirements condition the tenant’s obligation to open for business or
commence paying minimum rent on satisfaction of the cotenancy requirement.” (Ibid.)
“Operating cotenancy requirements condition the tenant’s obligation to either continue to
conduct business or to continue to pay minimum rent on the active operation of certain
named tenants and/or a predetermined level of occupancy within the shopping center.”
(Ibid.)
The major points covered by cotenancy provisions are (1) the specific named
cotenants and level of occupancy required, (2) any right the landlord has to cure failures
to meet a cotenancy requirement, and (3) the tenant’s remedies if a cotenancy failure
occurs. (1 Retail Leasing, supra, at § 7.1, p. 7-2.) These three major points can be
resolved by the landlord and tenant in many different ways. Consequently, there is no
standard form of cotenancy requirements. (See id. at §§ 7.27-7.29, pp. 7-17 to 7-25 [two
forms of opening cotenancy requirements, with three alternatives in the second form]; 2
Miller & Starr, Cal. Real Estate Forms (2d ed. 2005) § 2:21, pp. 512-563 [cotenancy
requirements addressed in section 2.2 of sample retail lease for space in large shopping
center under construction].)
Variation in cotenancy requirements may occur because a particular tenant’s
business concerns about other tenants might be more complex than simply avoiding
vacancies. For instance, a national greeting card chain might be more concerned that the
center’s supermarket continues in business than the center’s other stores because it has
ascertained its stores perform better in shopping centers anchored by a supermarket.
(1 Retail Leasing, supra, § 7.2, p. 7-3.) As to the tenant’s remedies on the failure of the
opening cotenancy requirement, they might include (1) the right to delay the opening of
10.
the tenant’s store, (2) payment of alternative rent, (3) termination of the lease, or (4) a
combination of these remedies. (Id. at §§ 7.13-7.15, pp. 7-10 to 7-11.) Further variation
can occur if a landlord seeks to impose conditions on the tenant’s exercise of these
remedies. (Id. at § 7.20, p. 7-14.) Conditions may include the absence of a tenant default
in the lease and, in the case of rent abatement, the tenant’s continued operation of its
business on the premises. (Ibid.) Finally, how these various points are resolved during
the negotiation of a commercial lease “varies greatly depending on the relative bargaining
strengths of the landlord and the tenant.” (Id. at § 7.3, p. 7-3.)
The variation in cotenancy requirements, and the remedies given to a tenant when
the requirements are not met, prevents the application of a categorical rule of law
regarding enforceability. For instance, there is no general principle of California law
holding cotenancy provisions in a commercial retail lease can never be unconscionable.
Similarly, there is no categorical rule holding cotenancy provisions are unreasonable per
se and therefore unenforceable penalties. Instead, the validity of a cotenancy provision
depends upon the facts and circumstances proven in a particular case.
B. Cotenancy Requirements in the Lease
The cotenancy requirements in the Lease are set forth in sections 1.7.1, 1.7.2 and
6.1.3. The provisions relevant to this appeal concern Mervyn’s absence from the
shopping center on the commencement date and the continuation of this vacancy for 12
months. As a result of these events, Ross paid no rent and, as soon as allowed, exercised
an option to terminate the Lease.
1. Commencement Date Cotenancy Requirements
Section 1.7.1 of the Lease required Mervyn’s and Target to occupy no less than
76,000 and 126,000 square feet of leasable floor area, respectively, on Ross’s
11.
commencement date. In addition, section 1.7.2 required 70 percent of the leasable floor
area to the shopping center to be occupied by operating retailers.5
2. Commencement Date Reduced Occupancy Period
Section 6.1.3(b) of the Lease defined a “Commencement Date Reduced
Occupancy Period” as beginning with the failure of one of the required tenants to be open
for business on the commencement date of the Lease and continuing until cured.
Because Mervyn’s had closed its store, a “Commencement Date Reduced Occupancy
Period” began. As a result, section 6.1.3(b) provided that Ross was not required to open
its store for business. That section also stated that, “regardless of whether [Ross] opens
for business in the Store, no Rent shall be due or payable whatsoever until and unless the
Commencement Date Reduced Occupancy Period is cured.” For purposes of this
opinion, this term of the Lease is referred to as the "rent abatement provision".6
5 Section 1.7.1 of the Lease also included the following operating condition:
“Provided that the Required Co-Tenancy set forth in Sections 1.7.1 and 1.7.2 is satisfied
on the Commencement Date, during the remainder of the Term, the Required Co-Tenant
shall be either Mervyn’s or Target occupying no less than the Required Leasable Floor
Area indicated in (a) and (b) above. The Required Co-Tenant may be replaced by a
nationally or regionally recognized Anchor Tenant (as herein defined) reasonably
acceptable to Tenant, operating in no less than the Required Leasable Floor Area of the
Required Co-Tenant being replaced. An ‘Anchor Tenant’ is a national retailer with at
least one hundred (100) stores or a regional retailer with at least seventy-five (75) stores
occupying no less than the Required Leasable Floor Area of the Required Co-Tenant
being replaced.” !(4-AA-846)
6 The rent abatement provision might have allowed Ross free rent for the 10-year
initial term of the Lease and perhaps during the optional renewal periods, so long as the
vacancy of Mervyn’s space was not cured with a replacement anchor tenant.
However, the “Commencement Date Reduced Occupancy Period” clearly was
curable, even though the Lease’s requirement that Mervyn’s and Target be operating on
the commencement date could not be satisfied by a substitute tenant operating in the same
space on the commencement date. The commencement date requirement focused solely
on commencement date operations by Mervyn’s and Target and was significant because,
if satisfied, for the remainder of the Lease the required cotenant could be either Mervyn’s
or Target. In contrast to the commencement date requirement, the provision regarding
Commencement Date Reduced Occupancy Period involved an examination of
12.
Section 6.1.3(b) also provided Ross with an option to terminate the Lease
conditioned upon (1) the Commencement Date Reduced Occupancy Period continuing
for 12 months and (2) Ross giving 30 days’ notice of termination prior to the expiration
of the Commencement Date Reduced Occupancy Period. Section 6.1.3(b)’s reference to
12 months did not limit the free rent to the first 12 months of the Lease and did not limit
the cure period to those months. Rather, the 12-month period identifies when Ross
accrued an option to terminate the Lease.
II. UNCONSCIONABILITY
A. Fundamental Principles
Unconscionability is a defense to the enforcement of an entire contract or
particular contractual provisions. (Civ. Code, § 1670.5, subd. (a).) “Unconscionability”
does not have a precise legal definition, but has been described as extreme unfairness.
(Black’s Law Dictionary (9th ed. 2009.) p. 1663; see A & M Produce Co. v. FMC Corp.
(1982) 135 Cal. App. 3d 473, 487 [no precise definition of substantive unconscionability
can be proffered] (A & M Produce).)
The unconscionability defense to the enforcement of a contract was codified in
Civil Code section 1670.5 in 1979. (Beasley v. Wells Fargo Bank (1991) 235 Cal. App. 3d
1383, 1398; see Stats. 1979, ch. 819, § 3.) The statute did not create new law, but simply
codified the existing common law. (Beasley v. Wells Fargo Bank, supra, at p. 1398.)
Civil Code section 1670.5 provides in full:
“(a) If the court as a matter of law finds the contract or any clause of the
contract to have been unconscionable at the time it was made the court may
refuse to enforce the contract, or it may enforce the remainder of the
contract without the unconscionable clause, or it may so limit the
circumstances existing after the commencement date. For instance, if the type of national
or regional retailer described in section 1.7.1 of the Lease began operating in Mervyn’s
space on or before the commencement date, there would have been no Commencement
Date Reduced Occupancy Period.
13.
application of any unconscionable clause as to avoid any unconscionable
result.
“(b) When it is claimed or appears to the court that the contract or any
clause thereof may be unconscionable the parties shall be afforded a
reasonable opportunity to present evidence as to its commercial setting,
purpose, and effect to aid the court in making the determination.”7
Some of the common law principles of unconscionability were set forth by Judge
J. Skelly Wright in his often-cited formulation of the doctrine:
“Unconscionability has generally been recognized to include an absence of
meaningful choice on the part of one of the parties together with contract
terms which are unreasonably favorable to the other party.” (Williams v.
Walker-Thomas Furniture Co. (D.C.Cir. 1965) 350 F.2d 445, 449.)
The first California court to quote this formulation was the Fourth Appellate
District. (A & M Produce, supra, 135 Cal.App.3d at p. 486.) Judge Wright’s formulation
has been repeated by our Supreme Court and the Ninth Circuit of the United States Court
of Appeal. (Sonic-Calabasas A, Inc. v. Moreno (2013) 57 Cal. 4th 1109, 1133, 1145,
1159; Ingle v. Circuit City Stores, Inc. (9th Cir. 2003) 328 F.3d 1165, 1170 [arbitration
agreement signed by employee as part of job application was unconscionable under
California contract law].) The formulation contains both a procedural and a substantive
element. (Pinnacle Museum Toward Assn. v. Pinnacle Market Development (US), LLC
(2012) 55 Cal. 4th 223, 246 (Pinnacle); Leff, Unconscionability and the Code—the
Emperor’s New Clause (1967) 115 U. Pa. L.Rev. 485 [seminal article discussing
procedural and substantive elements of unconscionability].)
7 Civil Code section 1670.5 was adopted verbatim from section 2-302 of the
Uniform Commercial Code, but expanded its coverage to include all contracts, not just
those for the sale of goods. (Carboni v. Arrospide (1991) 2 Cal. App. 4th 76, 81.)
14.
The procedural element addresses the circumstances of contract negotiation and
formation, focusing on oppression and surprise8 due to unequal bargaining power.
(Pinnacle, supra, 55 Cal.4th at p. 246.)
In contrast, the substantive element is concerned with the fairness of the
agreement’s actual terms and assesses whether they are overly harsh or one-sided.
(Pinnacle, supra, 55 Cal.4th at p. 246.) Thus, substantive unconscionability is described
by the phrases “‘“unduly oppressive,”’” “‘“so one-sided as to ‘shock the conscience,’”’”
and “‘unreasonably favorable to the more powerful party.’” (Sonic-Calabasas A, Inc. v.
Moreno, supra, 57 Cal.4th at p. 1145.)
1. Burden and Sliding Scale
The party challenging the validity of a contract or a contractual provision bears the
burden of proving unconscionability. (Pinnacle, supra, 55 Cal.4th at p. 247.) California
is among the jurisdictions requiring both elements be shown. (Ibid.; cf. Maxwell v.
Fidelity Financial Services, Inc. (1995) 184 Ariz. 82, 90 [907 P.2d 51, 59]
[unconscionability can be established by a showing of substantive unconscionability
alone].) The evidence presented must show the circumstances that existed at the time the
contract was made because the determination of unconscionability is not based on
hindsight in light of subsequent events. (Civ. Code, § 1670.5, subd. (a); Sonic-Calabasas
A, Inc. v. Moreno, supra, 57 Cal.4th at p. 1164.)
The elements of procedural and substantive unconscionability need not be present
to the same degree because they are evaluated on a sliding scale. (Armendariz v.
Foundation Health Psychcare Services, Inc. (2000) 24 Cal. 4th 83, 114 (Armendariz).)
Consequently, the more substantively oppressive the contract term, the less evidence of
8 This case does not involve surprise and, therefore, that aspect of procedural
unconscionability is not discussed further. (See McCaffery Group, Inc. v. Superior Court
(2014) 224 Cal. App. 4th 1330, 1349 (McCaffery) [surprise typically involves a provision
hidden within the prolixity of a preprinted form contract].)
15.
procedural unconscionability is required to conclude the term is unenforceable, and vice
versa. (Ibid.)
2. Procedural Unconscionability
The oppression that creates procedural unconscionability arises from an inequality
of bargaining power that results in no real negotiation and an absence of meaningful
choice. (Aron v. U-Haul Co. of California (2006) 143 Cal. App. 4th 796, 808; see
Pinnacle, supra, 55 Cal.4th at p. 247.)
In general, California law allows oppression to be established in two ways. First,
and most frequently, oppression may be established by showing the contract is one of
adhesion. (McCaffrey, supra, 224 Cal.App.4th at p. 1349 [oppression generally entails a
contract of adhesion]; see Pinnacle, supra, 55 Cal.4th at p. 246 [procedural
unconscionability generally takes the form of a contract of adhesion].)9 The principles
that define a “contract of adhesion” are discussed and applied in part II.C. of the
Discussion, post.
In the absence of an adhesion contract, the oppression aspect of procedural
unconscionability can be established by the totality of the circumstances surrounding the
negotiation and formation of the contract. (Sonic-Calabasas A, Inc. v. Moreno, supra, 57
Cal.4th at p. 1125.) The circumstances relevant to establishing oppression include, but
are not limited to: (1) the amount of time the party is given to consider the proposed
contract; (2) the amount and type of pressure10 exerted on the party to sign the proposed
9 We recognize that showing a contract is one of adhesion does not always establish
procedural unconscionability. (See Roman v. Superior Court (2009) 172 Cal. App. 4th
1462, 1470, fn. 2 [in some situations, the oppression typically inherent in adhesion
contacts is minimal].)
10 Pressure can come from a stronger party using high-pressure tactics, coercion or
threats short of duress. (See Lovey v. Regence BlueShield of Idaho (2003) 139 Idaho 37,
42 [72 P.3d 877, 882].) Pressure also can be generated by surrounding circumstances
such as market conditions and factors affecting timing. (Ibid.; see Comment, The
Philosophical Dimensions of the Doctrine of Unconscionability (2003) 70 U. Chi. L.Rev.
16.
contract; (3) the length of the proposed contract and the length and complexity of the
challenged provision; (4) the education and experience of the party; and (5) whether the
party’s review of the proposed contract was aided by an attorney. (See Ajamian v.
CantorCO2e, L.P. (2012) 203 Cal. App. 4th 771, 796; DiMatteo & Rich, A Consent
Theory of Unconscionability: An Empirical Study of Law in Action (2006) 33 Fla. St. U.
L.Rev. 1067, 1077 [the merchant-consumer distinction described as a meta-factor in
unconscionability cases as relatively few merchant unconscionability claims are upheld;
presence of an attorney in precontract negotiations diminishes the likelihood a contract
will be held unconscionable].)
In Ohio, another jurisdiction that examines both procedural and substantive
unconscionability, an appellate court stated: “Procedural unconscionability involves
those factors bearing on the relative bargaining position of the contracting parties, e.g.,
‘age, education, intelligence, business acumen and experience, relative bargaining power,
who drafted the contract, whether the terms were explained to the weaker party, whether
alterations in the printed terms were possible, whether there were alternative sources of
supply for the goods in question.’” (Collins v. Click Camera and Video, Inc. (1993) 86
Ohio App. 3d 826, 834[ 621 N.E.2d 1294, 1299].)
To summarize, courts evaluating procedural unconscionability must consider the
totality of the circumstances surrounding the negotiation and formation of the contract,
giving particular consideration to factors that affect the presence of oppression or the
absence of a meaningful choice.
3. Substantive Unconscionability
Substantive unconscionability is not susceptible to precise definition. (Sonic-
Calabasas A, Inc. v. Moreno, supra, 57 Cal.4th at p. 1163.) It appears the various
descriptions—unduly oppressive, overly harsh, so one-sided as to shock the conscience,
1513, 1514 [urging unconscionability be “defined solely by reference to external factors
that may prevent parties from making free choices”].)
17.
and unreasonably favorable to the more powerful party—all reflect the same standard.
(Id. at pp. 1145, 1159.) Substantive unconscionability is not concerned with a simple
old-fashioned bad bargain. (Ibid.)
“Factors courts have considered in evaluating whether a contract is substantively
unconscionable include the fairness of the terms, the charge for the service rendered, the
standard in the industry, and the ability to accurately predict the extent of future liability.”
(Hayes v. Oakridge Home (2009) 122 Ohio St. 3d 63, 69 [908 N.E.2d 408, 414].)
B. Standard of Review
The legal principles that define the doctrine of unconscionability demonstrate that
numerous factors are relevant to determining whether a contract or a particular provision
is unconscionable. Despite the numerous factual issues that may bear on the question,
unconscionability is ultimately a question of law for the court. (McCaffrey, supra, 224
Cal.App.4th at p. 1347.) Where the trial court’s determination of unconscionability
turned on the resolution of conflicts in the evidence or on factual inferences to be drawn
from the evidence, we consider the evidence in the light most favorable to the trial court’s
determination and review the trial court’s factual findings under the substantial evidence
standard. (Ibid.) When some facts of a case are determined under the foregoing rule and
other facts are undisputed because there are no material conflicts in the evidence,
appellate courts conduct a de novo review of those facts and makes its own
unconscionability determination. (Ibid.)
Our application of the de novo standard of review is illustrated by Crippen v.
Central Valley RV Outlet, Inc. (2004) 124 Cal. App. 4th 1159, a case in which we (1)
concluded the plaintiff had failed to prove procedural unconscionability and (2) reversed
the trial court’s determination that the arbitration agreement in question was
unenforceable.
18.
C. Contract of Adhesion
1. The Lease as a Whole
Grand Prospect contends the Lease was a contract of adhesion. Ross argues that
its unwillingness to sign a lease without the protection of cotenancy clauses cannot
transform a heavily negotiated lease between sophisticated parties into a contract of
adhesion. Ross also contends there is no case law supporting the position that procedural
unconscionability exists merely because a party viewed one of many points under
discussion as critical to reaching a deal, while willingly negotiating numerous other
material terms, including price.
The California Supreme Court has defined the term “contract of adhesion” to
mean (1) a standardized contract11 (2) imposed and drafted by the party of superior
bargaining strength (3) that provides the subscribing party only the opportunity to adhere
to the contract or reject it. (Armendariz, supra, 24 Cal.4th at p. 113; Von Nothdurft v.
Steck (2014) 227 Cal. App. 4th 524, 535.)
We conclude the undisputed facts of this case establish the lease was not a contract
of adhesion. First, it was not a standardized, preprinted form. (See Von Nothdurft v.
Steck, supra, 227 Cal.App.4th at p. 536 [management agreement “was not a preprinted
form contract”].)
Second, and more importantly, Grand Prospect was given the opportunity to
negotiate the terms of the lease. To reach an agreement acceptable to both sides, the
parties went through multiple drafts of a letter of intent and five versions of the Lease.
Furthermore, the Lease was based on the earlier Clovis lease, which was the product of
11 We note that California Supreme Court decisions more recent than Armendariz
have not included the “standardized contract” element in their description of an adhesion
contract. (See Sonic-Calabasas A, Inc. v. Moreno, supra, 57 Cal.4th at p. 1133; Little v.
Auto Stiegler, Inc. (2003) 29 Cal. 4th 1064, 1071.) Thus, it is possible to have a contract
of adhesion when a contract is used in one transaction—that is, is not standardized for use
in multiple transactions.
19.
negotiations between Paynter and Ross’s attorney Theani Louskos. She also represented
Ross in finalizing the Grand Prospect Lease. The facts establish that Grand Prospect’s
choices were not limited to rejecting or adhering to the draft of the Lease first presented
by Ross.
Therefore, the Lease itself does not fit the definition of a contract of adhesion.
2. Clause of Adhesion
A question presented by the facts of this case is whether the Lease should be
classified as a contract of adhesion because the cotenancy requirements were presented
by Ross on a take-it-or-leave-it basis. We conclude this aspect of Ross’s negotiating
posture did not make the Lease a contract of adhesion.
In Szetela v. Discover Bank (2002) 97 Cal. App. 4th 1094, the court used language
that suggests a clause might qualify as a contract of adhesion when it stated, “even if the
clause at issue here is not an adhesion contract, it can still be found unconscionable.” (Id.
at p. 1100.) In Szetela, a credit card company inserted a notice in its customer’s billing
statement that stated the cardmember agreement was being amended to include an
arbitration clause. (Id. at p. 1096.) If the customer did not wish to accept the terms of the
amendment, the only option was to notify the credit card company, which would then
close the account. (Id. at p. 1097.) When the customer challenged the arbitration clause
as unconscionable, the court analyzed the process by which that clause was added to the
contract, not the formation of the original contract. The court stated:
“Procedural unconscionability focuses on the manner in which the disputed
clause is presented to the party in the weaker bargaining position. When
the weaker party is presented the clause and told to ‘take it or leave it’
without the opportunity for meaningful negotiation, oppression, and
therefore procedural unconscionability, are present. [Citation.] These are
precisely the facts in the case before us. Szetela received the amendment to
the Cardholder Agreement in a bill stuffer, and under the language of the
amendment, he was told to ‘take it or leave it.’ His only option, if he did
not wish to accept the amendment, was to close his account. We agree with
Szetela that the oppressive nature in which the amendment was imposed
20.
establishes the necessary element of procedural unconscionability.” (Id. at
p. 1100.)
Szetela does not establish that the inclusion of a take-it-or-leave-it clause in an
agreement makes the entire contract one of adhesion. Instead, it establishes that when a
clause is added to a contract by an amendment, the inquiry into procedural
unconscionability is concerned with the circumstance surrounding the negotiation and
formation of the amendment, not the original contract. Where the amendment contains a
single clause, that clause or the amendment can be described accurately as a contract of
adhesion. It does not follow, however, that the inclusion of a take-it-or-leave-it clause in
a negotiated agreement turns the entire agreement into a contract of adhesion.
In summary, we do not interpret Szetela to mean that when the relatively stronger
party insists on including a particular provision in a contract, the entire contract becomes
a contract of adhesion. Therefore, the Lease was not a contract of adhesion by virtue of
Ross insisting that it contain cotenancy provisions.
D. General Circumstances Relevant to Procedural Unconscionability
1. Sophistication
The circumstances relevant to procedural unconscionability include age,
education, intelligence, business acumen and experience. Paynter received a bachelor’s
degree in business administration. At the time of trial, he had over 33 years of experience
in real estate. In 1988, Paynter and an attorney left a development company and formed
their own company to develop shopping centers. In 1998, the attorney returned to the
practice of law and Paynter formed his current company, Paynter Realty and Investments,
which is based in Tustin. Paynter Realty and Investments is involved in both
development of shopping centers and managing those properties. Its management fee is
typically three to four percent of the rent collected. Paynter testified that he had been
partners in developing over 60 shopping centers and that Paynter Realty and Investments
currently owned and operated seven shopping centers. Paynter’s limited partner, John
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Marshall, was equally experienced, and had earlier acted as Ross’s broker in numerous
lease transactions.
Paynter’s age, education, intelligence, business acumen and experience are not
among the factors that support a finding of procedural unconscionability. The record
shows Paynter was college-educated, very experienced in developing and managing
shopping centers, and successful in that business. In short, Paynter was sophisticated and
these factors did not place him at a disadvantage in bargaining with Ross.
Paynter’s sophistication means that his decision not to seek the advice of an
attorney to assist him in the negotiations with the attorney representing Ross was not
significant. From earlier business dealings with Ross, Paynter and Marshall were
familiar with the terms Ross wanted in the lease and they understood the cotenancy terms
without an explanation of those terms from a lawyer.
2. Time Pressure
The trial court did not find, and it does not appear from the evidence in the record,
that Ross exerted time pressure on Paynter and, as a result, prevented him from fully
understanding how the cotenancy provisions would operate. Cotenancy provisions were
in the first letter of intent presented by Marshall to Paynter in 2005 and the lease was not
signed until April 2008. Ross did not impose deadlines during the negotiations for the
purpose of pressuring Paynter into making a quick, ill-considered decision that would
have been more favorable to Ross than it could have obtained without any time pressure.
Therefore, time pressure is not a factor that supports a finding of procedural
unconscionability.
3. Economic Pressure
The record does not contain evidence showing Grand Prospect was economically
vulnerable and this vulnerability was exploited by Ross during the negotiations. For
example, there is no evidence that Grand Prospect was having difficulty servicing its debt
or that a balloon payment on a loan was coming due and, therefore, Grand Prospect was
22.
willing to accept onerous terms in order to begin receiving rent from the space. The only
economic pressure apparent in this case is the same pressure that every commercial
landlord experiences when a space is vacant and not generating rent.
4. Pressure from Coercion or Threats
The record contains no evidence that Ross used coercion or threats while
negotiating the Lease. For example, Ross did not threaten Paynter by saying that, if he
did not agree to the Lease and its cotenancy requirements, breaches would be “found” in
Ross’s other leases with him and payment of rent under those leases would be stopped.
5. Relative Bargaining Power
Ross had an advantage in bargaining power because it was the larger company in
terms of financial resources and personnel. Also, at the time the Lease was being
negotiated, Ross was negotiating leases at many other locations. The fact that Ross was
opening stores at other locations made the opening of a store in Porterville less important
to Ross than it was to Grand Prospect.
The fact that Ross had more bargaining power than Grand Prospect does not mean
that inequality in power resulted in no real negotiations and an absence of a meaningful
choice for Grand Prospect. (See Aron v. U-Haul Co. of California, supra, 143
Cal.App.4th at p. 808.) Here, the parties negotiated before the letter of intent was signed
and negotiated further before the Lease was signed. One of the points subject to further
negotiation was the specific terms of the cotenancy requirements. Although Ross would
not agree to a lease without cotenancy requirements, the terms for the tenant remedy and
landlord cure were subject to negotiation, and Ross eventually agreed to a base monthly
rent well above its original offer.
6. Meaningful Choices
The record shows that John Marshall of Grand Prospect, who had acted as Ross’s
broker in numerous earlier lease transactions, first approached Ross as a prospective
tenant. The record also shows that Ross was Grand Prospect’s first choice to fill the
23.
vacancy and that Paynter was familiar with the contents of the leases used by Ross,
including its cotenancy provisions. There were other companies that Grand Prospect
could have approached about the empty space. Thus, Paynter had a meaningful choice
when he began to pursue Ross as a tenant. The fact that other companies would have
required cotenancy provisions in any lease they signed with Grand Prospect does not
mean the choice made by Paynter was not meaningful. The specifics of the cotenancy
requirements vary and Paynter decided to pursue a company that would pay higher rent,
rather that pursuing a company that would have accepted cotenancy provisions more
favorable to Grand Prospect, at a lower rent.
7. Conclusion
Based on the foregoing factors, we conclude there were real negotiations between
the parties and Paynter was given meaningful choices both in initiating contact with Ross
and during the negotiations of the Lease. (See Aron v. U-Haul Co. of California, supra,
143 Cal.App.4th at p. 808.) The fact Ross insisted upon cotenancy provisions is not
determinative because the specifics of those provisions were subject to negotiations.
Therefore, we conclude there was no procedural unconscionability in this case and, thus,
unconscionability does not provide a ground for invalidating the cotenancy provisions in
the Lease. (See Crippen v. Central Valley RV Outlet, Inc., supra, 124 Cal. App. 4th 1159
[trial court reversed because plaintiff failed to prove arbitration agreement was
procedurally unconscionable].)
III. PENALTIES
A. Standard of Review
Whether a contractual provision is an unenforceable penalty is determined by the
trial court, not the jury. (Beasley v. Wells Fargo Bank, supra, 235 Cal.App.3d at p.
1393.) As a result, the issue has been described as a question of law. (Ibid.) However,
the validity of a provision alleged to be an unlawful penalty “is not really a classic
question of law, but is one of fact that, because of its character, is nevertheless committed
24.
to judicial determination.” (Id. at p. 1394.) Thus, a trial court decides, in light of all the
facts, including the whole instrument, whether the provision in question is an unlawful
penalty. (Ibid.)
Despite the nature of the trial court’s decision, some courts have stated the
determination whether a provision constitutes an unlawful penalty is subject to de novo
on appeal. (Harbor Island Holdings v. Kim (2003) 107 Cal. App. 4th 790, 794.)
Based on the foregoing precedent, we conclude the ultimate question of a
provision’s invalidity as a penalty is a question of law subject to de novo review, but the
factual foundation for appellate review consists of (1) the facts that are not in dispute and
(2) the facts that are established by viewing the conflicting evidence in the light most
favorable to the trial court’s judgment. (See A & M Produce, supra, 135 Cal.App.3d at p.
489.)
B. Conditional Provisions Sometimes Are Penalties
The first legal question raised by the parties’ contentions is whether a contract
provision triggered by one or more conditions precedent can be deemed a penalty under
California law. We conclude conditional provisions sometimes can operate as penalties.
1. General Principles
Ross’s argument that a condition precedent is not a penalty is contrary to a treatise
on contract law that devotes a chapter to the topic of conditions and promises that cause a
forfeiture or penalty. (14 Williston on Contracts (4th ed. 2013) ch. 42, pp. 403-594.)
When justice requires, a court “can excuse the performance of conditions and promises
otherwise agreed to by the parties. The fact that a promise or condition, if not excused,
will operate harshly or unfairly in a particular case does not in itself justify a court in
excusing its performance, but the law has long strictly scrutinized—and often prohibited
through the use of a principle inherently incapable of precise articulation or application—
the enforcement of forfeitures or penalties even though the parties’ agreement refers to
25.
them as ‘liquidated damages’ or some other innocuous term.” (14 Williston on
Contracts, supra, § 42:1, pp. 404-407, fns. omitted.)
The treatise’s reference to both conditions and promises indicates that, contrary to
Ross’s position, it is possible for a condition precedent to operate as a penalty. More
explicitly, the treatise states: “A condition may be as penal in its effects as a promise to
pay a penalty.” (14 Williston on Contracts, supra, § 42:6, p. 444, fn. omitted.) The
treatise also asserts that “relief against the effect of penalties should depend as little as
possible on the form a transaction takes.” (Id. at p. 445, fn. omitted.) In short, phrasing a
forfeiture of payment in conditional language does not exempt it from judicial scrutiny.
2. California’s Approach to Conditions and Penalties
We believe the treatise accurately described the law of California, which does not
allow unreasonable penalties or forfeitures simply because they are imaginatively drafted
as contractual conditions.
First, the Legislature has directed California courts to put substance before form.
Civil Code section 3528 states: “The law respects form less than substance.” Adhering
to this fundamental principle, our Supreme Court has “consistently ignored form and
sought out the substance of arrangements which purport to legitimate penalties and
forfeitures. [Citations.]” (Garrett v. Coast & Southern Fed. Sav. & Loan Assn. (1973) 9
Cal. 3d 731, 737 [charges assessed on late installment payments that were calculated as a
percentage of the entire unpaid balance of the loan, not the amount of the overdue
installment, were invalid penalties].) Pursuant to the substance-over-form principle, a
court must determine a contract provision’s true function and operation when evaluating
its legality. (McGuire v. More-Gas Investments, LLC (2013) 220 Cal. App. 4th 512, 523
(McGuire).)
Second, a California appellate court has applied the substance-over-form principle
to a contractual provision drafted as a condition. In Fox Chicago R. Corp. v. Zukor’s
(1942) 50 Cal. App. 2d 129 (Fox Chicago), the landlord and lessee entered a series of
26.
lease amendments reducing the rent to below the previously agreed upon $4,100 per
month. (Id. at p. 131.) As modified, the lease amendments included a clause providing
that, in the event of a default, the lessee would be obligated to pay the entire unpaid
portion of the $4,100 rent for each and every month the lessee had paid a smaller amount.
(Ibid.) When the lessee breached the lease by removing certain fixtures from the
premises without the landlord’s consent, the landlord sued and demanded approximately
$159,000 under the provision. (Id. at p. 133.) The lessee filed a demurrer, which the trial
court sustained without leave to amend. (Id. at p. 130.) The appellate court affirmed on
the ground the landlord’s recovery of rent at the initial rate constituted a penalty. (Id. at
p. 136.)
On appeal, the landlord argued the $159,000 was merely a debt payable upon the
happening of a certain event. (Fox Chicago, supra, 50 Cal.App.2d at p. 134.) The court
concluded there was no debt. Instead, the language of the lease modification and
surrounding circumstance convinced the court the provision was a penalty. (Ibid.)
“Where the language of a condition thus appears upon a fair construction to be a penalty,
the obligation is thereby invalidated. Any provision by which money or property is to be
forfeited without regard to the actual damage suffered calls for a penalty and is therefore
void.” (Ibid.)
The appellate court also addressed the fact the obligation to pay prior rent
reductions was worded as a condition:
“There is nothing in … the lease [provision] that might remove it from the
category of a penalty. It is not necessary that a penalty be designated as
such in specific terms before it may be so classified. A condition in a
contract providing for the payment of money not earned is just as much a
penalty as though it had been stipulated to penalize the promissor should he
default in the performance of his promise. [Citation.] If the lease had
contained a provision that the breach of any condition thereof should
obligate him to pay to the lessor the sum of $159,000, there would be no
question of its being properly classified as a penalty. But cloaked in the
innocent verbiage of a condition requiring the lessee to pay $159,000 in the
event he should fail to perform some covenant which is collateral to the
27.
main covenant, it is equally a penalty. [Citation.] A provision in a contract
exacting the payment of moneys for the violation of a collateral agreement
is opposed to public policy and is not bereft of its vice because it may
appear in the form of a condition. [Citation.]” (Fox Chicago, supra, 50
Cal.App.2d at p. 134.)
The statements in Fox Chicago that a lease provision drafted as a condition might
be classified as a penalty is consistent with decisions involving other types of contracts.
For instance, in Henck v. Lake Hemet Water Co. (1937) 9 Cal. 2d 136 (Henck), a water
supply contract stated that timely payment for the yearly bill was a condition precedent of
the right to receive water. The water company did not send a notice that the bill was due,
the buyer did not pay on time, and the company declared the contract terminated and
refused to reinstate it after the buyer tendered the amount due with interest. Our Supreme
Court affirmed the trial court’s reinstatement of the contract, stating: “If the breach of
such a condition works a forfeiture, equity in a proper case may grant relief.” (Id. at p.
142; see Root v. American Equity Specialty Ins. Co. (2005) 130 Cal. App. 4th 926, 939-
940 [nonoccurrence of conditions precedent in contracts excused when nonoccurrence
works a forfeiture].
Notwithstanding the foregoing cases, California courts have recognized that some
conditional provisions in a contract do not operate as a forfeiture or penalty. In Blank v.
Borden (1974) 11 Cal. 3d 963, the Supreme Court examined a real estate listing
agreement that provided the broker would be paid the full six percent commission if the
owner withdrew the listing. (Id. at p. 966.) The court acknowledged it must look to the
substance rather than form in determining the true function and character of an
arrangement challenged as a voidable penalty. (Id. at p. 970.) The court then stated the
listing agreement in question presented the owner with a true option or alternative.
Specifically, the owner could continue the listing or could change his mind about selling
the property, terminate the exclusive listing agreement, and pay the sum specified in the
contract. The court concluded the payment required upon termination was valid because
it did not have “the invidious qualities characteristic of a penalty or forfeiture.” (Id. at p.
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970.) In summary, a contract provision that provides a party with a true alternative
performance—that is, an alternative that provides a rational choice between two
reasonable possibilities—does not involve an unenforceable penalty. (Id. at p. 971; see
Parsons v. Smilie (1893) 97 Cal. 647 [land purchaser’s decision not to satisfy a condition
subsequent by operating a lumber yard on the property for five years was willful and
therefore he did not qualify under Civ. Code, § 3275 for relief from forfeiting property
back to seller].)
Here, the conditions contained in the Lease regarding Mervyn’s and the occupancy
of its space did not provide Grand Prospect with an alternative performance because, at
the time the Lease was made, Grand Prospect did not own the space or have any
opportunity to affect, much less control, Mervyn’s decision to cease its operations.
3. California’s Test of Invalid Penalties
Under California law, the characteristic feature of a penalty is the lack of a
proportional relationship between the forfeiture compelled and the damages or harm that
might actually flow from the failure to perform a covenant or satisfy a condition.
(Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal. 4th 970, 977.) In other words, an
unenforceable penalty “bears no reasonable relationship to the range of actual damages
the parties could have anticipated would flow” from a breach of a covenant or a failure of
a condition. (Greentree Financial Group, Inc. v. Executre Sports, Inc. (2008) 163
Cal. App. 4th 495, 497.)
Therefore, the general rule for whether a contractual condition is an unenforceable
penalty requires the comparison of (1) the value of the money or property forfeited or
transferred to the party protected by the condition to (2) the range of harm or damages
anticipated to be caused that party by the failure of the condition. If the forfeiture or
transfer bears no reasonable relationship to the range of anticipated harm, the condition
will be deemed an unenforceable penalty.
29.
C. Separate Conditions with Separate Consequences
The next legal question we address is whether the test for invalid penalties should
be applied to section 6.1.3(b) as a whole or whether the rent abatement provision and
termination provision should be analyzed separately. We conclude the provisions must
be analyzed separately.
Ross’s right to rent abatement is separate from its option to terminate because (1)
the abatement of rent existed whether or not Ross subsequently exercised its option to
terminate the Lease, (2) each right is triggered by different (albeit, partially overlapping)
conditions, and (3) each provision resulted in different consequences to the landlord-
tenant relationship between Grand Prospect and Ross. Pursuant to section 6.1.3(b) of the
Lease, the right to rent abatement came into existence if there was a Commencement
Date Reduced Occupancy Period and continued in effect until the reduced occupancy was
cured. In contrast, the option to terminate arose if the Commencement Date Reduced
Occupancy Period continued for 12 consecutive months and was exercised by Ross
giving a termination notice before the reduced occupancy was cured.
Given the distinct features of the rent abatement and termination provisions, we
conclude the validity of each provision must be determined separately.
IV. RENT ABATEMENT
A. Overview of Validity of Rent Abatement Provisions
There is no general rule of law that states all rent abatement provisions in a
commercial lease are valid or invalid. As the following cases from other jurisdictions
indicate, whether a particular rent abatement provision operates as an unreasonable
penalty depends upon the specific facts and circumstances of the case.
1. Rent Abatement Provisions That Were Penalties
In Mark-It Place Foods, Inc. v. New Plan Excel Realty Trust (2004) 156 Ohio
App.3d 65 [804 N.E.2d 979] (Mark-It Place), a grocery store’s lease included an
exclusive use provision that required an abatement of rent while a violation was in effect.
30.
(Id. at p. 1002.) The landlord later leased space in the shopping center to Wal-Mart
without including a provision prohibiting Wal-Mart from selling groceries and other
foodstuffs listed in the grocery store’s exclusive use provision. (Id. at pp. 985-986.) The
trial court concluded the lease’s rent abatement provision was a valid liquidated damages
clause and not an unenforceable penalty. (Id. at p. 987, fn. 4.) The appellate court
disagreed, noting that the Wal-Mart lease could run for 50 years and conceivably allow
the tenant to remain in the shopping center without paying rent for that period. (Id. at p.
1003.) As a result, the court concluded the provision abating the rent was a draconian
penalty prohibited by Ohio case law. (Ibid.)
Consequently, Mark-It Place provides an example of a rent abatement provision
that was deemed an unenforceable penalty.
In Sunny Isle Shopping Center, Inc. v. Xtra Super Food Centers, Inc. (D.V.I.
2002) 237 F. Supp. 2d 606, a tenant operating a supermarket in a shopping center had a
lease that stated the landlord would not permit another tenant to sell food for
consumption off premises and a violation of the covenant would allow the tenant to
withhold its rent. (Id. at pp. 607-608.) The landlord violated this provision by leasing
space to Kmart Corporation, a company that offered groceries for sale. (Id. at p. 608.)
The tenant began withholding rent and the landlord filed suit seeking a declaration that
the provision was unenforceable. (Ibid.) The tenant moved for summary judgment on
the landlord’s claim that the rent-withholding provision was an unenforceable penalty.
(Id. at p. 612.) The district court denied the motion because it was unclear from the
evidence whether the tenant suffered any financial loss since Kmart’s arrival or whether
any such losses were attributable to Kmart’s sale of food products. The existence of
these factual questions precluded the court from determining the rent-withholding
provision was enforceable and granting the tenant summary judgment. Accordingly, this
case provides an example of a provision for the abatement of rent that might be deemed
an unenforceable penalty.
31.
2. Rent Abatement Provisions That Were Not Penalties
Some challenges to a rent abatement provision in commercial leases have failed.
The federal decisions include Red Sage Ltd. P’ship v. DESPA Deutsche Sparkassen
Immobilien-Anlage-Gasellschaft mbH (D.C. Cir. 2001) 254 F.3d 1120 (rent abatement
provision resulting from breach of exclusive use covenant was enforceable) and N.
Providence, LLC v. A & P (S.D.N.Y. 2014) 510 B.R. 42 (forfeiture of rent during period
landlord did not pay construction allowance was enforceable under New Jersey law).
Decisions from state appellate courts include Majestic Cinema Holdings, LLC v.
High Point Cinema (2008) 191 N.C. App. 163 [662 S.E.2d 20] (reversed trial court’s
decision that lease provision requiring the landlord to open 15,000 square feet of adjacent
retail space or forego rent from tenant was unenforceable penalty]) and Bates Advertising
USA, Inc. v. 498 Seventh , LLC (2006) 7 N.Y.3d 115 [850 N.E.2d 1137, 1140]
(enforceable rent abatement was keyed to the number of days of landlord’s
nonperformance and varied from a half day to a day depending upon the importance of
the item of work not completed by landlord).
The foregoing cases demonstrate that there is no categorical rule of law holding
rent abatement provisions are enforceable or unenforceable. Thus, it is possible to draft a
rent abatement provision that is reasonably related to the anticipated harm likely to be
suffered.
B. Rent Abatement Provision Was a Penalty In This Case
Generally, a contractual provision is an unenforceable penalty if the value of the
money or property forfeited or transferred to the party protected by the provision bears no
reasonable relationship to12 the range of harm anticipated to be caused to that party by
the failure of the provision’s requirements. (See pt. III.B.3, ante.)
12 The phrase “bears no reasonable relationship to” is synonymous with “bears no
rational relationship to” (Sybron Corp. v. Clark Hosp. Supply Corp. (1978) 76
Cal. App. 3d 896, 903) and “without regard to” (Ebbert v. Mercantile Trust Co. of
California (1931) 213 Cal. 496, 499; Fox Chicago, supra, 50 Cal.App.2d at p. 134).
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The application of the legal test defining contractual penalties requires this court to
identify (1) the value of property forfeited or transferred by Grand Prospect and (2) the
anticipated harm or damages that Ross was likely to have experienced as a result of the
failure of the conditions specified in the rent abatement provision. The reference to
anticipated harm or damage indicates that courts examine the circumstances that existed
at the time of the making of the contract when determining if the provision is enforceable.
1. Value of Property Forfeited or Transferred
Under the terms of the Lease, Grand Prospect (1) transferred to Ross the right to
possession of the retail space and (2) lost the right to receive monthly rent. Regardless of
whether the loss is conceptualized as the forfeiture of possession of real estate or rent, we
conclude the value of the rights relinquished by Grand Prospect pursuant to the rent
abatement provision can be quantified by the rental rate set forth in the Lease.
The Lease specified the minimum rent as $33,473.92 per month. The Lease also
required Ross to pay a pro rata share of (1) the costs for maintaining and repairing the
shopping center’s common areas, (2) real property taxes and assessments, and (3) certain
insurance premiums.
Ross’s pro rata share of these items is reflected in the calculations of Stuart
Harden, a certified public accountant retained by Grand Prospect as an expert witness.
Harden calculated the amount of damages Grand Prospect experienced from May 10,
2009, to June 11, 2010, using Civil Code section 1951.2. Under this statute, when a
tenant’s breach of a lease causes a termination, a landlord may recover “[t]he worth at the
time of award of the unpaid rent which had been earned at time of termination.” (Civ.
Code, § 1951.2, subd. (a)(1).) Harden calculated (1) the unpaid rent as $513,320 and (2)
the accrued interest as $158,780, using an interest rate of 10 percent. Harden added these
two figures together and concluded the damages for the 13-month period was $672,100.
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The jury accepted Harden’s calculations when it answered “$672,100” to a
question in the special verdict form about “[t]he worth at the time of award of the unpaid
rent which had been earned at the time of termination.”
Based on the trial court’s finding that the withheld rental payments for 13 months
totaled $513,320 (which is consistent with the jury’s finding as to damages), we conclude
that the value of the property rights Grand Prospect relinquished pursuant to the rent
abatement provision was approximately $39,500 per month.
2. Trial Court’s Findings as to the Harm Anticipated
At page four of its statement of decision, the trial court explicitly found “Ross did
not anticipate any damage, i.e., lost sales or profits, if or because Mervyn’s would not be
open on the Commencement Date.” The court also found “the presence of Mervyn’s was
not a condition material to Ross under the Lease .…” The court reiterated its findings
about anticipated harm at page 16 of its statement of decision when it compared that
harm to the value of the property forfeited by Grand Prospect:
“[T]he withheld Rent of $513,320 for the 13 months Ross maintained
possession of the Premises[] bears no reasonable relationship to the actual
damages Ross anticipated it would have suffered if it had opened its store
at the [Porterville] Marketplace even though Mervyn’s was not open on the
Commencement Date because Ross did not anticipate it would suffer any
damages in such an event.” (Italics added.)
Ross does not challenge these findings of fact by the trial court on the ground they
are unsupported by substantial evidence. Such a challenge would have failed in light of
the e-mails and trial testimony of the Ross executives (Toth, McGillis and Fassio) cited
by the trial court. The executives testified that no study or analysis was done to
determine the impact of Mervyn’s traffic on Ross’s potential sales or, alternatively, the
impact of Mervyn’s closure on Ross’s potential sales. Furthermore, in October 2008
after the Ross executives learned of the Mervyn’s closure, they held the view that the
Porterville Marketplace remained a desirable location for a store. McGillis testified that
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he was unable to state, one way or the other, whether the closure of Mervyn’s stores in
shopping centers where Ross was present adversely effected Ross’s sales.
3. Ross’s Theory of Error as to Anticipated Harm
Ross contends the trial court’s analysis is “deeply flawed” because the “court
assumed—without analysis—that the relevant inquiry was whether Ross expected to
sustain losses if it opened and operated the store, and paid rent, despite Mervyn’s
closure.” Ross contends the legally relevant evaluation of the cotenancy provisions
“should have recognized that Ross would be entitled to defer opening its store as a way of
mitigating its damages if Mervyn’s failure to operate its store were deemed a ‘breach’ by
Grand Prospect.”
Ross argues that, in the situation where Ross mitigated its damages by not opening
a store, the parties anticipated that the failure of the opening cotenancy requirement
would have damaged Ross in the sum of (1) the $38,000 rent and common area charges it
would have paid during the 12-month period, (2) all of the costs Ross would have
incurred in building out and preparing to open the store, (3) unavoidable costs of
maintaining the premises during that period, and (4) the loss of profits Ross expected to
earn from operating the store with both Mervyn’s and Target open for business in the
shopping center.
We conclude Ross’s arguments have failed to identify a legal error in the trial
court’s analysis of the anticipated harm the cotenancy provisions purportedly addressed.
First, Ross has not shown it objected to the trial court’s statement of decision on
the ground it omitted the relevant legal analysis.
Second, Ross has cited no legal authority to support its position that an inquiry
into anticipated harm is limited to whether the tenant expected to sustain losses if it did
not open and operate the store. Ross’s position about the relevant inquiry is not
consistent with the applicable legal standard. Under that standard, a court evaluating a
contractual provision that might be a penalty must consider the range of harm or
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damages anticipated to be caused to that party by the failure to meet the contractual
requirement by evaluating the circumstances existing at the time the contract was made.
In considering this range, a court may not focus on a single scenario to the exclusion of
others, which is what Ross argues the trial court should have done. Consequently, Ross’s
argument about the relevant inquiry fails to identify trial court error. (Denham v.
Superior Court (1970) 2 Cal. 3d 557, 564 [appellant has the burden of affirmatively
demonstrating prejudicial error].)
Third, the trial court’s findings about anticipated harm support an implied finding
regarding the causation of the purported harm described by Ross. Specifically, if the
parties anticipated that Ross would have no damages if it opened and operated the store,
then it logically follows that any lost profits resulting from Ross’s decision not to open
the store would not flow from (i.e., been caused by) Mervyn’s absence. Instead, the loss
of profits would be caused by Ross’s own decision not to open the store—that is, the
losses would have been self-inflicted.
Fourth, Ross appears to assert that, when it decided not to open the store, it was
motivated by the desire to mitigate its damages. Under the well-established principles of
appellate practice, we cannot accept (1) the factual assertion as to Ross’s motivation or
(2) the assertion that Ross, in fact, mitigated any damages by deciding not to open a store.
The trial court made no such findings on these specific points and this court may not
presume the existence of these purported facts. The judgment of the trial court is
presumed correct and all intendments and presumptions are indulged to support that
judgment. (Denham v. Superior Court, supra, 2 Cal.3d at p. 564.) Under this principle
and the doctrine of implied findings, an appellant such as Ross is not entitled to presume
the existence of facts that support its claim of error unless the existence of that fact is the
only reasonable deduction to be drawn from the evidence. Viewing the evidence in the
light most favorable to the judgment, we must conclude Ross’s decision was not
motivated by the desire to mitigate its damages, but was part of a failed strategy to
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renegotiate the rent and achieve greater profits from a store at that location. Similarly,
we must conclude that Ross caused, rather than mitigated, any damages it might have
experienced because it was not operating a store at the Porterville Marketplace.
In summary, Ross has failed to demonstrate the trial court erred in its analysis of
the damages or harm anticipated to flow from the failure of the conditions in the rent
abatement provision.
4. Comparison of Anticipated Harm to Value Forfeited
The trial court’s finding that there was no anticipated damage expected to flow
from the Mervyn’s vacancy makes the final step of the penalty analysis—the comparison
of anticipated harm to the value of the property forfeited—relatively simple.
The value of the property forfeited by Grand Prospect was approximately $39,500
per month. As found by the trial court, no harm was anticipated to result from the
Mervyn’s vacancy. Therefore, we agree with the trial court’s determination that there
was no reasonable relationship between the value of the property forfeited by Grand
Prospect ($39,500 per month) and the anticipated harm to Ross ($0 per month).
Accordingly, the trial court correctly concluded the rent abatement provision was an
unenforceable penalty.
5. Civil Code Section 3275
In reaching its conclusion that the rent abatement provision was an unenforceable
penalty, the trial court referred to Civil Code section 3275, which provides:
“Whenever, by the terms of an obligation, a party thereto incurs a
forfeiture, or a loss in the nature of a forfeiture, by reason of his failure to
comply with its provisions, he may be relieved therefrom, upon making full
compensation to the other party, except in case of a grossly negligent,
willful, or fraudulent breach of duty.” )!
The trial court addressed the requirement for making full compensation to the
other party by finding Ross’s compensation would be the cost of installing and removing
its signs. The court stated Ross did not offer evidence and no evidence was admitted as
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to these costs. As a result, the court did not require Grand Prospect to compensate Ross
for these costs.
Ross argues Civil Code section 3275 is not applicable to the facts of this case
because the cotenancy provisions were conditions, not an “obligation” as that term is
used in the statute. (See Parsons v. Smilie, supra, 97 Cal. at p. 654 [question noted but
not decided].) We reject Ross’s proposed interpretation of the statute. (See Root v.
American Equity Specialty Ins. Co., supra, 130 Cal.App.4th at pp. 939-940.) Instead, we
conclude contracts are a type of “obligation” covered by Civil Code section 3275. (See
Civ. Code, § 1428 [obligations are created by contract or operation of law].) Therefore,
the phrase “the terms of an obligation” includes the terms of a contract, even when those
terms are drafted as conditions precedent. (See Civ. Code, §§ 1434 [conditional
obligation defined], 1436 [condition precedent defined].) Consequently, if a conditional
provision in a provision constitutes an illegal penalty, then the affected party “incurs a
forfeiture” for purposes of Civil Code section 3275 and “may be relieved therefrom.”
(Civ. Code, § 3275.)
Therefore, the trial court did not err when it applied Civil Code section 3275 to the
rent abatement provision in the Lease.
V. TERMINATION PROVISION
Section 6.1.3(b) of the Lease provided Ross with an ongoing option to terminate
the Lease upon 30 days’ notice if the Commencement Date Reduced Occupancy Period
continued for 12 consecutive months and Ross’s termination notice was given before the
reduced occupancy was cured. Our analysis of whether the termination provision
operated as a forfeiture begins with the rules that govern the termination of a commercial
lease. If a forfeiture occurred, then we will subject the termination provision to scrutiny
under the general rule that requires a reasonable relationship between the value of the
property forfeited and the anticipated harm.
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A. Rule of Law Applicable to a Commercial Lease Termination Provision
California courts have developed a specific rule that applies to termination
provisions in commercial leases. The rule was stated by the California Supreme Court in
C. M. Staub Shoe Co. v. Byrne (1915) 169 Cal. 122 (Staub Shoe), which involved a
commercial lease with a provision stating the lease shall cease and become null and void
if the premises were damaged by fire and the damage was so severe that it could not be
repaired within 60 days. (Id. at pp. 126-127.) After a fire occurred, the tenant wanted to
remain in possession and claimed the repairs could be completed within 60 days. The
landlord disagreed and seized the property. The tenant filed an action for damages
resulting from its exclusion from the property. (Id. at p. 124.) After a bench trial, a
judgment was entered in favor of the landlord. (Id. at p. 125.) Our Supreme Court
upheld the judgment for the landlord, stating “the ... clause makes entirely reasonable
provision for the various contingencies that might result in case of fire or other injury to
the building or premises. There is here no basis for applying the rule of strict
interpretation against conditions involving forfeiture. (Civ. Code, sec. 1442.) The clause
terminating the lease in certain contingencies does not declare a forfeiture. It fixes
events, having no relation to any act or default of the parties, upon which it is agreed that
the lease shall end.” (Id. at p. 129; Caswell v. Gardner (1936) 12 Cal. App. 2d 597, 600
[contingent termination provision in lease did not result in a forfeiture]; see 7 Miller &
Starr, Cal. Real Estate (3d ed. 2011) Landlord and Tenant, § 19:186, pp. 578-579
[exercise of an option to terminate lease].)
Similarly, in 11382 Beach Partnership v. Libaw (1999) 70 Cal. App. 4th 212, a
landlord and a tenant entered into a commercial lease that stated either party could cancel
the lease if a fire destroyed the premises within two years before the termination of the
lease expired. (Id. at p. 215.) After a fire, the tenant exercised a five-year option under
the lease. The landlord canceled the lease, returned the tenant’s latest rent check and
threatened legal action to recover possession of the premises. The tenant filed a
declaratory relief action and the landlord filed a cross-complaint for damages and quiet
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title. The trial court found for the landlord, holding the cancellation provision prevailed
over the tenant’s option to extend the lease. On appeal, the judgment quieting title in the
landlord was affirmed. (Id. at p. 220.) The appellate court relied upon Staub Shoe to
conclude the tenant had failed to establish a forfeiture occurred when the lease was
cancelled. (11382 Beach Partnership v. Libaw, supra, at pp. 217-218.)
Based on these cases, we conclude that a when a commercial lease contains a
clause terminating the lease upon the occurrence of contingencies that (1) are agreed
upon by sophisticated parties and (2) have no relation to any act or default of the parties,
no forfeiture results from the exercise of the termination clause. This specific rule of law
controls over the general test usually applied to determine if a contract provision is an
unenforceable penalty. In others words, the law declares that certain termination
provisions do not create a forfeiture and, therefore, those provisions cannot be deemed
unenforceable penalties or a forfeiture from which relief can be granted under Civil Code
section 3275.
B. Application of Law to Facts of This Case
The facts of this case show that the foregoing rule regarding termination
provisions in commercial leases applies to the termination provision in section 6.1.3(b) of
the Lease. First, Ross’s right to terminate the lease was based on contingencies (i.e.,
conditions) that were agreed upon by sophisticated parties. Second, the conditions that
triggered the right to terminate had no relation to any act or default of the parties because,
when the Lease was made, neither Ross nor Grand Prospect could control whether
Mervyn’s continued to operate a store in the shopping center or whether that space would
be occupied by the type of anchor tenant specified in the Lease.
Because these facts are not disputed, the application of the rule set forth in Staub
Shoe and confirmed in subsequent cases presents a question of law. (See Weakly-Hoyt v.
Foster (2014) 230 Cal. App. 4th 928, [application of law to undisputed facts presents a
question of law subject to de novo review].) Pursuant to that rule, we conclude the
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termination provision exercised by Ross did not cause a forfeiture. Therefore, the trial
court committed legal error when it concluded (1) the termination provision was
unenforceable, (2) the termination provision could be severed from the Lease, (3) Ross
breached the Lease by exercising the option to terminate the Lease, and (4) this breach of
the Lease entitled Grand Prospect to recover damages resulting from the termination of
the lease. The proper conclusion is that the termination provision is valid and Ross could
rely on it to terminate the Lease.
Correcting this legal error is straightforward because the special verdict form
completed by the jury separated Grand Prospect’s damages before termination from the
other items of damage. Consequently, this court can modify the judgment by
implementing the jury’s finding as to the worth of the unpaid rent earned at the time of
termination ($672,100) from the three other categories of damages that should not have
been awarded.
DISPOSITION
The amended judgment filed April 18, 2013, is modified such that the reference to
“the sum of $3,785,714.86” shall be reduced to “the sum of $672,100.00” and the
reference to “a total award of $4,701,990.83” shall be reduced to “a total award of
$1,588,375.97.” As modified, the amended judgment is affirmed.
The parties shall bear their own costs on appeal.
_______________________
Franson, J.
WE CONCUR:
_____________________
Kane, Acting P.J.
_____________________
Peña, J.
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