Loss or failure to attract anchor tenants can have devastating financial effects on a shopping center and its tenants. So, don’t be surprised if retail tenants with bargaining clout demand a cotenancy clause protecting them against this contingency. Such provisions typically give the tenant the right to pay reduced rent or terminate the lease when the number of anchor tenants or overall occupancy level of retailers in a shopping center falls below a specific threshold. Of course, relief to the tenant magnifies the blow the landlord suffers in not being able to draw and retain the anchor tenants it needs to operate the property at optimal capacity. 

The best way to avoid the adverse effects of a cotenancy clause is not to include one in the lease. The problem is that accepting the clause may be the price a landlord has to pay to do business with a national retail chain or other powerful tenant. If you’re currently saddled with a tenant that’s taking advantage of a cotenancy clause to pay substantially reduced rent, there’s a potential remedy that you might want to consider: Get a court to declare that the cotenancy rent abatement is invalid and unenforceable. 

What the Law Says

There are two possible avenues of attack open to a landlord seeking to challenge a cotenancy clause in court: 

Unreasonable penalty. Contract law, 101: Landlords, tenants, and other parties to a contract are allowed to specify the penalties one side must pay to the other if they violate the terms of the agreement. In most states, these so-called “liquidated damages” provisions are perfectly enforceable, as long as they don’t impose an unreasonable penalty or forfeiture on the defaulting party. A cotenancy clause may be considered an unenforceable liquidated damages penalty if it reduces the tenant’s rent to an extent that’s disproportionate to the financial loss the tenant suffers as a result of the anchor tenant’s loss.   

Unconscionability. Terms of a lease may be unenforceable if they’re unconscionable—that is, so overwhelmingly one-sided in the favor of the party with superior bargaining power that nobody in good conscience would enforce them. To prevail on unconscionability, a landlord might have to show that both the substantive terms of the cotenancy clause and the process by which they were drafted were unconscionable. 

Here are two recent cases illustrating how courts apply these principles to actual disputes in which a landlord contests the enforceability of a cotenancy clause. While both rulings come from California, the principles involved apply equally in most other states. 

Cotenancy Rent Abatement Is Unreasonable Penalty 

In this case, a court found a cotenancy clause in the tenant’s favor to be unenforceable. 

Situation: A shopping center lease included a cotenancy clause allowing national retail chain, Ross Dress for Less,to delay opening its new store and pay zero rent if no acceptable anchor tenant was open in the center at the time the lease began. There was an acceptable anchor in place, Mervyn’s, when the lease was signed, but it had closed up and gone out of business by the time the Ross lease commenced. No new anchor replaced Mervyn’s for over a year. 

As permitted by the cotenancy clause, Ross accepted delivery of the premises but didn’t open a store or pay rent for 12 months before moving out. The landlord sued Ross for rent over the full 10-year term of the lease, claiming that the cotenancy clause was unenforceable. The jury sided with the landlord and ordered Ross to pay $672,100 for unpaid rent. Ross appealed.

Ruling: The California appeals court upheld the award of unpaid rent to the landlord.

Reasoning: The court held that the cotenancy clause was an unreasonable and unenforceable penalty. A provision is considered a penalty when it “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.” Here, the trial court found that Ross didn’t anticipate that it would suffer any damages as a result of Mervyn’s not being open on the lease commencement date; and the $0 it “paid” in rent bore no reasonable relationship to the $39,500 per month it would have paid but for the cotenancy clause rent abatement. 

However, the court stopped short of finding the cotenancy clause unconscionable, reasoning that unconscionability requires proof of both procedural and substantive unconscionability. There was no evidence of procedural unconscionability because the parties were sophisticated and experienced in commercial lease negotiation. Ross’s insistency on cotenancy provisions didn’t make the lease a contract of adhesion or otherwise deprive the landlord of a meaningful choice, the court concluded [Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc., 182 Cal. Rptr. 3d 235 (Cal. Ct. App. 2015)].

Cotenancy Rent Abatement Is Not an Unreasonable Penalty 

Here’s another case involving the same principles and a similar situation but with a completely different outcome. 

Situation: Jo-Ann’s, a national fabric retail chain, signed a lease that required fixed minimum rent of $42,292 per month, but which included a cotenancy clause allowing the tenant to pay substitute rent of the greater of 3.5 percent of gross sales or $12,000 per month if the number of anchor tenants at the shopping center fell below three or the amount of space in the center occupied by anchor tenants fell below 60 percent. 

Jo-Ann’s invoked the clause twice during the term without the landlord’s objection. But when it sought to pay substitute rent under the clause for a third time, the landlord went to court seeking a judgment declaring the cotenancy provision to be an unreasonable penalty in accordance with the Grand Prospect decision, along with $638,293, the difference between the fixed minimum rent and substitute rent. 

The trial court rejected the landlord’s claim. One unsuccessful appeal later, the case landed in the California Supreme Court.

Ruling: The high court ruled that the cotenancy clause was valid and enforceable.   

Reasoning: The Court cited key differences between this case and Grand Prospect: The cotenancy clause in Grand Prospect allowed the tenant to pay no rent at all whereas the substitute rent provided for in this case bore a more realistic resemblance to the actual damages Jo-Ann’s suffered as a result of reduced anchor occupancy in the center. 

The other key difference was the landlord’s control and ability to keep the tenant from invoking the cotenancy clause. In Grand Prospect, everything turned on the actions of Mervyn’s, a business over which the landlord had no control since it wasn’t a tenant. By contrast, the Court found that the cotenancy clause in this case gave the landlord “a realistic and rational choice” between alternative methods of performance. “If [the landlord] wishes to avoid receiving a lower level of rent, it can choose to make inducements to attract additional anchor tenants or raise the overall occupancy rate. . . . [such as by] offering favorable lease terms, providing additional amenities to tenants, or renegotiating important leases.” 

Based on these factors, the Court concluded that the substitute rent provided for under the cotenancy clause wasn’t a penalty but an acceptable form of “alternative performance” that fairly allocated the risks between the landlord and Jo-Ann’s. “[T]he parties’ contractual intent when reduced to writing should be controlling and enforced, particularly as applied to the commercial leasing market in arms-length negotiations and transactions,” the Court reasoned [JJD-HOV Elk Grove LLC v. Jo-Ann Stores, LLC, 17 Cal. 5th 256, 2024 Cal. LEXIS 7043].

Takeaway

Enforceability of cotenancy clauses is the prevailing view. While the landlord in JJD didn’t argue unconscionability, the Court suggested that such a claim would be difficult to prove in a cotenancy case. Such clauses aren’t negotiated in a vacuum. Landlords and tenants “who are often sophisticated and well represented, consider such provisions alongside other lease terms during an arms-length negotiation process.” Landlords who understand the real estate market and how the clause works are perfectly free to walk away from the bargaining table and often make the “realistic and rational choice” of accepting a cotenancy clause “to entice retailers into rental agreements.”

Significantly, while Grand Prospect shows that it’s possible, proving that a cotenancy clause is an unreasonable penalty is an uphill climb. As the JJD Court notes, the “vast majority of cases” from other states have upheld these clauses. Examples: 

• Connecticut federal court upholds cotenancy clause allowing tenant to pay reduced rent of 5 percent of gross sales if either a specific anchor tenant (Borders) or 50 percent of other retail space in the mall weren’t open, refusing to “unmake a deal agreed to by two sophisticated parties” [Kleban Holding Co., LLC v. Ann Taylor Retail, Inc., 2013 U.S. Dist. Lexis 168231];
• Nevada court cites the extensive negotiations between sophisticated parties who “understood that they were negotiating and agreed to a contract with different benefits and risks for each party” in upholding cotenancy clause allowing tenant to pay substitute rent of 2 percent of gross sales [Boca Park Marketplace Syndications Group, LLC v. Ross Dress for Less, Inc., 2019 WL 2563814]; 
• Oregon federal court finds that cotenancy clause reducing tenant’s rent to the lesser of 2 percent of gross sales or the “Minimum Rent then applicable” if cotenancy requirements aren’t met is not an unenforceable liquidated damages penalty [Old Navy, LLC v. Center Developments Oreg., LLC, 2012 U.S. Dist. Lexis 82579]; and
• Tennessee federal court upholds cotenancy provision allowing tenant to pay reduced rent of 4 percent of gross sales [Hickory Grove, LLC v. Rack Room Shoes, Inc., 2012 U.S. Dist. Lexis 70353].