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Let’s say that you represent the owner of a strip shopping center in Northeast Philadelphia. The largest tenant in the center, a chain drug store, has shut down its operations at the center and opened a new store at a more prominent location nearby. The tenant has continued to pay the fixed rent and maintain the premises, but the loss of the drug store has reduced customer traffic in the center, and the other tenants are complaining. Even though the drug store is maintaining the premises and keeping it secure, the vacant space is a blight on the physical appearance and operation of the center. The lease, which you did not negotiate, does not expressly obligate the tenant to continuously operate in the premises during the term. There are, however, a number of other clauses that arguably imply the parties intended the tenant would operate throughout the term. For example, the lease contains a provision that specifically defines the purposes for which the premises may be used. In addition to the fixed rent payable under the lease, the tenant is also obligated to pay a portion of gross receipts as percentage rent. Your client wants to know if it can terminate the lease and recapture the space. How would you advise the client? Most leases contain a provision that restricts the purposes for which the tenant under the lease may use its space. In some circumstances, such as a retail lease in a shopping center, the use clause may be crafted precisely, listing even the types of merchandise or products which the tenant may sell. Such a provision is intended to assure a stable mix of stores in the shopping center and to protect the business of each individual tenant. A use clause must be distinguished from a covenant to operate. The latter obligates the tenant to continuously operate its business in the premises throughout the term of the lease. It may also require that the tenant remain open during specific days of the week and hours of the day. Provisions like this, which prohibit the tenant from “going dark” during the term of the lease, are common in shopping center leases. In such a context, it is not enough that the tenant pay rent and maintain its space. The success of the shopping center, and its tenants, requires some critical mass of open and operating stores. The need for a covenant to operate is even more apparent where the lease contains a percentage rent provision, since the rent payable under such a lease is determined at least in part by sales volume. When a tenant “goes dark” under a lease which does not contain an express covenant to operate, the landlord will sometimes argue that the use restriction, the percentage rent clause, or other provisions of the lease give rise to an implied covenant to operate. Giessow Restaurants v. Richmond Restaurants, a recent decision of the Missouri Court of Appeals, is one such case. Giessow Restaurants involved a long-term sublease that contained a use restriction and a percentage rent clause but no covenant to operate. The use restriction prohibited the use of space for any purpose “other than that of a restaurant, ice cream parlor, bar, tavern and cocktail lounge for the sale and dispensing of food and liquor, and for all activities related and incidental thereto.” Rent under the sublease included both a fixed rent component and a percentage rent component. On June 30, 2004, the sublessee closed the restaurant but continued to pay the fixed rent. The sublessor attempted to terminate the lease and recapture the space. In response, the sublessee filed a declaratory judgment action, seeking a determination that it was not in default, was not obligated to operate the restaurant, and was not required to pay percentage rent in the absence of gross sales. The sublessor counterclaimed, arguing, among other things, that the restrictive use provision gave rise to an implied covenant to operate. The Court of Appeals rejected this position, determining that the use provision did not “require that lessee must, at all times, put the property to use. Rather, it articulates the purposes for which lessee may use the property, should it choose to use property. . . . Indeed, a provision which restricts use of the premises is not identical to a provision which enjoins nonuse of the premises.” The sublessor also argued that a covenant to operate should be inferred from the percentage rent clause, citing the decision of the Federal Court of Appeals in EMRO Marketing Company v. Plemmons (8th Cir. 1988). In Emro, the court found an implied covenant to operate based in part upon the fact that the fixed rent under the lease was nominal ($100 per month), while percentage rent was significant. The court in Giessow Restaurants distinguished Emro on the basis of the relative amounts of the fixed rent. “The [sublease] here is further distinguishable from the lease in Emro because [the Giessow sublease] includes a [fixed] rental provision that is much more substantial than the nominal [fixed] rent contemplated in Emro. . . . We cannot conclude that the fixed rent of $25,000 per year in this case is insubstantial, especially when compared to the $100 per month the 8th Circuit considered nominal in EMRO.” Citing several earlier Missouri decisions, the court ruled in Giessow Restaurants that the mere existence of a percentage rent provision was insufficient in itself to give rise to an implied covenant to operate. Implied covenants, according to the Missouri Court of Appeals, are “disfavored” and will not be found to exist if the lease document is “clearly drafted.” In other words, the Missouri courts can be expected to follow a rule of strict construction and will not impose a covenant to operate in the absence of specific language to the contrary. It is interesting and instructive to compare Pennsylvania law with Missouri law, as delineated in Giessow Restaurants. There are only three Pennsylvania appellate level decisions that address the question of the implied covenant to operate in commercial leases. Two of these cases, Dickey v. Philadelphia Minit-Man Corp. (Pa. 1954) and McKnight-Seibert v. National Tea Co. (Pa. Super. 1979), are consistent with Giessow Restaurants. They follow the rule of strict construction. As stated by the Superior Court in McKnight-Seibert, “in the absence of a specific covenant to the contrary, we should not impose so onerous a burden” as an obligation to continuously operate. With respect to the interpretation of a use restriction, the Pennsylvania Supreme Court said in Dickey that “a provision in a lease that the premises are to be used only for a certain prescribed purpose imports no obligation on the part of the lessee to use or continue to use the premises for that purpose; such a provision is a covenant against a noncomplying use, not a covenant to use.” Although the tenant in Dickey did not “go dark” completely, it did discontinue a major part of its operations. The lease in Dickey contained a percentage rent provision, which the landlord argued gave rise to an implied covenant to operate that was violated by the partial discontinuance of operations. The Supreme Court held that so long as the decision was made “in good faith and in the exercise of legitimate business judgment,” the action taken by the tenant did not violate the lease. The most recent Pennsylvania appellate case, Slater v. Pearle Vision Center (Pa. Super. 1988), moves away from the rule of strict construction. It holds that “in construing the lease to ascertain what obligations respecting use and occupancy it imposes on the [the tenant], and thus in ascertaining the intentions of the parties to the lease, we must construe the lease as a whole in the light of the circumstances surrounding its execution.” In other words, there need not be an express covenant to operate. The court must look at the totality of the lease and the totality of the circumstances to determine what the parties intended. Slater involved a strip shopping center located in Bloomsburg, Pa. Pearle Vision signed a lease, paid its rent, but never occupied the leased space. The landlord filed a complaint in equity to compel Pearle to occupy and use the space. Pearle filed preliminary objections, arguing, among other things that there was no covenant to operate in the lease. The trial court sustained Pearle’s preliminary objections, ruling that the lease did not expressly obligate Pearle to occupy the premises and that as a matter of law, no such obligation could be implied. The lower court’s determination was based upon Dickey and McKnight-Seibert. The Superior Court found Dickey and McKnight-Seibert to be factually distinguishable and therefore not directly controlling, since neither of those cases involved “a completely vacant store front in an interdependent shopping mall where the lease itself contains provisions other than the use clause from which an obligation to use and occupy might be implied.” Citing more recent case Pennsylvania law on lease interpretation in general, the Superior Court in Slater said that in construing the lease, it would apply “general principles of contract law.” One such principle is the doctrine of necessary implication, which it characterized as follows: “In the absence of an express provision, the law will imply an agreement by the parties to a contract to do and perform those things that according to reason and justice they should do in order to carry out the purpose for which the contract was made and to refrain from doing anything that would destroy or injure the other party’s right to receive the fruits of the contract. . . . This is true even where the contract itself is not ambiguous.” Applying the doctrine of necessary implication to the facts of Slater, the Superior Court found that even though there was no express covenant to operate, there was “ample evidence in this lease that these parties may well have contemplated and intended that Pearle was obligated to occupy and use the premises.” This conclusion was based on a number of provisions in the lease including a requirement to open not later than 90 days after approval of plans, a prohibition on abandonment, a requirement that the tenant conduct it business in the entire premises, and affirmative obligations to act in the best interests of the shopping center as a whole. Relying on decisions from other jurisdictions, the Superior Court also indicated that other factors, including factors outside the body of the lease itself, must be considered in determining the intention of the parties. Circumstances such as the existence of interdependent economic units, the position of the premises in the shopping center and the relative amounts of fixed rent and percentage rent may also be relevant in determining the parties’ intentions. The language of Slater and the cases from other jurisdictions cited by the Superior Court in Slater suggest that in the appropriate factual circumstances, where the landlord has a significant interest in the continued active operation of the premises, a covenant to operate may even be inferred simply from the use clause or a percentage rent provision. The Superior Court reversed the decision of the trial court and remanded for further proceedings. The doctrine of necessary implication applied in Slater stands in marked contrast with the rule of strict construction applied in Giessow Restaurants. Under Slater, there need not be a specific covenant to operate. The court will look at the totality of the lease and the totality of the circumstances and will find an implied obligation where it is necessary to do so in order to effectuate the intent of the parties or avoid injustice. From the landlord’s perspective, it is, of course, far better to have an express covenant to operate in the lease than to argue for the existence of an implied covenant to operate under the doctrine of necessary implication. Those of us who draft and negotiate leases for property owners should be sure that the lease clearly spells out the tenant’s obligations in this regard. A well-drafted covenant to operate might include the following elements, among others: an obligation to open for business by a specific date; a covenant to operate in the entire premises throughout the term, unless the space is rendered untenantable by fire or other casualty; an undertaking to sell all of the products or provide all of the services enumerated in the use clause; and, an agreement to be open to the public during certain days and certain hours. Martin Doyle and David Felder are members of Saul Ewing’s real estate department in the firm’s Philadelphia office. Both have worked on a number of major real estate transactions and have been involved in all aspects of real estate development, sales, finance and leasing. Doyle received a law degree, cum laude, from the University of Pennsylvania Law School. Felder received his J.D. degree, cum laude, from Harvard Law School.

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