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There are many incentives that a commercial landlord may provide to convince a potential retail tenant to lease space in its shopping center. Sometimes, the landlord will budget a certain amount of money for the benefit of the tenant to use to “fit out” the space. Other times, the tenant will be provided free rent for a period of time during the term of the lease. And, in some situations, the landlord will agree to include a restrictive covenant in the lease that will prevent the landlord from leasing other space in the shopping center to any of the tenant’s competitors.

In Dollar Tree Stores v. Holiday Supermarkets, 2013 Phila. Ct. Com. Pl. LEXIS 457 (Dec. 31, 2013), Philadelphia Court of Common Pleas Judge Patricia McInerney issued a memorandum opinion explaining why such a restrictive covenant precluded a landlord from continuing to lease space to another tenant in a shopping center.

In the early 1990s, the landlord of the Mayfair Shopping Center in Philadelphia entered into a written lease with a supermarket tenant. That lease was subsequently assigned to an entity that owned and operated a Shop n Bag Supermarket at the shopping center.

Under the lease, the landlord promised the tenant that it would “not permit any person other than [the tenant] to operate a retail supermarket of any nature in the shopping center,” according to the opinion.

A decade after that lease had been executed by the parties, Dollar Tree Stores Inc. entered into a written lease with the landlord at the time that contained the same prohibitory language, which restricted Dollar Tree from operating as a “retail supermarket of any nature” in the shopping center, the opinion said.

Under Dollar Tree’s lease, while Dollar Tree was permitted to engage in the “retail sale of general merchandise, including … kitchen accessories, household supplies … [and] novelty candy and snacks and other incidental food items,” it could “not use the premises [as a] retail supermarket of any nature,” the opinion said.

Several years later, the supermarket tenant filed a lawsuit against Dollar Tree, the landlord at the time, and others for, among other things, breach of contract, based upon the restrictive covenant contained in the supermarket tenant’s lease.

In the complaint, the supermarket tenant alleged Dollar Tree operated as a “‘retail supermarket of any nature’ in the shopping center in violation of the restrictions contained in [the supermarket]’s lease and Dollar Tree’s lease,” the opinion said.

The complaint was subsequently amended, omitting Dollar Tree as a defendant, but Dollar Tree later intervened in the breach of contract action as an interested party.

Dollar Tree also filed a separate declaratory judgment action against the supermarket tenant and the landlord at the time, seeking a declaration that it had not operated as a retail supermarket of any nature at the shopping center.

These separate lawsuits were consolidated, and, after the discovery phase of the litigation concluded, the parties then filed separate summary judgment motions.

In its summary judgment motion, the supermarket tenant asserted Dollar Tree was acting as a supermarket in violation of both its lease as well as Dollar Tree’s lease and the landlord at the time, to the detriment of the supermarket tenant, had failed to enforce the terms and conditions of these leases.

The supermarket tenant argued Dollar Tree sold “various food items that [went] well beyond the ‘incidental food items’ it [was] permitted to sell per the lease … by offering the same essential items, such as eggs, milk, cheese, bread, and many other food products, in addition to numerous household items typically sold at [the supermarket] at discounted prices” and, thus, “Dollar Tree [was] indeed competing directly with [the supermarket tenant], causing [the supermarket tenant]’s sales to suffer.”

On the other hand, Dollar Tree and the landlord at the time, in their own summary judgment motions, pointed to various definitions of the term “supermarket” and, in doing so, argued that Dollar Tree was not operating as a “supermarket” because it was not primarily selling food items nor selling a number of types of fresh food items.

In their summary judgment motions, Dollar Tree and the landlord at the time, citing to cases that hold restrictive covenants must be strictly construed, argued that “because Dollar Tree is not unambiguously a retail supermarket, there can be no violation of the restrictive covenant” and the “landlord ha[d] no duty to act with respect to the restrictive covenant and cannot be found liable for failing to enforce the exclusivity provision.”

The late Judge Albert Sheppard, the trial court judge at the time presiding over the consolidated cases, denied the supermarket tenant’s summary judgment motion and granted the summary judgment motions of Dollar Tree and the landlord at the time, declaring that Dollar Tree had not been operating as a supermarket and had not violated the supermarket restriction in the lease between Dollar Tree and the landlord.

Sheppard “relied on dictionary and statutory definitions of ‘supermarket'” and concluded “the term ‘supermarket,’ as used by the contracting parties meant a ‘retail store selling especially foods, or primarily groceries, fresh produce, meat, bakery and dairy products, in a variety of volume.'”

On appeal, the Superior Court of Pennsylvania noted that, while restrictive covenants in leases are to be strictly construed, they also “must be construed in light of their language, their subject matter, the intent or purpose of the parties, and the conditions surrounding their execution,” and “where an ambiguity exists [a fact-finder] may consider extrinsic evidence of the parties’ intent.”

The Superior Court agreed with the supermarket tenant that Sheppard ignored “the import of the qualifying phrase, ‘of any nature,’ on the definition of ‘supermarket,'” which the supermarket tenant maintained expanded “the definition of supermarket to include retailers resembling supermarkets.”

In doing so, the Superior Court rejected the argument made by Dollar Tree and the landlord at the time that “the phrase ‘supermarket of any nature’ merely implicated subcategories of supermarket and that [the supermarket tenant’s] broader interpretation is wrong, because a ‘supermarket of any nature’ must be a ‘supermarket’ in the first instance.”

The Superior Court stated Sheppard’s singular focus on the word “supermarket” rendered the language “of any nature” superfluous or meaningless, but that nothing in the lease readily defined the scope of the qualifying language. As such, the Superior Court concluded “resolution of the ambiguity require[d] the finder of fact to determine the parties’ actual intent after considering the surrounding circumstances, the situation of the parties, the objects they apparently have in view … the nature of the subject matter of the agreement, and other relevant extrinsic evidence” and that Sheppard erred in granting summary judgment.

The Superior Court then remanded the consolidated cases back for proceedings consistent with its ruling.

A jury trial eventually took place in connection with the breach of contract action initiated by the supermarket tenant. The trial was presided over by McInerney.

At trial, the supermarket tenant, among other things, presented the testimony of the attorney representing the original supermarket tenant during the formation of the supermarket lease. While the attorney did not specifically draft or negotiate the restrictive covenant language contained in the supermarket lease, but merely included the language at the insistence of the original supermarket tenant, he did testify that he had represented the original supermarket tenant for several decades and explained that the original supermarket tenant had a lot of power as the anchor tenant and that every lease he negotiated on behalf of the original supermarket tenant had an exclusive-use provision to protect the original supermarket tenant and its sublessees from competition and that the original supermarket tenant would not enter into any lease without this protection.

With respect to the issue of intent of the parties at the time the supermarket lease was executed, the attorney testified both parties intended and understood the phrase “supermarket of any nature” was not limited to protecting the original supermarket tenant and its sublessee from competition just from another supermarket, but rather provided broader protection from competition from any business selling the same types or categories of products offered for sale by the supermarket.

At the conclusion of trial, the jury found in favor of the supermarket tenant.

On the same day the jury verdict was docketed with the prothonotary, a declaratory judgment was also entered in favor of the supermarket tenant and against Dollar Tree, making a number of declarations including that Dollar Tree had operated as a retail supermarket of any nature in the shopping center in violation of the restrictive covenants in the leases.

Dollar Store and the landlord at the time then filed an appeal to the Superior Court of Pennsylvania.

McInerney issued a memorandum opinion as part of the appellate proceedings, primarily explaining why the restrictive covenant contained in the supermarket lease should be enforced.

In the memorandum opinion, McInerney indicated that “the primary issue of the appeal is the interrelationship between the rule of strict construction for restrictive covenants and the use of extrinsic evidence to determine the intent behind an ambiguous restrictive covenant.”

On appeal, Dollar Tree complained that the trial court “failed to apply controlling Pennsylvania law which requires that restrictive covenants be strictly and narrowly construed, and that nothing will be deemed a violation that is not in plain disregard of the express terms of the restriction.”

In response, McInerney pointed out that the entire premise of Dollar Tree’s complaint of error is in direct contradiction with the Superior Court’s previous ruling that the phrase “supermarket of any nature” was ambiguous, which necessitated the consideration of extrinsic evidence of the intent of the landlord at the time and the original supermarket tenant as to what usage in the shopping center they intended to so restrict.

In other words, McInerney emphasized that “the fact that the restrictive covenants were found to be ambiguous simply means the intent of the parties had to be determined from extrinsic evidence, not that the parties did not know the intent of the restrictive covenants or that there can be no breach as a matter of law.”

LESSONS LEARNED

The recent rulings made by the Superior Court as well as McInerney in Dollar Tree Stores illustrate the potential impact of this type of lease provision. Presumably, at the time of lease execution, the landlord at the time wanted to secure a supermarket tenant that would serve as an anchor to the shopping center. What has happened, however, is that the restrictive covenant language contained in the leases has served as an anchor that has sunken the chances of the landlord’s successor-in-interest to potentially attract certain tenants to the shopping center.

Reprinted with permission from the April 15, 2014 edition of The Legal Intelligencer © 2014 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson