Amid the uncertainty plaguing brick and mortar retail establishments, some commercial landlords may find themselves with an extra tool in their arsenals to temporarily stave off tenant vacancies: continuous operations clauses. Conversely, these same clauses may force some commercial tenants to incur operational losses. Continuous operations clauses are covenants commonly found in commercial leases that compel tenants to operate efficiently and profitably by requiring them to conduct regular business at all times during the lease term. Some continuous operations clauses are so specific as to require the tenant to operate five or six days a week; some even go so far as to state the number of hours per day that the tenant's establishment must remain open. Other common clauses contain verbiage stating that the tenant shall maintain merchandise levels of such size, character and quality as shall be reasonably designed to produce the maximum return to landlord and tenant. Regardless of the specifics, continuous operations clauses generally are intended to prohibit tenants from ceasing operations and vacating the premises before the end of the term of the lease, even if tenants have the ability to compensate their landlords for any remaining rental payments.
How Do Continuous Operations Affect Landlords and Tenants?
Continuous operations clauses may help alleviate several concerns common to landlords. First, even when a vacating tenant pays a landlord for outstanding rental payments as liquidated damages, the landlord may still incur negative economic repercussions such as not receiving a percentage of the tenant's future sales. Second, when there is an unanticipated vacancy, landlords are often unable to promptly find qualified tenants to reoccupy the now unoccupied spot. Finally, some retail tenants may decide to lease a particular site based in large part on the tenant mix at the site. Therefore, a tenant vacating the site before the end of its term could disrupt the businesses of the remaining tenants and potentially jeopardize the total revenue generated by the site if the landlord is unable to find a comparable tenant to fill the void. Continuous operations clauses can potentially protect landlords from these risks by forcing the tenant to remain open until the anticipated end date contained in the lease.
Continuous operations clauses have the potential to place heavy economic burdens on tenants. Ordinarily, tenants choose to vacate prematurely only when doing so provides economic benefit. Oftentimes, tenants vacate prior to the termination of their lease terms only when remaining operational in that location is cost prohibitive and would cause operational losses. Consequently, some tenants who are forced to continue operations may not only lose out on the greater economic opportunities other locations may offer, but may be compelled to operate with significant losses.
Do Courts Generally Enforce Continuous Operations Clauses?
Although continuous operations clauses seem to restrict a tenant's ability to vacate a leased premises, courts have been hesitant for decades to enforce them. For example, in the 1993 M. Leo Storch, Ltd. Partnership v. Erol's, Inc. case, the Maryland Court of Special Appeals upheld a lower court's decision not to grant a preliminary injunction to force a tenant to remain open despite the presence of a continuous operations clause in the lease. (M. Leo Storch, P'ship v. Erol's, Inc., 620 A.2d 408 (Md. Ct. Spec. App. 1993)) In Storch, the tenant ceased operations prior to the lease termination date and the landlord filed suit in the circuit court asking the court to enjoin the tenant from closing. The court refused to grant the landlord's request for an injunction. On appeal by the landlord, the Court of Special Appeals upheld the lower court's decision and maintained that the majority view among courts in the modern era was not to enforce continuous operations clauses. Citing the Restatement (Second) of Contracts, the court held that courts do not need to grant injunctions when doing so requires continuous court supervision. The Restatement states, "A promise will not be specifically enforced if the character and magnitude of the performance would impose on the court burdens in enforcement or supervision that are disproportionate to the advantages to be gained from enforcement and to the harm to be suffered from its denial." (Restatement (Second) Contracts § 366 (1981)). In Storch, since any determination as to whether the tenant was sufficiently operating at the site pursuant to the continuous operations clause would require direct and continuous court supervision for the duration of the lease term, the Court of Special Appeals chose not to enforce the clause.
Are Things Changing?
A recent court decision in Indiana has some in the retail industry questioning whether the tide is turning in favor of landlords with respect to enforcing continuous operations clauses. In Simon Property Group LP v. Starbucks Corporation, the landlord, Simon Property, had continuous operations clauses in all of its leases with Starbucks for seventy-seven (77) of Starbuck's Teavana stores throughout the United States. (Simon Prop. Grp., L.P. v. Starbucks Corp., 2017 WL 6452028 (Ind. Sup. 2017)) Starbucks announced it would be closing all of its Teavana stores nationwide, and Simon Property sued to enjoin them from closing their stores located on sites owned by Simon Property. In November 2017, the Indiana Superior Court granted a preliminary injunction compelling Starbucks to keep the Teavana stores open based on the continuous operations clauses in the leases. Although the court only granted a preliminary injunction restricting closure throughout the length of the trial, the court only approved the injunction because it held that Simon Property was likely to succeed at trial to receive a permanent injunction compelling Teavana to remain open until the expiration of its leases. The questions of whether this decision will be upheld on appeal and whether other courts will follow suit remain unanswered. However, if more courts choose to enforce continuous operations clauses, thereby compelling tenants to remain in place when before they could leave without recourse, then landlords may have more time to determine how they will utilize space that they know will eventually become available as some tenants choose not to renew their leases. While this might not resolve long term vacancy issues for certain landlords, it at least provides a level of certainty that may allow them to plan for the future. Tenants, on the other hand, may find themselves obligated to conduct business even if doing so causes them to incur losses and severe economic harm.
The Current Situation for Landlords and Tenants
Although it is unclear if courts are beginning to take a new stance on enforcing continuous operations clauses, it is currently an opportune time for prudent landlords and tenants to review their current leases and to carefully review those they are planning to sign. If courts are becoming more open to enforcing continuous operations clauses, landlords may want to ensure that their leases contain clauses with language that courts will find both acceptable and enforceable. Judicious tenants may desire to audit their current leases to see if they are contractually obligated to continue operations, even if doing so would be at great cost. Both landlords and tenants may also desire to understand the implications of continuous operations clauses so they may better negotiate future leases.
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