Arbitration in Commercial Leasing

In May 2012 Premium Plastics Supply, Inc signed a two-year lease for commercial space owned by Thomas and Laura Howell. The Lease contained an arbitration provision, providing that all disputes related to it must be arbitrated.

The Lease term ended in May 2014, but Premium continued to occupy the space. In October 2014 the Howells sent a notice of default to Premium seeking payment under the holdover clause of the Lease. When Premium did not pay, the Howells started an arbitration proceeding.

After initiating arbitration, the Howells then changed the door locks on the leased space. Premium responded by claiming wrongful lockout under the Texas Property Code and several other claims, but ultimately all were voluntarily dismissed by Premium before the commencement of the arbitration.

The Howells were awarded $33,000 in unpaid rental at the arbitration. So the Howells filed a lawsuit in Harris County to confirm the award.

Premium responded to the lawsuit by reasserting the counterclaims previously raised and withdrawn in the arbitration.

The Howells obtained a confirmation of the arbitration award from the Harris County court, now converted to a Judgment. In rendering the Judgment, the court found that Premium no longer had the right to assert its counterclaims, as those matters should have been asserted in the arbitration.

The failure of Premium to timely assert those counterclaims, the trial court held, is not so much a waiver of legal rights as res judicata – a legal theory that says judicial resources will not be used to rehash the same arguments over and over, that have already been heard and decided. 

Or, should have been heard. And decided.

So Premium appealed, claiming it had claims that needed to be heard in the litigation forum.

The Appellate Court started by evaluating our Texas Rules of Civil Procedure, requiring counterclaims to be litigated in an initial arbitration or lawsuit when it arises out of the same transaction or occurrence, and does not need the presence of third parties of whom the court cannot acquire jurisdiction.

Next, it was time to consider the impact of arbitration awards. Basically, the Court concluded that there is not much difference between an arbitration award and a Court-ordered judgment. And an arbitration award is treated as a prior final judgment for purposes of res judicata.

Based on this, the Appellate Court had little trouble ruling for the Howells. It appears that Premium made a decision not to assert its claims in the arbitration, perhaps thinking those claims could be held for a later date. The Appellate Court did not agree that Premium could postpone the assertion of those claims, and found that the failure to assert such claims in the arbitration proceeding fatally impaired the ability of Premium to later assert them in Court.

So, Judgment is affirmed for the Howells. See Premium Plastics Supply, Inc. v. Thomas Howell and Laura Howell; Case No. 01-16-00481-CV; Texas Court of Appeals 1^st District-Houston; September 28, 2017: http://scholar.google.com/scholar_case?case=2032118509891223314&q=premium+plastics+v.+howell&hl=en&as_sdt=6,44.

Lessons learned:

1.      Arbitration is unusual in a commercial leasing context. Commercial landlords want the unrestrained right to claim a lease default and start court eviction proceedings in JP Court, as opposed to waiting for an arbitration award and then confirming it in a following lawsuit to convert the award into a Judgment. Typically JP Court eviction trials occur in only a few weeks after the eviction lawsuits are filed, but it can take years to obtain both an arbitration award and a Court-ordered confirmation and conversion to Judgment.

2.      This case is helpful to illustrate a sidebar point: Texas constables and sheriffs will not enforce an arbitration award. Only Judgments can be enforced. And Judgments only come from our courts – no arbitrator has the ability to issue a Judgment.

3.      Now you should be seeing how cumbersome arbitration proceedings can be in the context of a commercial lease. Most landlords won’t allow it; some power-tenants insist on it. In the latter situation, be sure to consider what happens when the tenant fails to pay rent or commits some other obvious lease default. An arbitration procedure followed by litigation might delay justice for a year or more.

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

Licensed in the States of Texas and New York

Reprinted with the permission of the North Texas Commercial Association of REALTORS®, Inc.

 

Lease Guarantees

In 2003, L + C Unlimited Corp. received the assignment of the tenant’s interest in a lease that permitted the Golden Isle Restaurant to operate in a strip mall. Xiao-Yan Cao, President of L + C, personally guaranteed the performance of L + C.

In 2006 the tenant’s leasehold estate was again assigned, this time to Hong Lin. At the same time, the Lease term was extended five years to September 30, 2013. Both Cao and Lin signed new, personal Guarantees.

From 2008 to 2010 L + C and Lin failed to timely make rent payments, and owed ~ $24,000. However, L + C, Lin and the Landlord PC Riverview, agreed to a repayment schedule to permit L + C and Lin to catch up by making five additional payments. Which Lin did.

In 2013, L + C and Lin defaulted again and failed to pay the last monthly installment of rent. PC Riverview sued both Lin and Cao for the rental deficiency. Cao defended, arguing that the 2010 repayment schedule materially modified the Lease and discharged Cao’s Guaranty, since Cao did not agree to the repayment schedule, was not notified about its existence, and did not execute the repayment agreement.

The district court agreed and ruled in Cao’s favor. PC Riverview appealed.

The court of appeals reversed, reasoning that merely extending the period within which a tenant may pay rent did not materially modify the Lease and consequently, all guarantors remain liable. Cao appealed to the Supreme Court.

The Supremes first turned to Cao’s Guaranty Agreement, which provided that Cao “. . . guarantees performance of all covenants, conditions and obligations and duties required of Tenant under said Lease.” And here’s what the Guaranty Agreement did not provide Cao: right to a notice before the Lease was amended or a prohibition against such amendments without Cao’s consent.

We can guess where the Supremes are headed when they state that before the 2010 Modification was made, Cao was responsible for the payment of rent, interest and late fees. And after the 2010 Modification was signed, Cao was responsible for – wait for it – rent, interest and late fees.

The Supreme Court affirmed the Judgment of the court of appeals. Xiao-Yan Cao is obligated to pay PC Riverview. See PC Riverview LLC v. Xiao-Yan Cao; Case No. 20160781; Utah Supreme Court; August 23, 2017: http://caselaw.findlaw.com/ut-supreme-court/1871913.html.

Lessons learned:

1.      Are you on the Guarantor-side of this issue? Then be sure the Guaranty Agreement does not obligate the Guarantor for future amendments and modifications to the Lease. Also provide that the Guarantor receives notice of all claims of the Landlord against the Tenant, and prohibit the Lease from being amended or extended without Guarantor’s prior written consent.

2.      Are you on the Landlord-side of this issue? Then be sure the Guaranty obligates the Guarantor for all amendments, without any requirement of notification or approval, and that the Guaranty continues until all obligations of the Tenant to the Landlord have been discharged as reported by Landlord.

3.      On both sides of this? Be sure that the Guaranty Agreement is clear and unequivocal, and 12 people sitting in a jury box with average 11^th grade educations can readily understand what you are trying to accomplish in both the Lease and Guaranty.

                                                                                    Stuart A. Lautin, Esq.*

                Reprinted with permission by North Texas Association of REALTORS®, Inc.

               * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

                 Texas Board of Legal Specialization

                 Licensed in the States of Texas and New York

 

Did You Say What You Mean? Did You Mean What You Said? (Part One)

Jeff Carpenter owned a 15-acre parcel of raw land in Charlotte, North Carolina. In 2006 Jeff transferred two acres to an entity he controlled, Pavilion, and Pavilion leased the two acres to CVS Pharmacy. Jeff agreed to place a restriction in the CVS Lease on the future use of Jeff’s remaining tract, to entice CVS to sign the Lease by granting CVS an exclusive pharmacy use.

Pavilion sold the CVS tract in 2008 to Sonny Boy. At that time Jeff implemented the exclusive restriction on the remainder of the 15-acre tract with a restrictive covenant, as Jeff and CVS previously agreed two years prior. The balance of Jeff’s larger tract had not yet been developed.

The recorded covenant essentially stated that during the term of the CVS Lease, no portion of the balance of the 15-acre parcel could be leased or used as a drug store or pharmacy.

In 2012 Jeff contracted to sell the restricted remainder parcel to Charlotte Pavilion Road Retail Investment, LLC and WLA Enterprises, Inc. Charlotte Pavilion and WLA simultaneously contracted to purchase an adjacent, unrestricted tract of land from Charter Properties. The developers planned to lease the Charter parcel to Wal-Mart for construction of a retail store that would sell, among other items, drugs and pharmaceuticals. The developers intended to use Jeff’s 13-acre tract for parking and access for customers to the Wal-Mart and other retail stores.

So, although Wal-Mart would share the parking lot with other retail businesses, Wal-Mart customers would be expected to park on Jeff’s parcel to access the Wal-Mart store. In which, again, the customers could purchase items in direct competition with CVS.

When CVS learned that the developers intended to construct a parking lot on the restricted tract for use by Wal-Mart, CVS informed the developers that such use would violate the restrictive covenant. So the developers sued CVS and Sonny Boy, asking the Court for an Order to the effect that their proposed parking lot development plans did not violate the restriction.

In January 2014 the trial court granted the developers’ request, and entered Judgment holding that the proposed construction of a parking lot and use for Wal-Mart customers would not violate the terms of the restrictive covenant.

CVS and Sonny Boy appealed.

CVS  and Sonny Boy likely knew they were in trouble when the Appellate Court immediately took the position that North Carolina courts use a strict construction rule to interpret restrictive covenants, and that such covenants are not favored in North Carolina law. It was of no help to CVS that the Court stated that covenants are not enforceable unless clear and unambiguous.

Then, it was time to closely examine the language of the restriction. The restrictive covenant prohibited the construction of a building that is used for the sale of drugs, vitamins, health and beauty aids, or as a pharmacy. The covenant banned various business activities, but not incidental purposes (such as parking for a restricted use).

The North Carolina Appellate Court concluded that construction of a parking lot and access easement on Jeff’s parcel, to serve Wal-Mart’s customers on an adjacent and non-restricted tract, was not violative of Jeff’s restriction although such customers would be purchasing from Wal-Mart at least some items that were directly described in the CVS restriction.

The Appellate Court agreed with the developers Charlotte Pavilion Road and WLA Enterprises. The developers won and CVS lost. See Charlotte Pavilion Road Retail Investment vs. North Carolina CVS; No. COA14-658; North Carolina Court of Appeals; December 16, 2014.

Lessons learned:

1.      Commercial leasing is one of the most difficult things I do, and most of my colleagues feel the same. It is incredibly difficult to forecast issues and draft provisions for every possible contingency over the life of a 10 or 25 year lease. And, some leases have terms that are 99 years. If we could cover every possible issue that might arise, the Lease would be three inches thick, no one would read it and no one would sign it.

2.      Restrictive covenants are inherently tricky because courts don’t like them and uses change over time. Did any of us imagine the advent of lottery sales in 1991 or e-cigarettes in 2003? How many older retail leases prohibit “gambling” and how many office leases prohibit “smoking”? Do you think those provisions preclude lottery sales and e-cigs?

3.      Practice Point: Stay tuned for Part Two. In that installment I will evaluate how Texas deals with this issue. There may be some surprises.


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.