Restrictive Covenants in Commercial Leases

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Beyond the employment or sale of a business context, restrictive covenants also feature prominently in commercial leases. This is an entirely different type of restrictive covenant. The end result – e.g. a potentially lawful restraint on competition – is the same but the mechanics are much different. In the classic scenario, when an anchor tenant agrees to move into a certain plaza, it receives the benefit of a restrictive covenant in its favor.
Let’s use Winn-Dixie, which is an excellent example from a recently litigated case. Winn-Dixie, which is based in Jacksonville, FL, commits to become an anchor tenant of a new commercial plaza in Jacksonville for a term of 15 years. Winn-Dixie is the first tenant to sign a lease with the plaza. Winn-Dixie’s lease contains a restrictive covenant in its favor: The lease gives Winn Dixie the exclusive right to operate a grocery store within the plaza. The plaza agrees not to lease space to any other grocery stores. The lease between Winn-Dixie and the landlord is recorded in the public record. All subsequent tenants take their leases subject to the terms of the Winn-Dixie lease. Eventually, the plaza leases space to Dollar Tree. This creates a problem because there is a grocery section in the Dollar Tree store. At this point, Winn Dixie could sue either the landlord, Dollar Tree or both. The following are significant issues that may arise in the context of litigating restrictive covenants in commercial leases:

  • Real Property Law: Cases involving restrictive covenants in commercial leases are fundamentally property cases. For instance, in the actual Winn-Dixie case, Winn Dixie sued its competitors.
    • Winn-Dixie alleged that Dollar Tree took its lease subject to the Winn-Dixie lease and the restrictive covenant contained therein and that Dollar Tree was violating that obligation. Winn Dixie did not allege that Dollar Tree’s lease with the plaza contained explicit reference to the Winn Dixie grocery exclusive, but instead that Dollar Tree (1) took its lease subject to all outstanding covenants and (2) that Dollar Tree was on notice of the restrictive covenant because it was publicly recorded and (3) that the restrictive covenant ran with the land.
    • In this sort of situation, the enforceability of a restrictive covenant in a commercial lease will hinge on state property law. Specifically, property law that governs the enforceability of covenants running with the land. This can implicate numerous aspects of property law: privity, real vs. personal property, real obligations, etc.
  • Contract vs. Covenant Running with the Land: As noted above, these cases tend to fall into two different categories: Contract or covenant running with the land.
    • Contract cases: In the contract cases, you’ll see the exclusive tenant suing the landlord for breach of contract. In some contract cases, the subsequent tenants will have leases that explicitly mention the restrictive covenant and make the anchor tenant a third party beneficiary. In those instances, the anchor tenant would also sue the subsequent tenant for breach of contract.
    • Covenant Running with the Land Cases: In these cases – like the actual Winn Dixie case – the plaintiff is not alleging breach of a contract between it and the defendant. Instead, it’s alleging breach of a covenant that ran with the land—issues of notice, constructive notice, etc.
  • Choice of Law
    • As is often the case in the non-compete context, choice of law is incredibly important when evaluating restrictive covenants in commercial leases. There are significant variations in property law from one state to another. Analyzing a covenant running with the land (e.g. the grocery exclusive in the Winn-Dixie commercial lease), courts must consider numerous property law doctrines. These includes privity, obligations that touch and concern the land, etc.
  • Impact of Florida Statutes 542.335
    • The Florida non-compete statute 542.335 is generally invoked in the case of restrictive covenants tied to employment or the sale of a business. Some commentators – and even some Florida cases – have suggested that the 542.335 does not apply to restrictive covenants in commercial leases. But in my view, those cases are limited to their specific facts. I can envision a variety of scenarios in which Chapter 542 of the Florida Statutes could apply. Recall that 542.335 is the specific section of the Chapter that deals with employment and sale of a business non-compete agreements. Chapter 542 – as a whole – goes beyond that. Chapter 542 is referred to as The Florida Antitrust Act. Ultimately, all of this goes back to antitrust. Chapter 542 is basically a codification of certain well-established antitrust principals, particularly the “rule of reason.” When you look at 542.335, that is pure rule of reason framework. Bottom line: Restraints of trade are illegal unless they are reasonable.
    • In some instances, you may have a commercial lease/restrictive covenant situation in which the restraint is unreasonable and is therefore an illegal restraint of trade in violation of 542— the Florida Antitrust Act.
      • Here’s an example from one of my case files: John Smith signs a commercial lease to rent a gas station. His lease contains a restrictive covenant that provides: For a period of three years from the termination of this Lease Agreement or any renewal thereof, Lessee and its owner John Smith jointly and severally agree that they will not directly or indirectly own or operate a business, agency, organization or entity of a kind similar to the business being operated by John Smith as Smith Gas & Go located at the Premises, nor act as an officer, director, owner, partner or shareholder, nor give any advice or counsel to, nor be an employee or creditor of any individual, partnership, corporation or entity which owns or operates a kind similar to John Smith Gas & Go within a five (5) mile radius of the Premises.
      • As I’ve said before— In this arena, I have seen literally everything imaginable. The foregoing is from an actual dispute. The restrictive covenant contemplated in this example serves no legitimate business interest (neither one spelled out in 542.335 nor otherwise) and is clearly unenforceable. It’s antitrust.
  • Damages
    • A note about damages: Let’s return to the Winn-Dixie example. Assume that the restrictive covenant at issue (i.e. grocery exclusive) is enforceable. Winn-Dixie still has to prove damages. This is incredibly difficult if not impossible: Dollar Tree had a small grocery section in its store. How can Winn-Dixe plausibly demonstrate how much revenue Dollar Tree took from it by violating the grocery exclusive? How many of those customers went to Dollar Tree for a specific purpose and grabbed one or two small grocery items while there— but would not have made a separate trip to Winn Dixie. There are a litany of factors that make it extremely difficult to calculate damages in restrictive covenant cases, including commercial lease restrictive covenant cases. Bottom line: Fighting these cases on damages is often the best strategy. In fact, that’s why Winn Dixie largely lost its case—It failed to put forth a viable theory of damages.

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