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Retail Closures: Clearing The Continuous Operation Clause Hurdle

Guest Post by Danielle C. Lesser, Edward Gilbert, and Brett Dockwell of Morrison Cohen LLP:

Bricks-and-mortar retail has been among the hardest-hit sectors of the economy during the COVID-19 global pandemic. The mandatory stay-at-home orders issued in March 2020 essentially shuttered “nonessential” retail businesses in much of the country, abruptly slashing revenues and pushing many retailers deep into the red. As retailers now struggle to stabilize their businesses and avoid bankruptcy — a fate that has already claimed such iconic names as J.Crew, JC Penney, Neiman Marcus and Pier 1 — landlords may be faced with a wave of potential store closures.

To stem rising vacancies, landlords may resort to a little-used tactic that gained new life in recent years – enforcement of the “continuous operation” provision contained in many retail leases. As its name suggests, a continuous operation provision requires a tenant to continuously operate its store during certain hours for the entire term of the lease. Some continuous operation provisions also address adequate levels of inventory and staff. Such clauses are typically found in mall or shopping center leases and are generally intended to create a vibrant shopping environment, thereby drawing in shoppers and potential tenants.

Over the years, landlords had occasionally tried to use the clause to force retailers to continue operating stores that they would otherwise close. In such cases, the landlord would sue the retailer and ask a court to enforce the continuous operation provision by compelling the retailer to continue operating during specified hours for the remaining term of the lease. Such suits rarely succeeded, with courts permitting the tenant to close but requiring it to pay the landlord for any lost rent and expenses. However, in 2018, an Indiana State Court breathed new life into this tactic by imposing a nationwide injunction against Teavana, a division of Starbucks, prohibiting the tea retailer from closing its stores in malls owned by Simon Property Group.

The Teavana decision surprised many observers because it marked a break from prior decisions. In prior cases, courts were unpersuaded by landlord claims that closure of a non-anchor store would cause other retailers in the mall or shopping center to close their stores as well. But in the Teavana case, the court found that such consequences were likely. The court also found that even though Teavana stores were losing money, Starbucks as a whole was profitable and could afford to continue operating Teavana.

The Teavana decision was a shot in the arm for landlords facing store closures. However, a recent case in New York suggests that the Teavana decision might have been an outlier, rather than a legal turning point. In a 2020 decision involving the closure of a J.Crew store in upstate New York, an appellate court concluded that the drastic measure of forcing a tenant to operate its store could not be justified because the lease included a “liquidated damages” provision, entitling the landlord to recover a specified sum in the event the store closed prematurely.

The J.Crew decision arises from a 2018 dispute involving a J.Crew store in Eastview Mall, located in Victor, New York. J.Crew sought to close the underperforming store in the 150-store Eastview Mall by exercising an early termination, or “kick-out,” clause in its lease. The mall owner contested J.Crew’s right to exercise the clause and sued to prevent J.Crew from closing the store. The landlord asked the court to impose a preliminary injunction against J.Crew, prohibiting the retailer from closing the store.

Courts are generally reluctant to impose injunctions and will do so only when the party seeking the injunction meets three requirements: (1) it is likely to succeed on the merits of its lawsuit, (2) it cannot be adequately compensated through a monetary payment (a so-called “irreparable injury”) and (3) the harm it will suffer absent an injunction is greater than the harm the opposing party will suffer if the injunction is imposed (known as the “balance of the equities”). In the J.Crew case, the trial court found that the landlord has satisfied all three requirements and in July 2018, it granted the preliminary injunction.

However, on May 1, 2020, the Appellate Division, Fourth Department, reversed the trial court and vacated the preliminary injunction. In its decision, the Appellate Division focused on the latter two requirements for a preliminary injunction – irreparable injury and the balance of the equities. The appellate court noted that J.Crew’s lease included a liquidated damages provision which provided that in the event breached its obligation to operate its store, the landlord would be entitled to the amount of 150% of J.Crew’s minimum rent to compensate the landlord for “loss of value in the property because of bad publicity or appearance by Tenant’s actions” (i.e., harm to goodwill and reputation). The court ruled that “because the lease specifically provides that plaintiff [i.e., the landlord] is entitled to certain money damages in the event that [J.Crew] vacate[s] the premises in breach of the agreement—the very injury that serves as the predicate for plaintiff’s action—we conclude that plaintiff has an adequate remedy at law and, moreover, that plaintiff has not suffered irreparable harm because the liquidated damages clause was intended as the sole remedy for such a breach.” The court rejected the landlord’s argument that it would be irreparably harmed by the loss of good will if J.Crew, an important store in the mall, closed.

The court also ruled that the balance of the equities weighed in favor of J.Crew. “Here, we conclude that the harm defendants will suffer if forced to keep their 6,000-square-foot store open against their will is greater than the injury plaintiff will suffer from the loss of one tenant in the mall, especially because plaintiff may still recoup its loss via the liquidated damages provision.”

As retailers cope with the effects of the COVID-19 pandemic, they are likely to be confronted with difficult business decisions. The Appellate Division’s decision in the J.Crew case, together with earlier decisions by other courts in store-closure cases, suggests that the 2018 Teavana decision is best seen as arising from unique facts and that retailers can and should evaluate closure options even in the face of a continuous operation provision.

Danielle C. Lesser is a partner and chair of the Business Litigation department at Morrison Cohen LLP.  Edward P. Gilbert and Brett Dockwell, CRE are also partners in the Business Litigation department. (Pictured above from L-R)

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