Competition or Destructive Competition: What Is the Difference?

Given the current challenging economic times and the impact on owners and users of retail space, the recent Court of Appeals case in Maryland addressing the concept of a landlord’s “implied covenant to refrain from destructive competition” requires attention and consideration.

In the case of RRC Northeast LLC v BAA Maryland, Inc., RRC, a concessionaire at BWI-Marshall Airport claimed that the holder of the master lease for the airport (defendant BAA) violated an implied covenant to refrain from destructive competition when BAA sublet spaces at the airport terminal to other merchants selling the same tourist-themed products that RCC was selling at its store. While the case was ultimately dismissed on procedural grounds, the Maryland Court of Appeals took the opportunity to reject the argument posed by BAA – given the complexity of lease documents, as well as the competition in the marketplace – that there is no place for an implied covenant regarding competition. In making its decision, the Court did not, however, expressly overrule the prior rulings on this point and in fact distinguished the prior rulings from the case at issue. The Court also took the opportunity to specifically restate the law in Maryland on the issue by providing:

“an implied covenant to refrain from destructive competition may be inferred from a percentage lease, based on the duty of good faith and fair dealing, where the intentions of the parties, as indicated by the terms of the lease and the circumstances surrounding the formation of the lease, suggest that such a reference is appropriate, namely by limiting competition to a particular level with, or granting exclusivity to, the plaintiff, ether in the contract or an incorporated pre-lease document.”

In its ruling the Court sited several cases which are very instructive as to what factors owners and tenants need to consider when addressing this issue. In the Maryland case of Eastern Shore v. J.D. Associates, 213 F 3d. 175 (2000) the parties entered into a lease where the tenant was to lease and operate a grocery store in a shopping center. The lease provided that the tenant would pay base rent as well as a percentage rent equal to 1.25 percent of the store’s annual gross sales in excess of $10 million, incorporated a site plan showing remaining space in the shopping center as future department store and retail store space, restricted the tenant to only operating as a “supermarket primarily for the sale of food” and required the tenant to include in its gross sales the revenues from any other grocery store owned and operated by it within a three mile radius from the center. While the lease was in effect, the owner of the shopping center leased one of the remaining spaces, designated on the site plan as department store and retail store space, to a competing grocery store. As a result, the first tenant’s sales were adversely impacted and the tenant sued. In the final holding in the case, the Court of Appeals for the Fourth Circuit held that:

“under Maryland law, the intentions of the parties expressed in the lease providing for rent calculated in part as a percentage of sales, combined with the circumstances surrounding the lease’s formation, may give rise to an implied covenant to refrain from competition that is destructive to the mutual benefit of the contracting parties.”

In the Eastern Shore case, the Court based its ruling in favor of the tenant on the fact that an enforceable promise to refrain from destructive competition arose because the shopping center site plan, which was incorporated into the lease, limited competition by identifying the specific uses that would be located in the rest of the center.

Far Reaching Implications

The implications of these cases are far reaching for both owners and tenants and warrant additional consideration when parties are entering into a retail lease. While an owner will want flexibility as to who it can lease to in the future (especially given the limited pool of credit tenants), the tenant will want protection against serious competition on its specific product line – especially if it is restricted as to what it can sell from its space. As an owner, any lease clause which deals with use, operations, exclusivity or competition needs to be carefully scrutinized to make sure that there are no provisions or references that could be used to support a destructive competition claim. By way of example, has the owner provided any representation as to how many stores of a specific type will be located in the center? Has the owner limited the total square footage within the center that can be used or occupied by a specific tenant or use? Has the owner agreed not to use any adjacent property for a specific use? These provisions and representations could support a destructive competition claim under the Maryland Court’s interpretation.

From the tenant’s perspective, during negotiations, did the owner or its broker make any representations (orally, or in writing such as in a letter of intent) that are similarly restrictive and could be viewed as “pre-lease documents” which would be incorporated into the lease for this purpose? Did the owner or its broker made any representations about the type or nature of other users to be located in the center and did the tenant rely on these representations?

In Maryland and possibly other jurisdictions, owners and tenants need to carefully review and consider all of the facts and circumstances surrounding the lease negotiation, as well as the final lease document and all exhibits to it, to make sure that the intent of the parties is clearly stated so as to avoid future conflict and a potential destructive competition claim by a tenant.

A version of this article appears in Southeast Real Estate Business, July 2010. Southeast Real Estate Business is © 2010 France Publications, Inc.