1. Operating Costs and the Law
Presented By:
Gregory D. Call, Esq. & Tracy E. Reichmuth, Esq.
Crowell & Moring LLP

2. The Question
Are landlords charging you for “operating costs” that are not permitted under your lease language or failing to make offsets required under your operating cost clauses?
Are landlords charging for costs that are not incurred in operating the shopping center (or common areas)?
Are landlords charging management fees that may not be permitted under leases?
Are landlords earning revenues from their operations in the common areas of shopping centers (parking, advertisements, concierge sales, etc.) and then charging you for the related costs?

3. What to Do: Read the Lease
Three main sources to understand what the landlord can and cannot charge:
The language of the lease
“Parol” evidence
Correspondence during negotiation, changes made to drafts of lease, course of dealing, industry practice, etc. – what is admissible depends on state law. See Fresh & Easy Neighborhood Market, Inc. v. WCPP-CT, 2014 WL (Feb. 26, 1014, Cal. Ct. App.) (court considered changes made to draft language of CAM clause and testimony on industry practice regarding management fees).
Case law interpreting similar provisions

4. What to Do: Read the Lease
Of these, the language of the lease is most important.
Your lease language may vary from your neighbors’ – the landlord cannot just apply the same formula across the board.

5. Agenda Consider some fundamental questions of lease interpretation.
Apply our lease-reading skills to hypothetical disputes based on real-life scenarios.
Questions.

6. Some Preliminary Lease Questions: Operating Cost Clause v. CAM Clause
One of the most fundamental questions of interpretation is whether your lease permits the landlord to charge for costs of operating the shopping center, or only the common areas. Compare:
“Tenant shall pay its Tenant Share of the costs of operating, managing and maintaining the Shopping Center.”
“Tenant shall pay the costs of operating, managing and maintaining the Common Areas of the Shopping Center.”

7. Some Preliminary Lease Questions: Shopping Center/Common Areas
How is the shopping center defined?
How are the common areas defined?
What about outparcel buildings? Off-site expenses?
What about roofs?
What about building exteriors?

8. Some Preliminary Lease Questions: Which Activities Are Covered?
Compare:
“Tenant shall pay its Tenant Share of the costs incurred by Landlord in operating and maintaining the Shopping Center.”
“Tenant shall pay its Tenant Share of the costs incurred by Landlord in operating, managing, supervising, and maintaining the Shopping Center.”
Does “managing” the shopping center mean something different than “operating and maintaining”? Different than “supervising”?
Does it matter what earlier versions of the lease said?

9. Some Preliminary Lease Questions: What Are the Enumerated Costs?
Example:
“Tenant shall pay its Tenant Share of the costs actually incurred by Landlord in operating the Common Areas of the Center, specifically including landscaping and gardening, parking lot, line painting, lighting, traffic control, if any, sanitary control, and removal of snow, trash, rubbish and garbage and other refuse. . .”
Exclusive list? Or just illustrative?

10. Some Preliminary Lease Questions: What Are the Excluded Costs?
The lease may explicitly exclude certain items, such as:
Depreciation
Capital improvements
Reimbursed/reimbursable costs
Costs covered by insurance
Costs associated with certain parts of the mall (roofs, walls, etc.)

11. Some Preliminary Lease Questions: Denominators
The denominator can be as important as what goes into the pool of operating costs.
We will discuss this more later.

12. Hypotheticals
Let’s look at some of the common disputes that arise under operating cost clauses – and some you might not have considered.
Costs benefitting certain tenants
Access fees
Revenues generated by landlord
Management fees
Denominators

13. Hypothetical 1: Costs Benefitting Certain Tenants
Facts:
Landlord passes through costs of security required to patrol near restaurants and bars that stay open after the retail stores close for the night.
Landlord passes on construction costs associated with relocating entrance to a department store.

14. Hypothetical 1: Costs Benefitting Certain Tenants
Lease language:
“Common Area Costs shall include all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas Common Area Costs shall not include depreciation and amortization of equipment or debt; capital improvements or repairs under generally accepted accounting principles; taxes; costs that are reimbursable by other tenants; legal fees; costs incurred as a result of negligent conduct by Landlord’s employees or agents . . .”

15. Hypothetical 1: Costs Benefitting Certain Tenants
Arguments regarding security:
Security is not incurred in operating the common areas, but rather necessary due to activities of particular tenants.
Question: Are these costs “reimbursable” by the restaurants and bars? Would likely depend on those tenants’ own leases, which landlord will be reluctant to turn over.

16. Hypothetical 1: Costs Benefitting Certain Tenants
Arguments regarding construction:
Is construction a capital improvement and therefore excluded?
Are the construction costs not incurred in operating the common areas, but rather to improve a tenant’s premises/access?
How are the common areas defined? Do they include exteriors of stores/exits?
Are these costs “reimbursable” by the department store?

17. Hypothetical 2: Access Fee
Facts:
Landlord retains a third-party vendor to remove snow from the parking lot and other common areas of the shopping center.
The Landlord requests and receives an access fee from the vendor of 5% of the total amount charged for the services.
Landlord passes through all charges paid to the vendor and keeps the 5% access fee without offset against CAM.

18. Hypothetical 2: Access Fee
Lease Language:
“Tenant shall pay to Landlord, as additional rent, Tenant’s proportionate share of all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas, specifically including landscaping and gardening, parking lot, line painting, lighting, traffic control, if any, sanitary control, and removal of snow, trash, rubbish and garbage and other refuse, together with a reasonable allowance for Landlord’s supervision and administration of said Common Areas in an amount equal to eight percent (8%) of the total amount of said annual Common Area costs and expenses.”

19. Hypothetical 2: Access Fee
Issues:
Should Landlord deduct the access fee prior to charging tenant?
How do our answers change if the Lease language changes?

20. Hypothetical 2: Access Fee
Issue 1
Should Landlord deduct the access fee prior to charging tenant?
Is it a “cost or expense”?
See Johanneson’s, Inc. v. Kraus-Anderson, No. C , 1999 WL , at *1 (Minn. Ct. App., Aug. 17, 1999) (landlord not entitled to charge a management fee, which was not a common area expenditure but an overhead cost not authorized under the lease).
Is it “incurred”?
Should it otherwise be offset?

21. Hypothetical 2: Access Fee
Issue 2
How do our answers change if the Lease language changes?
For example, what if the Lease also provided: “Notwithstanding the foregoing, Common Area costs and expenses shall not include items for which Landlord receives actual reimbursement from other sources or is otherwise reimbursed under this lease.”

22. Hypothetical 3: Revenues
Facts:
Shopping center is located in a busy downtown area and has a large parking garage accessible to the public.
Landlord contracts with third party to operate the parking garage, including providing parking attendants to collect payments and to operate a paid valet service.
Under contract with third-party vendor, Landlord pays vendor all costs (including payroll) plus a percentage of total costs.

23. Hypothetical 3: Revenues
Facts:
Center charges for parking on an hourly, daily or monthly basis.
Parkers include employees of tenants, shoppers, and monthly parkers who work in nearby office buildings.
Landlord receives all revenues from the garage.
Landlord passes all payments to the parking vendor through to Tenants as CAM.

24. Hypothetical 3: Revenues
Lease Language:
“Tenant shall pay to Landlord, as additional rent, Tenant’s proportionate share of all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas Notwithstanding the foregoing, Common Area costs and expenses shall not include items for which Landlord receives actual reimbursement from other sources or is otherwise reimbursed under this lease.”

25. Hypothetical 3: Revenues
Issues
Should Landlord pass through costs of operating the parking garage?
If yes, should Landlord offset the revenues from the garage before charging Tenant?
What are similar scenarios that might arise?

26. Hypothetical 3: Revenues
Issue 1
Should Landlord pass through costs of operating the parking garage?
Are they “costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas”? See Sheplers, Inc. v. Kabuto Int’l, 63 F.Supp.2d 1306, (D. Kan. 1999) (landlord could not charge tenant for costs not incurred in managing and maintaining common areas).
Or are they costs of operating a revenue-generating business?

27. Hypothetical 3: Revenues
Issue 2
If yes, should Landlord offset the revenues from the garage before charging Tenant?
Are the costs “incurred”?
Are the costs “actually reimbursed”?

28. Hypothetical 3: Revenues
Issue 3
What are similar scenarios that might arise?
Advertising in common areas
Concierge sales, gift certificates, etc.
Vending machines
Sales not covered by cart/kiosk agreement

29. Hypothetical 4: Management Fees
Facts:
Landlord retains a closely related entity to manage the entire shopping center operation (including running the common areas, collecting rent, leasing vacant space, etc.).
Landlord “pays” the related entity for these services and passes through to tenants as CAM.
Management fee is equal to 10% of all collections (rent, CAM, taxes, etc.)

30. Hypothetical 4: Management Fees
Lease language:
“Tenant shall pay to Landlord, as additional rent, Tenant’s proportionate share of all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas, specifically including landscaping and gardening, parking lot, line painting, lighting, traffic control, if any, sanitary control, and removal of snow, trash, rubbish and garbage and other refuse, together with a reasonable allowance for Landlord’s supervision and administration of said Common Area in an amount equal to three percent (3%) of the total amount of said annual Common Area costs and expenses.”

31. Hypothetical 4: Management Fees
Argument 1:
Lease is silent as to “management” of the common areas or “management fees”
“Tenant shall pay to Landlord, as additional rent, Tenant’s proportionate share of all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas. . .”
Some courts have held that if a CAM provision does not expressly allow the landlord to charge a management fee, landlord should not include any management fee in CAM costs and expenses. Sheplers, Inc. v. Kabuto International (Nevada) Corp., 63 F.Supp.2d 1306 (Kan Dist. 1999).

32. Hypothetical 4: Management Fees
Argument 2:
The management fees are not related to the common areas of the shopping center.
“Tenant shall pay to Landlord, as additional rent, Tenant’s proportionate share of all costs and expenses incurred by Landlord in the operation, repair and maintenance of the Common Areas. . .”
Here, costs are related to managing the entirety of the shopping center operation, not just the common areas.

33. Hypothetical 4: Management Fees
Argument 2:
Management fees are not related to the common areas of the shopping center.
What if the lease expressly provides for a fee for managing the common areas?
Even where the CAM provision mentions management fees, absent other language, landlord should only charge management fees specifically related to the common areas. Sheplers, Inc. v. Kabuto International (Nevada) Corp., 63 F.Supp.2d 1306 (Kan Dist. 1999).

34. Hypothetical 4: Management Fees
Argument 3:
The management fees duplicate the allowance to the landlord for supervising the common areas.
“. . . together with a reasonable allowance for Landlord’s supervision and administration of said Common Area in an amount equal to three percent (3%) of the total amount of said annual Common Area costs and expenses.”
Courts have held that a landlord should not pass through management company’s fee in addition to administrative costs. McDonald’s Corp. v. Goler, 251 Neb. 934 (1997).

35. Hypothetical 4: Management Fees
Argument 4:
At minimum, management fees should be allocated between common area activities and other activities (finding new tenants, marketing the shopping center, activities benefitting one tenant).
“For future years, defendant is entitled to charge as CAM expenses any expenses that directly relate to CAM, including a portion of the compensation of on-site employees, but plaintiff is entitled to be provided with reasonable detail. Plaintiff may reasonably require that the percentage of time spent by the property manager or her assistant be evidenced by records of her daily time and the allocation of that time to various activities.” Sheplers, Inc. v. Kabuto International (Nevada) Corp., 63 F.Supp.2d 1306 (Kan Dist. 1999).

36. Hypothetical 4: Management Fees
Argument 4:
At minimum, management fees should be allocated between common area activities and other activities (finding new tenants, marketing the shopping center, activities benefitting one tenant).
Where management company charged landlord a management fee based on a percentage of total rent for the center, and did not allocate between CAM and non-CAM tasks like rent collection, tenant was not obligated to pay any portion of management fee. Viking Bank v. Firgrove Commons 3, LLC, 183 Wash. App. 706 (2014).

37. Hypothetical 4: Management Fees
Argument 5:
Fees are not “incurred by Landlord”
Rather, money is simply transferred between related entities.
Also look for provisions excluding amounts paid to closely-affiliated entities (for example, payments excluded unless the amount paid is competitive with non-related vendors).

38. Hypothetical 5: Denominators
Facts:
Lease calls for you to pay a proportionate share of operating costs.
Landlord excludes the following from denominator:
55,000 s.f. movie theater
Carts and kiosks
Vacant store temporarily converted to landlord office space

39. Hypothetical 5: Denominators
Lease language:
Denominator includes “all gross leasable space in the Shopping Center.”
Excludes “all Major Stores” with “Major Stores” defined as “all stores larger than 50,000 square feet.”

40. Hypothetical 5: Denominators
Arguments:
Theater is not a “store,” and therefore not a “Major Store” under the lease.
What about:
Banks
Post offices
Real estate agents
Non-profit organizations

41. Hypothetical 5: Denominators
Arguments:
Carts and kiosks occupy leasable space
Some tenants have succeeded in arguing that such an agreement should be considered a lease (rather than a license) where the agreement gives the cart or kiosk operator the exclusive right to occupy a space for a period of time. Schloss v. Sachs, 63 Ohio Misc.2d 457 (1993); Park v. Automotive Realty Corp., 1998 WL (S.D.N.Y. 1998).
Office space is “leasable” even if not currently leased.

42. Hypothetical 5: Denominators
Other issues affecting pro rata share
Where tenant agreed in lease to pay share based on square footage set forth in the lease, and lease clearly stated that they were approximations, tenant was not entitled to pay less because true measurements differed from estimates. Village of Palatine v. Palatine Associates, LLC, 966 N.E.2d 1174 (Ill. App. 2012).
Tenant had claim for fraud where landlord misrepresented tenant’s likely pro rata share of CAM. Thrifty Payless, Inc. v. Americana at Brand, LLC, 218 Cal. App. 4th 1230 (2013).

43. Potential Claims What Claims Could The Tenant Bring?
Breach of Contract
Breach of the Covenant of Good Faith and Fair Dealing
Fraud
Equitable Relief (unjust enrichment, money had and received)
Statutory Unfair Business Practice Claims

44. Landlord’s Potential Defenses
Waiver (tenant’s conduct showed intent to waive claims)
Estoppel certificate
Statute of limitations (time to bring claims depends on state)
Laches (even if tenant is within the limitations period, it waited too long to bring its suit and either acquiesced to the overcharges or landlord was prejudiced by delay)
Terms of lease limit time to challenge overcharge or limit remedies

45. Landlord’s Potential Defenses
Example: Payless Shoesource, Inc. v. Joye, 2014 U.S. Dist. LEXIS (Feb. 4, 2014 E.D. Cal.)
Tenant filed suit to recoup overcharges by landlord under provision that required tenant to pay a pro rata share based on LFA. However, because tenant had failed to object to the methodology used by landlord for 15 years, claims were barred by estoppel and waiver.

46. Questions?

47. Contact Information:
Greg D. Call, Esq. Tracy E. Reichmuth, Esq. Crowell & Moring LLP