In a pivotal 2024 decision, the California Supreme Court upheld a co-tenancy clause in JJD-HOV Elk Grove, LLC v. Jo-Ann Stores, LLC, S275843 (Cal. 2024), offering much-needed clarity on a legal issue that has unsettled landlords and tenants alike since the controversial ruling in Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. (2015) 232 Cal.App.4th 1332.

Rewind: Grand Prospect’s Troubled Legacy

As explored in our January 2015 Dirt Report, Grand Prospect sent ripples through the industry by invalidating a retail co-tenancy clause on the grounds that it operated as an unenforceable penalty. Ross had negotiated the right to pay no rent if a key anchor, Mervyn’s, failed to open. When Mervyn’s shuttered, Ross invoked the clause – but the California Court of Appeal found the remedy disproportionate and disconnected from any actual harm to Ross, particularly since Ross executives testified they didn’t expect to lose any sales.

Critically, the landlord in Grand Prospect didn’t even own the Mervyn’s parcel and had no control over whether it opened or operated. That lack of control weighed heavily in the appellate court’s decision – a key distinction the California Supreme Court would later amplify.

Fast Forward: JJD-HOV’s Co-Tenancy Clause Survives Scrutiny

As discussed in our August 2022 Dirt Report, Jo-Ann had a co-tenancy clause allowing for reduced rent if overall occupancy in the shopping center fell below 60 percent. When that threshold was breached, Jo-Ann paid reduced rent equal to the greater of 3.5 percent of its sales or $12,000 per month in lieu of the contract rent of $42,292 per month—prompting the landlord to sue, citing Grand Prospect.

But both the trial court and the California Court of Appeal sided with Jo-Ann. And now, the California Supreme Court has affirmed: the clause is enforceable.

The Supreme Court’s Focus: Control

In distinguishing JJD-HOV from Grand Prospect, the California Supreme Court centered its analysis on one crucial factor: control. In Grand Prospect, the co-tenancy clause allowed the tenant to delay opening its store and avoid paying rent if the anchor tenant, Mervyn’s, closed its doors. However, the landlord had no control over that closure because it did not own the parcel Mervyn’s occupied. Upon determining that the landlord lacked control over such outcome, the Grand Prospect Court found it fundamentally unfair to penalize the landlord by allowing the tenant to pay no rent despite the tenant’s testimony that it had not anticipated suffering any harm as a result of such closure.

By contrast, in JJD-HOV, the co-tenancy provision was tied to overall occupancy levels of the shopping center which was entirely owned and controlled by the landlord. The California Supreme Court explained that the landlord could control and influence the shopping center’s occupancy levels by, “choos[ing] to make inducements to attract additional anchor tenants or raise the overall occupancy rate. These efforts may include offering favorable lease terms, providing additional amenities to tenants. Or renegotiating important leases.” This difference in control mattered.

Ultimately, the California Supreme Court’s ruling reinforced the broader principle that co-tenancy clauses are enforceable when they are tied to factors a landlord can reasonably control and are part of a commercially reasonable allocation of risk.

A Clearer Path for Retail Leasing?

The JJD-HOV decision offers meaningful clarity for landlords and tenants navigating co-tenancy clauses. While it doesn’t validate all co-tenancy clauses across the board, it sets a workable standard: rent adjustment provisions are enforceable when they’re the product of fair negotiation, tied to objective conditions, and linked to circumstances the landlord can reasonably influence. This decision, however, does leave a few questions open: What if a lease provides that a tenant could operate its store and pay zero rent if there is a co-tenancy failure in a shopping center entirely owned and controlled by a landlord? What if a lease provides a tenant would only be entitled to reduce its rent from the contract rent to 5 percent of its gross sales (versus paying zero rent) in the event of a co-tenancy failure that occurs on a property not owned by the landlord? In the first instance, we believe a court could rule such a scenario to be unenforceable and in the latter instance, enforceable. Control may not be the only determinative factor after all.  Leasing lawyers should be careful not to overreach on behalf of their clients.