Dependent Covenants in Commercial Leases: Hindquarter Corp. v. Property Development Corp

• Publication year: 1984

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 8, No. 2WINTER 1985

NOTES

Dependent Covenants in Commercial Leases: Hindquarter Corp. v. Property Development Corp.

I. Introduction

One of the most significant trends in modern leasing has been the application of contract law principles to an area of law heretofore governed by the law of property conveyance.(fn1) Contract principles are now being applied in disputes over residential leases.(fn2) Many residential leases today are based on the assumption that the tenant has contracted for a certain quality of housing.(fn3) If that quality is less than the tenant has a right to expect, courts and legislatures have used contract law to award the tenant damages or other relief.(fn4) Contract remedies have similarly protected landlords against nonpaying tenants.(fn5) In many cases, courts have used the doctrine of dependent covenants to find contractual remedies in residential leases.(fn6)

Commercial leases, however, have not been affected to the same degree by the growing dependent covenant trend. Most courts apply strict conveyancing rules to commercial leases.(fn7) An oft-cited reason for not applying contract rules is that business persons bargain "at arm's length" and therefore have the knowledge and leverage to ensure that each party profits from the lease arrangement.(fn8) Thus, bargaining between commercial parties should result in a classic conveyancing situation: the obligations of the landlord and tenant should be mutually exclusive, and breach of one party's covenants should not excuse a breach of the other person's promises.(fn9)

A small but growing number of courts and commentators, however, understand that commercial tenants often deserve the protections of a contract theory that stresses dependence of covenants.(fn10) Some courts have turned to contract law to fashion relief for commercial landlords as well, especially when tenants refuse to pay rent or to perform other agreed-upon services.(fn11) Washington courts have joined the modern trend that finds dependent covenants in commercial leases. Indeed, the Washington Supreme Court applied contract law to a commercial lease dispute in Hindquarter Corp. v. Property Development Corp.,(fn12) thus moving to the forefront of the trend. The decision has serious implications for those who draft and enforce nonresidential leases in Washington. Following Hindquarter, Washington courts will be increasingly receptive to claims that nonresidential lease provisions are mutually dependent, even to the extent that courts will find dependent covenants implied in commercial lease agreements.

This Note demonstrates that the Washington Supreme Court correctly applied contract principles to the Hindquarter lease dispute. The Note first reviews the historical development of dependent covenants in both residential and commercial contexts. After setting out this important background information, the Note examines Hindquarter and the three factors that influenced the Washington Supreme Court in following the dependent covenants trend: (1) material inducements to execute the lease; (2) the intent of the parties; and (3) equity and policy considerations. The Note concludes that, even though the landlord prevailed in Hindquarter, commercial tenants stand to gain most from the supreme court's decision.

II. Historical Application of Dependent Covenant Arguments

Under English common law, lease agreements involved an exchange of independent promises.(fn13) The breach of one party's promises did not excuse the other party's nonperformance unless the lease contained express conditions allowing nonperformance.(fn14) Whether express or implied, the two covenants invariably present in any lease were the tenant's duty to pay some kind of rent and the landlord's promise not to interfere with the tenant's quiet enjoyment of the leased property.(fn15) A feudal tenant could not be ejected for nonpayment of rent unless the lease specifically so provided.(fn16) Not until the early 1800s did English statutes permit ejectment for failure to pay rent.(fn17)

American courts followed the English common law until the twentieth century, when they began to find express or implied dependent covenants in residential leases.(fn18) The impetus stemmed in part from housing codes brought about by changes in public policy.(fn19) Residential tenants successfully argued that a warranty of habitability could be inferred from the standards set forth in local housing codes.(fn20) In the typical case, the landlord tried to evict the tenant for nonpayment of rent, and the tenant countered that the apartment's condition violated the local housing code.(fn21)

Even in the absence of an express housing code, many courts have recently held that a residential tenant may be relieved of the promise to pay rent if the landlord has breached an implied warranty of habitability.(fn22) The successful tenant must prove that the defects were so substantial that they amounted to a breach of the landlord's duty to provide habitable premises. Some examples of substantial defects include lack of heat, faulty plumbing, vermin infestation, or other major health and safety defects.(fn23)

Until 1973 Washington courts generally held that there was no implied warranty of fitness in either residential or commercial leased property.(fn24) In that year, both the legislature and the supreme court spoke in favor of residential tenants' rights to habitable premises. The Residential Landlord-Tenant Act(fn25) modified traditional conveyancing law to give tenants more protection. Within a few months of the Act, the supreme court held in Foisy v. Wyman(fn26) that there was also a state common-law warranty of habitability for residential tenants.(fn27) The tenant in Foisy knowingly rented run-down premises at a greatly reduced monthly rental. When the landlord later brought an unlawful detainer action for nonpayment of rent, the tenant defended by claiming that the landlord violated an implied warranty of hab-itability by renting dilapidated premises.(fn28) The court first traced the growing implied warranty trend in other jurisdictions(fn29) and then concluded that in Washington, too, every dwelling lease contained such a dependent covenant by implication.(fn30)

By comparison, commercial tenants have not been as successful as their residential counterparts in persuading courts to accept dependent covenant theories.(fn31) This has been true even when commercial tenants have offered as precedent analogous residential cases decided in the same jurisdiction.(fn32) In several instances, the state courts that generously implied the existence of dependent covenants in residential leases have refused to imply dependent covenants in commercial leases under similar facts.(fn33)

There have been some instances, however, in which the courts have found dependent covenants in commercial leases.(fn34) Some commercial tenants have successfully argued that constructive eviction,(fn35) noncompetition clauses,(fn36) or inequality of bargaining position(fn37) are reasons why their duties to landlords should be dependent on fulfillment of the landlord's responsibilities. In most cases, the success of the commercial tenant has hinged upon the degree to which the commercial tenant resembles a residential tenant: the more similar the circumstances, the more willing courts have been to find dependent covenants in commercial leases.(fn38) Although tenants have usually had the most to gain from a dependent covenant theory of leasing, landlords, too, have argued that mutually dependent promises should be upheld.(fn39) A landlord usually rents the property with the expectation that the tenant will pay the rent on time. When the tenant fails to pay, the landlord often turns to the theory of dependent covenants and claims that the promise of quiet enjoyment need not be kept. This was the situation that the Washington State Supreme Court confronted in Hindquarter Corp. v. Property Development Corp.(fn40)

III. Hindquarter Corp. v. Property Development Corp.

Hindquarter is a reversal of the usual pattern in which the tenant seeks relief or raises a defense based on a dependent covenant theory. In Hindquarter, it was the landlord who defended its refusal to grant an option to renew by claiming that its promise to renew depended on the tenant's timely payment of rent.(fn41)

Tenant Hindquarter Restaurant (Hindquarter) attempted to exercise a lease renewal option for its premises in a shopping center. The landlord's assignee, Property Development Corporation (Property Development), refused to grant the renewal because the tenant was chronically late with monthly rent checks, many checks were returned for insufficient funds, and the tenant was one month in arrears at the time it tried to exercise the five-year option.(fn42) The landlord had filed suit twice to obtain overdue rent. Hindquarter claimed that its obligation to pay rent was independent of the option to renew, especially since the lease did not expressly impose timely rent payment as a condition of renewal.(fn43) Property Development argued that the tenant's right to renew was "implicitly and inherently . . . conditioned upon its timely performance of its lease obligations."(fn44)

The King County Superior Court dismissed Hindquarter's complaint, holding that the renewal right was...