Restrictive Covenants Against Thrift Stores. Daniel Goodwin Gill Elrod Ragon Owen & Sherman, P.A. Little Rock, Arkansas

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1 Restrictive Covenants Against Thrift Stores Daniel Goodwin Gill Elrod Ragon Owen & Sherman, P.A. Little Rock, Arkansas Introduction On November 10, 2008, Circuit City filed for Chapter 11 bankruptcy protection. That action set off a wave of Circuit City store closures and lease terminations that left landlords with empty big-box retail space in their shopping centers. As other big box retailers have closed nonperforming stores or simply filed for bankruptcy protection, their former landlords have been forced to become creative in locating new tenants for these large retail spaces. Many have found a viable solution in thrift stores. The slow economy has made thrift stores, which generally sell lower-cost, secondhand merchandise, more attractive to budget conscious consumers. Thrift stores have been able to expand into new areas and empty big box stores often fit their needs. However, some landlords have run into unexpected problems when attempting to execute a routine lease with their new thrift store tenant: a restrictive covenant prohibiting the use of the premises as a thrift or secondhand store. Those covenants can be located in deeds or other recorded documents which run with the land or simply in the lease of another tenant located in the shopping center. Regardless of the source of the covenant, they can effectively kill a new lease. This article examines restrictive covenants generally, typical covenants against thrift stores, the traditional interpretation and enforcement of such restrictive covenants and ways in which parties may attempt to work around or with them. Restrictive Real Estate Covenants Generally First year law students learn that restrictive covenants are a legitimate tool of landowners to control the use of their land. In theory the covenant enhances the value of land by prohibiting inherently undesirable uses or uses which are inconsistent with the owner s development plan. The covenant may be in a lease between the landlord and tenant or it may be recorded in a deed, bill of assurance or other similar instrument. If subsequent interest holders in the land have notice of the covenant, usually because it is recorded, the covenant will run with the land 1

2 meaning that it will be enforceable against the successors and assigns of the original interest holders. For a restrictive covenant to run with the land, its performance or nonperformance must affect the nature, quality, or value of the property demised independent of collateral circumstances, or it must affect the mode of enjoyment, and there must be a privity between the contracting parties. 20 Am Jur 2d Covenants, Conditions, and Restrictions 149. Even if the covenant is not recorded, it may bind successors and assigns if a court finds that such enforcement is equitable, thus converting the covenant into an equitable servitude. In general, restrictive covenants are enforceable. Notable exceptions include covenants that are racially discriminatory, covenants that create monopolies or otherwise impermissibly restrain trade and covenants that violate some other supervening statute. Furthermore, covenants can be waived by lack of enforcement or if the nature of the property has so changed from the time the covenant was adopted that its continued enforcement would be inequitable. Because restrictive covenants are a restraint on the free alienation of property, courts narrowly construe them. However, assuming none of these elements exist, covenants are typically enforced for as long as they serve their originally intended purpose. Typical Covenants Against Thrift Stores In the author s experience, most covenants against thrift or second-hand stores are contained within a list of other prohibited uses. The list will vary from development to development but it usually includes one or more of the following uses: billiard or bingo parlors, flea markets, massage parlors, funeral homes, facilities for the sale of drug paraphernalia, facilities for the sale or display of pornographic materials, off-track betting parlors, car dealerships, video game arcades, auction or business liquidation stores, odd-lot stores, banquet halls, or facilities for the sale or rental of used goods (including, thrift shops, secondhand or consignment stores). Rarely do the typical covenants contain much description of the prohibited use. Rather, the covenant merely describes the prohibited use by reference to a commonly accepted word or phrase, such as secondhand store. Over time, developers have determined that these uses are not consistent with a first class retail center, usually because the retail traffic they do bring is not consistent with the customers other 2

3 first run retailers are trying to attract and because the appearance of the stores themselves may become cluttered and unsightly. However, the lease covenants rarely describe the intent of the drafter or the harm sought to be avoided. The absence of such language creates a more rigid document less likely to be adaptable to changing economic or demographic conditions. When the restrictive covenant is contained in a bill of assurance or similar recorded document and the land subject to the covenant is sold to third parties, as in an outparcel sale, the developer may lose the ability to amend the covenant. The outparcel purchaser may in fact demand the inclusion of certain covenants as a condition to purchasing the property. Likewise, if the covenant is contained in a lease with a third party tenant, the landlord probably will not have the right to amend it at a later time. In either scenario, that loss of control over the property may come back to haunt the landowner if it later wants, or needs, to rent a big box or other space to a thrift store. Interpretation of Typical Covenants As noted earlier, restrictive covenants are generally enforceable unless they violate a public policy. While they are narrowly construed in favor of free alienation of property, most would probably agree that the term thrift store or secondhand store would describe stores operated by Savers or Goodwill, two large national retailers. In fact, Savers refers to itself as a thrift store on its website and it is clear from Goodwill s website that it sells donated used goods. So, under the typical restrictive covenant prohibiting thrift or secondhand stores, Savers and Goodwill would almost certainly be prohibited under the plain meaning of the text. Certainly no competent attorney would advise Savers, Goodwill or a similar tenant to sign a lease if such a covenant had been filed of record. In the author s experience, these types of tenants condition any leasing letter of intent or lease on the receipt of leasehold title insurance insuring the particular use; the practical result being, that if a restrictive covenant against secondhand stores has been recorded, no secondhand store will locate on the premises or even try to litigate the meaning or validity of the covenant. They will simply move on to another location. Yet, there is something unsatisfying about seeing large relatively new buildings sit empty for no other reason than old words. This is especially true in the case of Savers and Goodwill who 3

4 seem to have gone to great lengths to make their retail operations comparable to first run retailers. In an article on Goodwill expansions in the Washington, D.C. area published on October 13, 2009, the Washington Business Journal reported that [a]ccording to Goodwill research, the typical shopper is highly educated and makes a fairly high annual salary: Around 44 percent of its shoppers have an annual household income in excess of $50,000 and 45 percent have a college degree or better. In an August 9, 2010 article on Savers, the Arkansas Business Journal quoted a Savers spokesperson as stating, [t]hrift store shopping has entered the mainstream as more and more customers have become accustomed to buying second-hand merchandise from a wide variety of sources, including ebay and Craigslist, and is no longer considered a resource solely for lower income individuals Furthermore, newer Savers and Goodwill stores seem to have contemporary storefronts, fitting rooms, retail shelving and racks, are well-staffed and have wide, well-lit uncluttered aisles that seek to emulate the shopping experience of their first run counterparts. Despite these changes in the stereotypical thrift store, it is difficult to see a scenario under these circumstances where parsing the words will provide much flexibility to a landlord and thrift store tenant who want to make a deal. In most instances, there are simply other locations that provide no such difficulty. Working with Restrictive Covenants There are two primary situations where legal counsel may have the opportunity to deal with a restrictive covenant against thrift stores. Once, when the retail developer is structuring the development and putting the covenants in place and then again when attempting to enforce (or get around) the covenants. In the first situation, developers typically include the laundry list type of restrictions previously noted. However, developers should consider whether providing more detail in the restriction might provide them greater flexibility in filling their center in a down economy. Specifically, if the goal of the covenant is to ensure a clean, well-lit, uncluttered shopping experience in stores that attract retail consumers, the developer can craft language that more efficiently achieves that goal. A covenant that requires prospective thrift store tenants to comply with typical sign covenants, interior design quality, lighting requirements, aisle width, check out areas, tenant credit requirements and even target demographics could provide that 4

5 flexibility. In addition, if the development will have multiple outparcel owners or tenants, the developer could provide for a voting requirement that would allow a majority or some other number of stakeholders to approve a new thrift tenant. The second situation arises when the thrift store tenant would like to locate in a center that does contain the typical bald prohibition on thrift or second hand stores. Where the covenant is contained in a bill of sale or similar document with neighboring landowners or a lease with another tenant in the center, most likely the landlord will be required to get the permission of all or a majority of the neighbors in order to consummate the lease. In that scenario, providing the neighbors with demographic studies, proposed storefront elevation drawings and merchandise display floorplans may be sufficient to convince them that the proposed tenant will be an asset to, rather than a blight on, the project. In a recent case, this second situation confronted the author. A national thrift store retailer desired to lease a dark big box building. However, a bill of assurance affecting the big box parcel as well as several adjacent parcels prevented thrift and secondhand store uses. The adjacent parcels were owned by a regional bank, an international fast-food franchise and a regional furniture retailer, respectively. After months of negotiating with the neighbors and providing demographic studies, floor plan and elevation drawings, everyone but the regional furniture retailer agreed to amend the bill of assurance to allow a thrift store that fit certain criteria. Although the furniture store agreed that the proposed thrift store would not affect its business negatively, it also contemplated a sale of its location and worried that the marketability of its space might be negatively impacted by a thrift store and it refused to agree to the amendment. One year later, the building remains empty. Conclusion While in most situations it would be futile, or at least inefficient, to fight the validity of a typical restrictive covenant against thrift or secondhand stores, counsel should consider whether, at the inception of the development, more detailed language could benefit the developer. Furthermore, maintaining an open mind with respect to the purpose of the covenant, and not just the 5

6 stereotypes underlying it, may provide for creative and flexible solutions for tougher economic conditions. Daniel Goodwin is a shareholder and director of Gill Elrod Ragon Owen & Sherman, P.A., Little Rock, Arkansas, and is member of the firm s Real Estate Practice Group. He can be reached at Goodwin@Gill-law.com. 6