California Contract Law Update: Conditional Payment Clauses

Recent developments in California case law have strengthened the ability to enforce conditional or tiered payments in commercial contracts and leases.  

Retail leases provide one common example of the contracting issue. Retailers frequently seek co-tenancy provisions in their shopping center leases, which address the amount of rent due in the event that occupancy changes in a center after the lease is entered. A co-tenancy provision often provides that if shopping center occupancy falls below a specified level, the retailer may be entitled to pay a lower amount of alternative rent. Conceptually similar provisions can also be found in other commercial contracts—any contract which provides for alternative compensation in the event that a condition is not satisfied.

Conditional provisions such as these have previously been subject to challenge on the ground that they are liquidated damages provisions that are unenforceable to the extent they provide for penalty damages in excess of the estimated harm. For example, in Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc., 232 Cal. App. 4th 1332 (2015), the California Court of Appeal found that a lease provision providing for alternative rent (instead of full rent) in the event that a co-tenancy provision was violated was akin to a liquidated damages provision. Under the facts of that case, the court concluded that the provision was unenforceable because it operated as a penalty.

But a more recent decision in California has called this challenge into question. In JJD-HOVElk Grove, LLC v. Jo-Ann Stores, LLC, 80 Cal. App. 5th 409 (2022), the California Court of Appeal upheld a co-tenancy provision allowing for the payment of alternative rent. The landlord and shopping center owner challenged the enforceability of a tenant’s co-tenancy provision, which allowed the tenant to pay alternative rent if the center’s occupancy fell below a specified level. The Jo-Ann Stores court analyzed the Ross case and expressly disagreed with its conclusion. The Jo-Ann Stores court found that the provision allowing for alternative rent was unlike a liquidated damages provision. The court noted that instead, “the co-tenancy provision simply varies the rent owed by [the tenant] based on the shopping center’s occupancy. If three anchor tenants are open for business or if 60 percent of the space is occupied, then Fixed Minimum Rent is owed; if not, then [the lower alternative rent] is owed.” Id. at 425. The court further noted that under prior California authority, “a contractual provision that provides for alternative performance or different rents is valid.” Id.[1]

Jo-Ann Stores provides strong support for parties seeking to enforce alternative payment conditions in commercial contracts. Under the Jo-Ann Stores analysis, California courts will look to the specific words of the clause in analyzing whether a payment provision is dependent on the occurrence of a condition, rather than a liquidated damages provision addressing a breach or violation. Under this analysis, provisions using language such as “if in the event of X, then Y” are likely to be upheld as permissible alternative payment clauses. In contrast, provisions that use terms such as “breach” or “violation” or “default” are more likely to fall outside of the Jo-Ann Stores analysis.