Last week, the California Court of Appeal for the Second District reversed a trial court’s decision which dismissed a tenant’s lawsuit against a shopping center landlord based on the disparity between estimates of certain charges provided by the landlord prior to lease execution and the amounts billed by the landlord after the tenant’s first full year of occupancy.[1]

The Letters of Intent and the Lease

The landlord and tenant entered into lease negotiations and exchanged draft letters of intent in 2004. The landlord provided the tenant with estimates of what the tenant would pay annually per square foot for common area maintenance fees (CAM), real property taxes and insurance (collectively, the “triple-net charges”). The parties executed a written lease in 2005. Although the lease did not contain specific amounts or percentages for the triple-net charges payable by the tenant, it did specify that the tenant would pay its pro rata share of the triple-net charges based on the square footage of the leased premises and the gross leasable area of the retail portion of the development. The lease also contained fairly standard integration language (i.e., the lease represents the entire agreement of the parties notwithstanding prior negotiations or discussions, etc.). 

The Litigation

In 2009 the landlord billed the tenant for triple-net charges in amounts substantially higher than the estimates provided prior to execution of the lease (CAM billed was 386% of the estimate, real property taxes billed were 233% of the estimate and insurance billed was 194% of the estimate). The tenant sued the landlord under various theories to recover money damages, as well as for reformation and/or rescission of the lease. The landlord moved to dismiss the complaint (on the basis that the allegations of the complaint did not support the relief requested) and the trial court granted the landlord’s motion. On appeal, the appellate court reversed, effectively allowing the tenant’s case against the landlord to proceed in the trial court.

The Appeal

The appellate court reasoned that the tenant could proceed on the fraud and negligent misrepresentation claims because extrinsic evidence (i.e., the letter of intent and communications before lease execution) is admissible to establish fraud or negligent misrepresentation even when the lease has an integration clause. Similarly, the appellate court opined that the tenant’s claims of “innocent” misrepresentation and mutual mistake were improperly dismissed because the tenant had alleged specific facts to support pleading requirements in order to reform and rescind the lease based on a lack of mutual assent in the formation of the lease (i.e., there was never any meeting of the minds between the landlord and the tenant). Finally, the appellate court opined that because the tenant alleged that the landlord improperly exercised its discretion in allocating the triple-net charges between the retail and non-retail portions of the development, the tenant’s claims for breach of contract and the implied covenant of good faith and fair dealing should not have been dismissed.

The Lessons

It is important to note that the appellate court’s ruling simply allows the case to proceed beyond the pleading stage, and possibly to trial, but it is nonetheless troubling. The opinion suggests that despite an integration clause, extrinsic evidence and communications prior to execution of a lease may prevent a shopping center landlord from securing early dismissals of tenant lawsuits. It is also disturbing that the appellate court concluded that “the huge disparity between the estimates and the ultimate costs supports an inference of misrepresentation,” particularly when this case involved a new mixed-use development with no historical data available (for either party) regarding the magnitude of the triple-net charges. Indeed, under these circumstances, it is difficult to know what more the landlord could have done to emphasize that the amounts set forth in the letters of intent were only estimates, and that the lease terms would ultimately control. Even as more shopping center owners migrate to fixed CAM leases, leasing personnel should exercise great care in all pre-lease communications relating to triple-net charges, and owners should consider revising the language of their leases to address significant variances in triple-net charges and limit the tenants’ rights appropriately.