Many retail leases require tenants to pay a significant share of the landlord’s costs of operating the shopping center. In order to limit your expenses, you should be vigilant in reviewing the costs passed on by your landlord. Successfully fighting overcharges requires that you take three steps: (1) read and understand your operating cost clause, (2) review the facts and (3) convince the landlord that your claim is valid and that you are ready to enforce your rights. In this article, we will give an overview of these steps and discuss some overcharge claims that you might not have considered.
Reading and understanding your operating cost clause
A retail lease’s operating cost clause generally defines the types of costs that may be passed on to the tenant. Too often, landlords charge all of their retail tenants for operating costs according to the same formula. However, your operating cost clause may be very different from your neighbors’ clauses, and your own lease language prevails. If your operating costs are not fixed, there are many variables that go into calculating your share of operating costs. That is why it is critical that you read and understand your operating cost provision when reviewing your landlord’s charges.
Carefully review the types of charges that the landlord may legitimately pass on to you. The operating cost clause might state, for example, that you are obligated to pay a percentage of “the costs of operating, managing and maintaining the shopping center.” Often, the clause lists certain types of expenses that are included in the definition of operating costs. This list may be exclusive, or may simply be illustrative (i.e., “operating costs include, but are not limited to. . .”). The clause may also contain language excluding certain costs. For example, it may exclude costs related to certain parts of the building. It might also exclude certain categories of costs, such as capital improvements.
One critical question to ask in reviewing your operating cost provision is whether it is truly an operating cost clause (allowing the landlord to pass on the costs associated with operating and maintaining the shopping center as a whole), or whether the landlord can only pass on costs incurred in operating and maintaining the common areas of the shopping center (i.e., the common area maintenance or “CAM” costs). If you are only required to pay CAM costs, understand how the common areas are defined in your lease. You should also pay particular attention to how common areas are defined. Are walls and roofs included in the “common areas”? Are outparcel areas included? The definition of the common areas helps determine what expenses may be passed on by the landlord.
In addition to determining the types of operating costs that may be passed on, you should also understand the “denominator” set forth in your operating cost clause. Is your percentage share determined based on the total leaseable space in the shopping center? Only the leased space? Are certain stores excluded? The answers to these questions can make a big difference in calculating your proper share of operating costs.
Investigating the Facts
Once you understand the language of your operating cost clause, you will need to investigate the facts. Some information can be gathered on your own. For example, if your denominator is calculated based on the amount of space leased in the shopping center, you can monitor when new tenants move in to vacant space. However, much of the information and documents relating to operating costs are under the landlord’s control. If you suspect an overcharge, make a written request to the landlord for supporting documentation.
Landlords frequently resist requests by tenants for information supporting operating cost charges. Your lease may explicitly provide that you have the right to audit operating costs. If so, cite that provision in your request. Note, however, that your lease may set limits on your rights, such as limiting the time period for which you can request an audit.
If your lease is silent as to your audit rights, that does not mean you have no recourse. You should still request supporting documentation from your landlord. In fact, some courts have found an implicit right to demand supporting documentation for operating costs, even where the lease is silent. See PV Properties v. Rock Creek Village Associates Ltd. Partnership, 549 A.2d 403 (Md. Ct. Spec. App. 1988).
Also note that if your right to audit is limited to a certain time period, that does not mean your right to sue your landlord is also limited to the same period. Unless you explicitly waive the right to sue for overcharges after a certain period, your claims will likely only be limited by the relevant statute of limitations in your state.
Presenting your claim to your landlord
Once you have reviewed your lease and analyzed the facts, it is time to present your claim, in writing, to the landlord. If you reach an impasse, it may be necessary to retain an attorney knowledgeable about these types of claims. Sometimes, just hiring an attorney is enough to spur your landlord to make a reasonable offer to settle your claims. This is particularly true if your lease specifies that the landlord may be responsible for your legal fees.
Potential overcharge claims
There are many ways your landlord might overcharge you under an operating cost or CAM clause. Some are fairly intuitive. For example, your landlord might improperly calculate the denominator applied to determine your percentage share of operating costs. Likewise, if you are only required to pay for CAM costs, you should challenge any costs not related to maintaining the common areas of the shopping center.
Some other claims may not be so obvious. We will discuss two potential overcharges you might not have considered.
Can your landlord charge a management fee? Many landlords charge tenants a fee alternately referred to as a “management fee,” “supervisory fee” or “administrative fee.” This fee may be based on a set percentage of total operating costs or CAM costs. Alternatively, it may represent an amount the landlord pays to a management company (often an entity closely affiliated with the landlord) to operate the shopping center. Your lease may or may not permit these fees.
Some leases expressly authorize landlords to impose such a fee. For example, your lease might state that you are obligated to pay a percentage share of all CAM costs “plus a fee for supervising the common areas of the shopping center in an amount equal to 7.5% of common area costs.” However, where the lease is silent, there may well be grounds to question the imposition of a management fee.
Issues regarding management fees have been litigated on several occasions. For example, in Johanneson’s, Inc. v. Kraus-Anderson, 1999 WL 619016, *1 (Minn. Ct. App., Aug. 17, 1999), a tenant sued its landlord, alleging that the landlord was not permitted to charge a management fee under the terms of its lease. The court found that the management fee charged by the landlord was not a common area expenditure but an overhead cost, which the landlord was not permitted to pass through to the tenant. In Viking Bank v. Firgrove Commons 3, LLC, 183 Wash. App. 706 (2014), a management company charged landlord a management fee based on a percentage of total rent for the center, and did not allocate between CAM and non-CAM tasks like rent collection. The court ruled that the tenant was not obligated to pay any portion of management fee.
If your lease does not expressly mention a management fee, you should look to the rest of the operating cost clause and related provisions. For example, you may have a stronger case for excluding management fees if you are responsible for a share of “operating and maintaining the shopping center” rather than “operating, maintaining and managing the shopping center.”
You might also contest management fees if your lease specifies that the landlord can only pass on costs that are actually “incurred by” the landlord. If a landlord imposes an additional 15% charge for supervising the shopping center or common areas, you might argue that such a charge is not a cost “incurred by” the landlord; it does not represent an actual expense but rather an arbitrary surcharge.
You should also consider whether a management fee duplicates other charges under a lease. Some landlords have charged tenants both an administrative fee explicitly permitted under the lease and an additional management fee, essentially double-charging for the same activities.
If you determine that your landlord is permitted to charge a management fee under your lease, you should nevertheless review your operating cost clause to determine whether you should pay the entire fee. For example, if you are only obligated to pay a share of costs associated with managing the common areas of the center, the landlord should not pass on the costs to have a management company oversee the entire shopping center operation.
Should certain revenues be offset against operating costs? In many instances, landlords generate revenues in the common areas of the shopping center. For example, owners of urban shopping centers sometimes charge customers and tenants for parking in their garages. The shopping center may charge for concierge services or sell gift cards in the common areas.
Your lease may specifically provide that such revenues should be offset against your share of operating costs. Alternatively, you may argue that costs incurred in revenue-generating activities, such as the salaries of valet parking attendants, should be excluded. Tenants should question whether they are paying for costs such as electricity used to power advertising kiosks and vending machines. Arguably, these are not costs incurred in operating the shopping center or common areas, but rather the expenses associated with the landlord’s own money-making ventures.
Making a successful claim for operating cost overcharges starts with reading and thoroughly understanding your lease language. Think carefully and creatively about charges that might not be authorized. Follow through by investigating the facts and presenting a convincing case to your landlord. The result may be a huge savings over time.
Tracy Reichmuth is counsel with the firm of Crowell & Moring, LLP, where she is a member of the firm’s litigation and retail practice groups.
Greg Call is a partner with Crowell & Moring, and co-chairs its litigation group.