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Dispute over common charges in shopping centers – commentary

In mid-2023, information emerged on the market about the impending wave of tenant lawsuits against shopping center owners following a landmark ruling made by the Court of Appeal in Warsaw, finding charging common costs (service charges) to tenants, not covered by anchor tenants, to be an act of unfair competition.

While the ruling has sparked a lively discussion in the market and has led many tenants to file claims, this remains an individual ruling issued in a specific case. It does not predetermine the outcome of other similar disputes between landlords and tenants.

Without understating the importance of requirements specified in the statement of reasons for the judgment, there are reasons for examining them in the context of trading practice.

In this article, we present our observations on an unpublished judgment of the Court of Appeal in Warsaw, issued in connection with the Supreme Court review of the cassation appeal, in a judgment of 28 October 2022, case No. II CSKP 456/22.

Differentiation criteria and how shopping centers function in practice

The volatility of the market means that the tenant mix structure in shopping centers is constantly being adjusted. The market for retail space (creation of new centers, evolution of existing facilities through redevelopment, renovation, recharacterization) and the market for products (creation and market entry of new brands, changes in the positioning and perceived prestige of existing brands) are growing rapidly, and consumer habits and behavior (e.g. the popularization of e-commerce, the growth of discount and outlet sales) are changing rapidly as well. Brands that are highly attractive to shopping center customers today may cease to have this attribute years later or lose out to new competitors. Ensuring that a facility continues to be attractive requires the constant acquisition of new tenants of reputation and popularity often caused by the emergence of new trends. The perceived attractiveness of the brands in question to consumers is a major factor when structuring the tenant mix, and it is impossible to define this attractiveness in objective terms.

Changes to the tenant mix are primarily a response to the expectations of tenants and their customers. By concluding a lease agreement in a shopping center, the tenant acquires not only the right to use a specific area enclosed by walls, but also – and perhaps mainly – the opportunity to conduct business in a specific community of other tenants, in a facility with a certain degree of attractiveness.

Lease agreements for some commercial premises are for periods of two or three years, while others are for periods in excess of ten years. Even a short-term tenant must be aware that the center will appear differently at the end of the  lease from the way it did at the time the lease agreement was entered into. Similarly,  market trends, customer tastes, and the business environment will also be different. This is even more the case for tenants entering into long-term contracts.

Under such conditions, it can hardly be expected that a tenant will be classed as an anchor tenant in the center on the basis of a priori, time-invariant and completely objective criteria, applied uniformly to all concluded leases.

Common charges are one component of the overall cost to the occupier of retail space in a facility. The tenant’s situation and the attractiveness of doing business in the facility is shaped by a number of factors, and the total cost of presence in the facility is driven by contractual parameters such as fixed rent, rent on turnover, marketing fees, and individual charges, as well as discounts, rent-free periods, landlord contributions, and other types of incentives.

The aim of a landlord running a shopping center is, naturally, to make a profit, which requires the costs of operating the building to be covered in the first instance. In the final economic calculation, these must be covered irrespective of the determined mechanism for settling payments with tenants. The separation of the common charges component in lease agreements operating on the market is the result of the adoption of a particular model for settling payments in the commercial lease market – known as the triple-net lease. Despite its popularity, this model is clearly not the only one. , If a lease agreement is structured in any other way, the facility maintenance costs are transferred to the tenants, and this follows directly from the economic sense of running a shopping center. If the costs of maintaining the facility were not covered by common charges, this would translate in practice into a corresponding increase in rent. In the final business calculation, it makes little difference to the tenant whether a particular cost has been incurred as rent or as a cost of operating the facility. The total cost of doing business in the mall for individual tenants is ultimately determined by the market mechanism.

A single business parameter should not – in isolation from the overall commercial picture – determine whether a landlord is accused of an act of unfair competition. Attributing critical importance to only one aspect of the payment settlement model may lead to modification of the model without resulting in real economic benefits for tenants.

Anchor tenants are not given preferential terms for paying the common charges due to the generosity of center owners or their innate tendency to act unfairly. It is dictated by the market position of tenants of this type on the competitive retail space market. Every year, the commercial space for rent in Poland increases by hundreds of thousands of square meters, and this causes a constant flow of tenants looking for the most attractive facilities and the most favorable rental conditions. Data from the Polish Council of Shopping Centers show that there are currently over 1.2 million square meters of modern retail space for rent in the planning, preparation or construction phase, due to be opened by the end of 2025.

These are also important arguments from the point of view of tenants’ assertions that unfavorable terms are “imposed” on them  in lease agreements, as the party at a disadvantage, or that owners of retail space exploit their market power, as well as for determining whether  a tenant’s access to the market has been hindered

All this requires a critical look at the criteria presented in the statement of reasons for the judgment issued by the Warsaw Court of Appeal. The presence in shopping centers of anchor tenants and their privileges in bearing common costs are widely known facts under the well-established model of operation of shopping centers and the structure of lease agreements. When determining whether an act of unfair competition has been committed in a given legal relationship, other circumstances also need to be taken into account, such as the fact that the agreement was concluded as a result of individual negotiation of the terms of payment and other privileges granted to the tenant (e.g. discounts), the market position of the parties when negotiating the agreement, and agreement performance practice.

The interpretation presented in the Court of Appeal Judgment is therefore flawed from the perspective of the reality of trading and operation of shopping centers.

Permissibility of differentiating between the situations of tenants

The Court of Appeal stated explicitly in the statement of reasons for the judgment that differentiating between the terms on which anchor tenants and other tenants are charged the common costs is permissible, and found substantive grounds for this within the meaning of Article 15(1)(3) of the Act on Combating Unfair Competition (ACUC) if this mechanism is employed in order to ensure the presence in the center of entities and brands that attract customers and generate traffic in the facility. The court goes on to point out that if the presence of a designated trader in a shopping center ensures interest in the facilities available at the center, increases traffic in the center, and attracts a significant number of customers – such a presence will, on the one hand, be particularly desirable for the landlord and, on the other hand, will also be useful to the other tenants. Customers who visit the shopping center because of the presence of a particular brand may also benefit from the goods and services offered by other tenants. Thus, the mere mechanism of creating a category of key, main, and anchor tenants who are exempt from certain fees (e.g. maintenance, operating fees), while other tenants are required to pay these fees, will not always be differentiation between tenants that is not materially justified.

The court formulated two criteria for examining the rules for the allocation of common costs between tenants in a facility, to determine whether there are factual grounds for differentiation between tenants’ situations:

  1. Under the first, clear, transparent and predetermined criteria should be used to classify tenants as anchor tenants. These criteria are to be known to the tenant at the latest at the time the tenancy agreement is concluded and  must be objective;
  2. The second is quantitative, according to which differentiation may not lead to extreme disproportions in the allocation of these charges. As an example, the Court of Appeal in Warsaw cites a situation where tenants of premises covering 5% of the leasable area bear 95% of the maintenance costs.

It should be noted at the outset that the arguments presented in the judgment only ostensibly resolve the above dilemma. In fact, the court does not address the question as to what circumstances justify differential treatment, but instead gives indications as to the methodology for implementing such differential treatment (criteria that are clear, transparent, objective and known in advance) and the acceptable results (no particularly gross disproportion in the allocation of costs).

Such an approach can lead to unsatisfactory results. After all, clear, transparent and objective criteria are not necessarily fair. For example, in a shopping center where half of the units (representing half of the center’s lease area) are located on the north side of the building and the other half on the south side, if the tenants of the south-side units bear 50% of the common costs and the north-side tenants cover the other 50%, this differentiation would meet the requirement of being based on an objective and clear criterion. However, this criterion would not have any factual economic justification. Following this reasoning consistently, even the most unfair criterion is lawful as long as the criterion is objective and clearly formulated and the tenant is adequately informed of the criterion.

Criteria for differentiation between the situations of tenants in the Court of Appeal judgment

The second (quantitative) criterion considers cases of extremely disproportionate allocation of common charges to tenants to be acts of unfair competition. The preferential treatment of anchor tenants must have reasonable limits and correspond to the benefits their presence brings to the other tenants. However, the question of how to determine these limits remains unanswered (apart from the fact that the quoted proportion of 5%:95% exceeds these limits, probably not only in the opinion of the adjudicating court).

In practice, the first criterion is much more important.

A significant number of commercial lease agreements do not contain precisely defined criteria for classification as anchor tenants. Such criteria cannot always be formulated in a fully objective manner, and even if this is possible, these criteria are modified in a reasonable way under the influence of market evolution. What is worse – as a shopping center is a “living organism” – these changes occur during the lease relationship.

Does this automatically mean that the differentiation between tenants’ situations is materially unjustified and that concluding a lease agreement constitutes an act of unfair competition? If the arguments in the statement of reasons are strictly applied, this is the case, regardless of the scale of privilege given to the anchor tenants, their impact on the attractiveness of the facility, and the satisfaction of other tenants with the results of operations in the center. However, such an approach would be inappropriate in many cases and would ignore the broader context of shopping center operation and the relationship between the tenant and the landlord.

Article 15(1)(3) vs. other provisions of the ACUC

Pursuant to Article 3(1) of the Act on Combating Unfair Competition, an act of unfair competition is an act that is unlawful or immoral, if it threatens or violates the interest of another entrepreneur or customer. The view is widely endorsed in case law that whenever chapter 2 (Articles 5-17d) of the ACUC is applied, it is necessary to demonstrate general conditions for liability for an act of unfair competition. These are provided for in Article 3(1) of the ACUC.

Moreover the activities specified in Article 15 (1) 1-5 of the ACUC are only an indication that an act of unfair competition has occurred, which is hindering access to the market. According to case law, an act of unfair competition only takes place when, as a result of the behavior described in Article 15(1)1-5 of the ACUC, it will restrict access to the market. This factor must be examined in any conducted court proceedings.

So how should the requirements formulated in the statement of reasons for the Court of Appeal judgment be approached in practice?

Regardless of how the lease agreement is formulated, substantive justification can be demonstrated for the differentiation between tenants’ situations by presenting arguments in favor of preferential treatment of specific categories of tenants. In order to defend against potential claims, facility owners should be prepared to present business-wise and convincing substantiation of the impact of anchor tenants on the center’s footfall and the results achieved by tenants due to trading in the facility. It is also important to demonstrate the market position of the anchor tenants, including in comparison to the market positions of other tenants.

In many cases, due to the significant space they occupy and the infrastructure present in their premises, anchor tenants use their own security, cleaning, waste disposal and other services, which in a typical operating model are billed collectively for the entire facility. This justifies a proportionate reduction in the charges attributable to such tenants. There are also cases where anchor tenants contribute to the cost of renovation of the facility – such a situation (where previously incurred costs are included in the payment calculation) can also justify the anchor tenant paying a smaller proportion of the common costs – renovation/repair of common infrastructure (a cost that is a typical component of the service charge) is funded in some way by the anchor tenant and at some point in the future ‘recovered’ from the other tenants as part of the increased scope of the common charge.

The Court of Appeal in Warsaw clearly focuses on protecting a tenant against the arbitrary action of a landlord and preventing a situation in which the costs charged to a tenant change significantly over the course of the lease term and the tenant is unexpectedly burdened with costs it could not have foreseen.

It does not follow from the Court of Appeal judgment that these requirements can only be fulfilled in a single, strictly defined manner, i.e. by defining the anchor tenant criteria in the content of the lease agreement itself. This obligation is not specified in provisions of the law, and judicial interpretation of the law cannot impose liability on legal entities for formulating an agreement differently, particularly if the agreement was concluded long before that interpretation became an element of legal practice and discourse. The interpretation of the ACUC as addressed to professional participants in economic trading, should not depart from the requirements of trading practice. The requirements stated in the Warsaw Court of Appeal judgment may, in our opinion, also be implemented by providing the tenant, upon request, with information on the scope of anchor tenants and detailed rules on the settlement of common costs.

Certainly, the lease agreement should set out a mechanism for calculating the tenant’s charges for common costs in a way that allows the tenant to verify that the costs billed are correct. This mechanism should be described on the periodic billing statement. The wording or practice of the agreement should give the tenant the opportunity to determine in detail how the tenant’s charges will be calculated.

In relation to a specific lease agreement and the practice of executing it, the question to be considered is whether there has been a breach of law or moral values leading to an infringement of the tenant’s interests, and whether the tenant’s access to the market has been impeded. If a tenant has no influence on the content of the lease agreement terms, this is a different situation to that in which the parties – additionally represented by professional advisers – conduct negotiations concerning the key business parameters of the agreement.

Whether a landlord can be alleged to be in  breach of Article 15(1)(3) of the ACUC in the case of lease agreements which provide for individually agreed limitations on the tenant’s  common costs e.g. a percentage (cap) limitations on the increase of advance payments or maximum surcharges when settling accounts per annum) seems particularly doubtful. After all, the purpose of such clauses is to mitigate the risk borne by the tenant and ensure predictability of the range of costs associated with the use of the commercial space.

Equally, a landlord cannot be alleged to have committed an act of unfair competition if the tenant’s share in service charges remains unchanged or insignificant over a number of years. This is because in such cases it is difficult to conclude that the landlord arbitrarily exercises the rights set out in the lease agreement. The absence of arbitrary action and infringement of the tenant’s interests is also indicated by the fact that throughout the lease period, the amount of the advance payments paid and the shortfall covered by the annual settlement is relatively stable (apart from increases due to higher costs of maintenance of the center).

Was the question of common charges addressed in the Supreme Court ruling?

In a case finally resolved by the Court of Appeal in Warsaw, a cassation appeal was also heard by the Supreme Court in the judgment of 28 October 2022, Case No. II CSKP 456/22. However, the discussion of the content of this judgment overlooks the fact that the classification of  differential charging of operating costs to the tenants of premises in the shopping center as an act of unfair competition within the meaning of Article 15(1)(3) of ACUC was not itself the subject of any of the cassation grounds. All of the allegations made in the complaint (cassation grounds) concerned the application by the courts adjudicating in the case of the principle of compensatio lucri cum damno and the issue of calculation of damage, and these issues were the subject of the main part of the statement of reasons for the Supreme Court judgment.

The Supreme Court, ruling within the limits of the cassation grounds (Article 39813 § 1 of the Code of Civil Procedure), consequently stated only that the classification of the differential charging of operating costs to the tenants of premises in the shopping center as an act of unfair competition within the meaning of Article 15(1)(3) of the ACUC “remained beyond dispute”. It is not accurate to suggest that the Supreme Court interpreted Article 15(1)(3) of the ACUC and determined that this differentiation constituted an act of unfair competition.