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The Importance of Condemnation and Access Clauses in Commercial Leases

By George J. Kroculick and Michael J. McCalley
November 2007
Retail Law Strategist

I. INTRODUCTION

We have all heard the phrase "location, location, location," in connection with real estate literature. While it may now seem trite, the phrase still deserves a certain amount of reverence. Location of course is critical to the success of most commercial retail enterprises. For many retail businesses, success or failure will turn on the owner's selectivity and judgment in picking the "right" location. In this regard, businesses may spend numerous hours scouting potential locations, reviewing whether access is safe and convenient, studying visibility and traffic patterns, and determining whether current zoning allows for their permitted use and/or optimal design in an effort to find what they believe will be a successful site.

However, a good location can quickly turn bad in the wake of a condemnation or modification of access. Despite the up-front investment made in finding a good location, relatively little time is spent drafting condemnation and access clauses that will adequately protect a tenant's interests should there be any significant changes to a site as a result of a condemnation or modification of access. Typical condemnation clauses may be good in some cases, but rarely seem to provide the protection a tenant wished it had when confronted with a condemnation or change of access. Consequently, before drafting that next lease, commercial tenants should ask themselves two questions: (1) does my condemnation clause provide me adequate protection and (2) are my interests protected in the event of a change in or modification of access?

II. CONDEMNATION CLAUSES

Leasehold interests are compensable interests in property.1 Generally, absent a provision in the lease to the contrary, it is well established that as between an owner and a tenant, a tenant is entitled to share proportionately in the condemnation award for the value of its leasehold interest.2 Normally, property interests, and whether such interests are compensable in condemnation, are created and defined by existing rules or understandings stemming from state law.3 Still, care must be taken to distinguish between the taking of a leasehold interest, which is compensable, and the purported taking of other interests in real estate which may not be compensable (e.g., lost good will).4

For example, in New Jersey, a tenant has a right to participate and present non-cumulative evidence of its claim in a condemnation.5 This is important because New Jersey follows the "unit rule," which means that there is only one award for all rights implicated by the condemnation (although relocation assistance/payments are treated separately).6 Thus, if there is a dispute as to who gets how much of the award, it is settled in an allocation hearing after the total award has been determined. Consequently, a condemnation clause that provides that a tenant "may only participate and/or receive an award of compensation such that it will not diminish or reduce the award, judgment or settlement receivable by the Landlord," would be inconsistent with the concepts expressed above. Likewise, a clause that provides that a tenant is entitled to only compensation for loss of good will or business opportunity might mean that such a tenant, in a state where such items are non-compensable, has contracted away any right to share in the compensation award.7

While provisions in a lease will not determine what items are compensable, the lease terms will control most disputes between landlord and tenant. Where a lease contains a condemnation clause spelling out the basis for dividing the condemnation award, such a clause will govern. Accordingly, precision in drafting of the lease and recognition of local laws will help to preserve a tenant's interests and may help to avoid disputes.

A. Drafting Remedies.

The key to a condemnation clause is providing for appropriate remedies. Condemnation lease clauses may provide for leasehold termination, leasehold extension options, restoration obligations, apportionment, bonus value, abatement of rent, and may address relocation rights. It is often best to simply provide that the tenant may pursue all available remedies under common law. Additionally, it is important for tenants who construct improvements or fixtures on a property, should they so desire, to provide in the condemnation clause that the tenant is the owner of the improvements and fixtures and is entitled to compensation therefor should they be taken or impacted by a condemnation.8

B. Distinguishing between Total Takings and Partial Takings - Drafting for Discretion.

When drafting leases, tenants should seek to ensure that the condemnation clause provides them sufficient discretion in the event of a condemnation. Further, it is important that the condemnation clause distinguishes between partial and total takings. Frequently, tenants are most vulnerable in a partial taking situation where only a portion of property may be taken, but which will have a large impact on the use of the property.

While the area taken may appear small, it may have big impacts. For example, a partial taking of only a few hundred square feet may reduce drive aisles thereby causing internal circulation problems such that the site is no longer workable (e.g., drive-throughs) or preventing large delivery vehicles from making deliveries. A partial taking can significantly impact the availability of parking, potentially rendering the property non-conforming under local zoning regulations. A reduction in size of a property can severely limit its developability given the existing bulk requirements. A small taking at the corner of a property may eliminate the prime location for identification signs. The construction of an elevated roadway or improvement by the condemning agency on the property acquired can result in a loss of visibility of the remaining property to passing motorists. These are but a few of the impacts a partial taking can have on a property. Accordingly, when drafting leases, effort should be taken to address situations where a partial taking will have significant impact on the "workability" of a site. In this regard, tenants should seek as much discretion as possible to determine whether the partial taking has rendered the remaining property "not capable of being used for its intended or permitted use," and to choose the desired remedy (e.g., termination, restoration, or abatement).

C. Access Clauses.

Equally important to the success of retail operations is the availability of safe and convenient access to a property. However, many commercial leases provide scant attention to access and the potential impacts a change in access can have on a property or use. While a change in access can have as much of an impact, if not more, than a partial condemnation of property, commercial leases are often void of any reference to the implications of a change in access. Perhaps it's because the parties to the lease believe that the condemnation clause will govern their interests should a governmental agency modify their access. If this is the case, commercial tenants may be in for a rude awakening should a modification of access occur.

1. Regulation of Access Under the Police Power is Not a Taking.

By and large, the owner of land abutting on a street or highway has a right of access to and from the adjacent street.9 The right is considered a natural easement and an incident of land ownership. It is a property right and its deprivation therefore requires just compensation.10

It is generally accepted, however, that pursuant to the police power, a government may regulate access to and from the road for the public safety and welfare.11 Consequently, the rights of an abutting owner may be subordinated to the right of the public to the proper use of the highway and the right of governmental agencies to enforce proper police regulation. In such an instance, the regulation does not constitute a taking or condemnation for which just compensation is required. The inconvenience, reduction in profits or depreciation in the value of property that occurs as a result of a legitimate exercise of the state's police power is considered damnum absque injuria (loss or damage without injury in the legal sense).12 In other words, there is no "legal damage." There is no "taking" and the loss is not compensable.

Thus, the right of access is more properly regarded as the right to reasonable, but not unlimited, access to existing and adjacent public roads. That is, "the property owner is not entitled to access to his land at every point between it and the highway but only to 'free and convenient access to his property and the improvements on it.'"13 To this end, it is often stated that a property owner has no vested right in the continued flow of traffic past his or her property.14 Therefore, where by virtue of state action, access is limited but remains reasonable, there is no such denial of access as entitles the landowner to compensation.15

2. The Impact of Access Regulation.

Access is a key component of property value, and the impairment of access that results from a partial taking of property often has significant real-world effects on value. For example, many retail establishments depend upon pass-by customers who, while driving by, choose to stop and purchase goods or services. These businesses require a certain traffic flow and easy access. If entry onto the business establishment becomes difficult, customers will likely patronize other competing businesses that have easier or more convenient access. Consequently, an impairment of access for such businesses can mean a devastating loss of business.

Under proper exercise of its police power in the regulation of traffic, a state entity or transportation authority may:

  • reduce the number of existing access points;
  • change the width of an access point;
  • change the location of an access point;
  • re-route or divert traffic;
  • construct a traffic island;
  • install a median strip prohibiting or limiting crossovers from one lane to another;
  • use or install traffic control devices;
  • prescribe one-way traffic;
  • place restrictions on u-turns, left and right turns;
  • install guardrails or curbing;
  • restrict the weight, size, and speed of traffic on the street;
  • construct a fly-over past a property;
  • replace access on a highway with access on a local roadway;
  • or install "no parking" signs.16

A change in access or similar exercise of police power as described above can have myriad impacts. A change in access may reverse traffic flows through drive aisles or around improvements; disrupt the ability of delivery vehicles to safely enter or exit the site; cause internal circulation problems such as mixing of commercial vehicles with customer traffic; cause traffic to flow by a competitor's business before reaching an entry point on the subject property; create a more circuitous access route; shift a primary access point from the front of a building to the back; shift a primary access point from a highly traveled highway to a local roadway or connector road; make access more difficult by creating the need to cross a newly constructed feeder lane; limit movements entering or exiting the subject property; and reduce visibility.

Simply stated, the regulation of access can turn a good location into a bad location. Given the potential impacts a change or modification of access can have on a property, it is imperative that retail or commercial operators who enter into leases include clauses that address the potential for administrative changes in access. Moreover, commercial operators must keep in mind that the regulation of access can be accomplished outside of the condemnation arena and frequently will not provide for any compensation to property owners or tenants. Accordingly, commercial leases should be drafted and negotiated to address potential issues involving loss/change of access, such as requiring notice to tenants, participation in access proceedings if legally permissible, and an escape clause should the operator determine that the change in access will have a material impact on the business' operation. Without such clauses, a commercial tenant might be stuck at its site with no way in and no way out.

Biography

George J. Kroculick is a partner in Duane Morris' Real Estate Practice Group. His practice focuses on eminent domain and highway access management and control, land use and land use litigation, relocation assistance, tax appeal matters and general commercial litigation.

Michael J. McCalley is an associate in Duane Morris' Real Estate Practice Group, with a practice focusing on eminent domain/condemnation, redevelopment, highway access management and control, and relocation assistance.

Footnotes

  1. Silberman v. United States, 131 F.2d.715, 717 (1st Cir. 1942).
  2. Amoco Oil Company v. Commonwealth of Pennsylvania, 157 Pa. Commw. 222, 227 (1993).
  3. See Board of Regents of State Colleges v. Roth, 408 U.S. 564, 577 (1972).
  4. E.g., State, by the Com'r of Transp. v. Hess Realty Corp., 226 N.J. Super. 256 (App. Div. 1988), certif. denied, 113 N.J. 383, aff'd, 115 N.J. 229 (1989), cert. denied., 493 U.S. 964, 110 S. Ct. 406, 107 L.Ed.2d 371 (1989) (value of lost good will and business opportunity non-compensable).
  5. New Jersey Sports & Exposition Authority v. East Rutherford, 137 N.J. Super. 271, 279 (Law Div. 1975); City of Atlantic City v. Cynwyd Investments, 148 N.J. 55, 73 (1997).
  6. Jersey City Redevelopment Agency v. Costello, 252 N.J. Super. 247, 259 (App. Div. 1991).
  7. Hess Realty Corp., supra.
  8. Almota Farmers Elevator & Warehouse Co. v. United States, 409 U.S. 470, 474, 93 S.Ct. 791, 794, 35 L.Ed.2d 1 (1973) (finding that "just compensation" may include compensation for a lessee's expectancy in the continued use of an improvement beyond the remaining term of the lease).
  9. 4 Nichols on Eminent Domain § 13.23[1] (Sackman, 3rd Ed.).
  10. Id.; Mueller v. N.J. Highway Auth., 59 N.J. Super. 583, 158 A.2d 343, (App.Div.1960).
  11. 4 Nichols on Eminent Domain, § 13.23[1].
  12. See Commonwealth, Dep't of Transp. v. Nod's Inc., 14 Pa. Commw. 192, 321 A.2d 373 (1974); Yegen v. City of Bismarck, 291 N.W.2d 422 (N.D. 1980).
  13. Id. at 595, 158 A.2d 343; Wolf v. Department of Highways, 422 Pa. 34, 220 A.2d 868 (1966).
  14. City of Wichita, supra, 266 Kan. at 718.
  15. Hession Condemnation Case, 430 Pa. 273, 279-280, 242 A.2d 432 (1968) (a reasonable restriction to an abutting property owner's right to access does not give rise to a compensable claim); State Highway Comm'r v. Kendall, 107 N.J. Super. 248, 258 A.2d 33 (App.Div.1969) (limitation of access to designated openings resulting from the installation of curbing and railing along highway); State v. Stulman, 136 N.J. Super. 148, 345 A.2d 329 (App.Div.1975) (substitution of more circuitous access roads not compensable).
  16. See Yegen, supra, 291 N.W.2d 422; City of Phoenix v. Wade, 5 Ariz. App. 505, 428 P.2d 450 (1967); State v. Gannons Inc., 275 Minn. 14, 145 N.W.2d 321 (1966); Painter v. State, Department of Roads, 177 Neb. 905, 131 N.W.2d 587 (1964); Darnall v. State, 79 S.D. 59, 108 N.W.2d 201 (1961); Iowa State Highway Commission v. Smith, 248 Iowa 869, 82 N.W.2d 755, 73 A.L.R.2d 680 (1957); Lee v. North Dakota Park Service, 262 N.W.2d 467 (N.D.1978); Commwealth, Dept. of Transp. v. Kastner, 13 Pa. Commw. 525, 320 A.2d 146 (1974), cert. denied, 419 U.S. 1109, 95 S.Ct. 783, 42 L.Ed.2d 806 (1975); State v. Interpace Corp., 130 N.J. Super. 322, 327 A.2d 225 (App.Div.1974); State v. Monmouth Hills, Inc., 110 N.J. Super. 449, 266 A.2d 133 (App.Div.1970); City of Wichita v. McDonald's Corp., 266 Kan. 708, 971 P.2d 1189 (1999)].

Reprinted by permission of Retail Law Strategist.