254 F.3d 1120 (D.C. Cir. 2001), 00-7129, Red Sage Ltd v. DESPA Deutsche Sparkassen Immobilien-Anlage-Gasellschaft

Docket Nº:00-7129
Citation:254 F.3d 1120
Party Name:Red Sage Limited Partnership, Appellant v. DESPA Deutsche Sparkassen Immobilien-Anlage-Gasellschaft mbH, a/k/a DespaEuropa, Appellee
Case Date:July 13, 2001
Court:United States Courts of Appeals, Court of Appeals for the District of Columbia Circuit
 
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Page 1120

254 F.3d 1120 (D.C. Cir. 2001)

Red Sage Limited Partnership, Appellant

v.

DESPA Deutsche Sparkassen Immobilien-Anlage-Gasellschaft mbH, a/k/a DespaEuropa, Appellee

No. 00-7129

United States Court of Appeals, District of Columbia Circuit

July 13, 2001

        Argued February 5, 2001

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[Copyrighted Material Omitted]

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        Appeal from the United States District Court for the District of Columbia (No. 98cv02533)

        Andrew J. Kline argued the cause for appellant. With him on the briefs was Jeffrey L. Berger.

        J. Jonathan Schraub argued the cause for appellee. With him on the brief was Paige A. Levy.

        Before: Edwards, Chief Judge, Ginsburg and Tatel, Circuit Judges.

        Opinion for the Court filed by Circuit Judge Tatel.

        Tatel, Circuit Judge:

        A Washington, D.C. restaurant sought a declaration that its landlord breached an exclusive use covenant by renting space in the same building to a specialty cake shop. The restaurant claimed that under its lease, the breach entitled it to a 50 percent rent abatement. The district court granted summary judgment for the landlord, finding that under the circumstances of this case, a 50 percent rent abatement would constitute an unenforceable penalty. Because we conclude that the rent abatement, negotiated by sophisticated parties, was not an unreasonable estimate of the damages likely to result from a breach of the exclusive covenant, and because the landlord's additional arguments for summary judgment fail, we reverse and remand for further proceedings.

         I

         Red Sage Limited Partnership operates an "internationally known ... fine dining" restaurant in the Westory building, a Washington D.C. office building. Appellant's Opening Br. at 5. In the same building, Red Sage operates several private dining rooms used for catering and special events, a casual Tex-Mex restaurant, and the Red Sage Market, a take-out facility that sells sandwiches, salads, snacks, cold drinks, tea, coffee, and desserts, including a variety of whole cakes available by special order.

         Red Sage first leased space in the Westory building in September of 1990. At that time, the building was owned by 607 14th Street Associates Limited Partnership. Insofar as the original landlord, through his wife, had an ownership interest in Red Sage, the original lease was not negotiated at arm's length. The lease provided that "[t]enant shall use and occupy the Leased Premises solely as a bar and/or

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a restaurant." The lease also included the following exclusive covenant and penalty clause:

         34. Exclusive Covenant

         (a) To the extent permitted by law, Landlord covenants that during the Term it shall not permit any other tenant within the Building to operate a bar, restaurant or food service establishment of any kind (a "Competing Use"). The provisions of this Section 34 shall be enforceable only so long as Tenant is operating a bar and/or a restaurant in the Leased Premises.

        .

        (e) In the event that a Competing Use is operated in the Building at any time during the Term and Landlord has violated its covenants under this Section 34, then (i) one half (1/2) of the Base Rent payable hereunder shall be abated during the period that the Competing Use is operated in the Building, and (ii) Tenant may terminate this Lease if the operation of the Competing Use continues for a period of six (6) months after written notice thereof by Tenant to Landlord.... The provisions of this subsection (e) shall not limit ... any other remedies which Tenant may have against Landlord for violating its obligations under this Section.

        Six years later, in 1996, 14th Street Associates and Red Sage executed an Amended and Restated Lease. The amended lease contained the same exclusive covenant and penalty clause as the original lease, but included a revised tenant use provision:

         Tenant use and occupancy of the Leased Premises shall consist of owning and operating a restaurant and bar and carrying on any and all activities incidental or related thereto, including, but not limited to, operating a retail general store primarily selling t-shirts, sweatshirts, souvenirs, spices, baked goods, foods and other items related to Tenant's bar and restaurant.

        The new lease also set base rent at "six and one-half percent ... of [Red Sage's] Gross Revenues, but in no event less than Four Hundred Thousand Dollars." The parties do not dispute that this lease was executed at arm's length.

         In 1997, in preparation for the sale of the Westory Building to DespaEuropa--Red Sage's current landlord and appellee in this case--14th Street Associates and Red Sage again amended the lease. This amendment left intact the tenant use, base rent, exclusive covenant, and penalty clause provisions in the amended lease, stating that "[a]ll terms and provisions of the Lease which are not amended hereby are hereby ratified and confirmed in all respects." Red Sage asserts that Despa was "actively involved" in negotiating the 1997 amendment, since "reformulation of the Red Sage Lease was a precondition to the purchase of the Westory Building by Despa." Appellant's Opening Br. at 6. For its part, Despa asserts that it "was not involved in any way in the negotiations for or the drafting of the Red Sage Lease, but rather inherited it as a second or third generation owner of the building." Appellee's Br. at 5. It is undisputed, however, that a Despa representative signed the 1997 amendment, endorsing it "Accepted and Agreed."

         Later that year, Despa purchased the Westory building from 14th Street Associates and, the following year, leased space in the building to a specialty store known as Cakes & Company, triggering the dispute leading to this litigation. Cakes' original lease permitted it to operate a "bakery/cafe" selling "specialty cakes, baked goods, coffee, non-alcoholic beverages and associated paper goods," but as Red Sage concedes, Despa later amended the lease,

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deleting the reference to operating a "cafe" and permitting Cakes to sell food items only for consumption off the premises. The parties agree that Cakes primarily sold whole cakes--prepared elsewhere and decorated on-site--for weddings and special occasions. It also sold tea, coffee, single slices of cake, and some of the same prepackaged drinks sold by Red Sage Market. Cakes had no menu, wait staff, or customer tables or chairs. In Cakes' first four months of operation, its gross sales were almost $95,000, its gross profits around $50,000, and its net income about $11,000.

         Learning of the lease to Cakes, Red Sage wrote to Despa, asserting that the landlord was violating the exclusive covenant in Red Sage's lease and requesting a 50 percent rent abatement. Despa replied: "The exclusive right you currently enjoy in your lease ... pertains to a competing 'food service operation.' Cakes & Company could not infringe upon the highly stylized and critically acclaimed Red Sage." Letter from Laurie McMahon, Director of Downtown Property Management, Cassidy & Pinkard Property Services L.L.C., to Bo Nilsson, Managing Partner, Red Sage, Inc. (May 26, 1998). Red Sage then sued Despa in the Superior Court for the District of Columbia, seeking a declaration that Despa "has breached and continues to breach section 34 of the Lease, [and] that as a result of this breach Red Sage is entitled to an abatement of one-half of the Base rent...." Compl. for Declaratory Relief, Red Sage Ltd. P'ship v. DESPA mbH, No. 98ca007066, at 6 (D.C. Super. Ct. Sept. 16, 1998). Despa removed the case to federal court, and both parties moved for summary judgment, contending that there were no disputed issues of material fact. The district court denied the motions, stating that "the contractual term 'food service establishment' is not susceptible to definitive construction as a matter of law under either the ... Lease or the Municipal Regulations of the District of Columbia," and that there were "material questions of fact concerning: 1) the parties' intentions as to the scope and coverage of the restrictive covenant ... and 2) the exact nature of the 'services' provided by Cakes." Order Den. Cross-mot. for Summary J., Red Sage Ltd. P'ship v. DESPA mbH, No. 98-2533 (D.D.C. Sept. 8, 1999).

         At a subsequent status conference, Despa renewed its motion for summary judgment on the alternative ground that the rent abatement provision in Red Sage's lease constituted an unenforceable penalty. Following supplemental briefing on the issue, the district court granted Despa's motion for summary judgment, finding that since "a rent abatement of $200,000 ... would indeed impose an improper...

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