OLYMPUS HILLS SHOPPING CENTER, LTD
v.
SMITH'S FOOD & DRUG CENTERS, INC.
889 P.2d 445 (Ut.App. 1994)
JACKSON, Judge: Smith's Food & Drug Centers, Inc. (Smith's) appeals the trial court's denial
of its motions for summary judgment and directed verdict concerning claims by Olympus Hills
Shopping Center, Ltd. (Olympus Hills) that Smith's breached its lease with Olympus Hills, as
well as the covenant of good faith and fair dealing associated with the lease. . . .. We affirm.
FACTS
Olympus Hills owns a 13.9 acre shopping center in Salt Lake County, the development of
which began in the early 1960s. Smith's leased 23,000 of the 160,000 total square feet of the
shopping center from Olympus Hills in the 1960s to operate a grocery store. In January 1979
Smith's began negotiating with Olympus Hills for additional space. After extended negotiations,
Smith's signed a thirty-year lease, obtaining an additional 22,000 square feet of space, for a total
of 55,000 square feet.
In December 1989, Smith's purchased a building about 1.5 miles from the Olympus Hills
location, and on March 7, 1990, announced its plan to close its Olympus Hills store. Olympus
Hills negotiated with Smith's, attempting to convince Smith's to remain at the shopping center.
When these negotiations failed, Olympus Hills filed a complaint on March 9, 1990, seeking
monetary damages and injunctive relief. Smith's filed a counterclaim seeking a declaratory
judgment of its rights under the lease. In its motion for summary judgment on its counterclaim,
Smith's argued that the unambiguous language of the use clause gave Smith's the right to operate
any “lawful retail selling business” at the shopping center. On April 3, 1990, the trial court
determined that the lease's use clause, which provided that Smith's may use the building for “any
other lawful retail selling business not directly in conflict or competition with another major
tenant in the shopping center,” allowed Smith's to operate any retail business that did not
compete with other tenants.
On April 13, 1990, Smith's announced its intention to operate a “warehouse discount box
store” to be known as “Buy 'N Save” on the premises. On April 23, 1990, Olympus Hills filed a
second amended complaint, contending that Smith's proposed warehouse box store was a breach
of the covenant of good faith and fair dealing. Smith's filed an answer along with a counterclaim
for declaratory judgment to authorize Smith's to temporarily close the leased premises to
implement its change of use. In the meantime, Olympus Hills, on April 27, 1990, served a notice
of default on Smith's. Smith's filed a motion for summary judgment on the covenant of good
faith claim; however, the trial court determined that this issue was one for the jury to determine. .
. ..
At the end of Olympus Hills's case before the jury, Smith's moved for a directed verdict.
The trial court denied the motion and sent the issues to the jury. The jury found that Smith's
breached the covenant of good faith and fair dealing by changing the use of the premises from a
supermarket to the Buy 'N Save. . . .
ISSUES
This case raises the following issues: (1) whether the trial court properly submitted to the jury the
issue of whether Smith's operation of the Buy 'N Save breached the covenant of good faith and
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fair dealing even though Smith's had the express right to operate any retail selling business in the
leased space; . . . (3) whether the trial court properly rejected Smith's proffered jury instructions
and whether the jury instructions given were legally sufficient; . . .
ANALYSIS
A. Good Faith Covenant v. Express Lease Provision
Smith's asserts that the trial court improperly denied its motion for summary judgment
and later its motion for directed verdict on the issue of whether Smith's breached the covenant of
good faith and fair dealing by choosing to operate the Buy 'N Save in the leased space. Smith's
asserts the trial court could have decided the issue as a matter of law but instead, improperly
submitted the issue to the jury. Specifically, Smith's claims that because the express provision of
the lease allowed it to operate any retail selling business, it could not have breached the covenant
of good faith and fair dealing by operating the Buy 'N Save. Smith's argues that as long as the
changed use is to “any other lawful retail selling business,” its discretion as to what type of
business to operate could not be hampered by any duty of good faith.FN3
FN3. Interestingly, Smith's conceded before the jury that “Olympus Hills is entitled to
have a lawful retail selling business in the premises.... We have to make the decision [of]
what kind of a retail selling business to put in there in good faith.” Further, one of the
jury instructions, which Smith's does not challenge on appeal, states that “Smith's further
contends that the Lease gives it the contractual right to choose the retail selling business
which is in its own interest, so long as its use as a lawful retail selling business is not in
bad faith.”
. . . Smith's argument poses the question of whether parties who retain express power or
discretion under a contract can exercise that power or discretion in such a way as to breach the
covenant of good faith and fair dealing.FN4 We believe that they can. Our courts have
determined that a party must exercise express rights awarded under a contract reasonably and in
good faith. . . .
FN4. It is fundamental that every contract includes a covenant of good faith and fair
dealing with respect to dealings between the parties. . . . Many courts have stated that a
covenant of good faith is “implied” in every contract, perhaps because a leading opinion,
Kirke La Shelle Co. v. Paul Armstrong Co., 263 N.Y. 79, 188 N.E. 163, 167 (1933), used
that language. 3A Arthur L. Corbin, Corbin on Contracts § 654A(B) (2d ed. 1993).
“While it is true that courts impose an obligation of good faith in every aspect of the
contractual relationship ... the obligation of good faith is ‘constructive’ rather than
‘implied’ ” because the obligation is imposed by law and cannot be disclaimed. . . .
At first blush, this concept seems to contravene good sense because “if contracting parties
cannot profitably use their contractual powers without fear that a jury will second-guess them
under a vague standard of good faith, the law will impair the predictability that an orderly
commerce requires.” . . . However, contracting parties, hard as they may try, cannot reduce
every understanding to a stated term. . . . Instances inevitably arise in which one party exercises
discretion retained in a way that denies the other a reasonably expected benefit of the bargain. . .
. For example, if taken to its logical extreme, the express provision of the lease in the instant
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case would allow Smith's to set up a cardboard box in the leased space and sell cigars, an action
that would clearly deny Olympus Hills the expected benefit of its bargain. The law of good faith
and fair dealing, though inexact, attempts a remedy for such abuse. . . .Restatement (Second) of
Contracts § 205 cmt. a (1979) (“[g]ood faith performance of enforcement of a contract
emphasizes faithfulness to an agreed common purpose and consistency with the justified
expectations of the other party”).
Consistent with Burton's approach and the Restatement examples, courts have determined
in a variety of contexts that a contracting party can exercise a retained contractual power in bad
faith. . . .
Thus, in this case, our inquiry does not end with the recognition that Smith's had the
discretionary power or contractual authority to operate “any lawful retail selling business.” The
question is whether, upon a motion for summary judgment or directed verdict, the trial court
properly found that reasonable minds could differ as to whether Smith's wrongfully exercised
this power for a reason beyond the risks that Olympus Hills assumed in its lease with Smith's or
for a reason inconsistent with Olympus Hills's “justified expectations.” . . .
The trial court correctly determined that Olympus Hills justifiably expected that Smith's
would select a reasonable economic use for the property in good faith. . . .
Olympus Hills asserts that Smith's wrongfully exercised its express right to select any
retail selling business in a manner inconsistent with Olympus Hills's justified expectations under
the lease. Olympus Hills maintains that the evidence shows “manifest bad faith on the part of
Smith's in attempting to invent an artificial use of the ‘warehouse box store’ at Olympus Hills.”
Olympus Hills argues that Smith's Buy 'N Save was a “sham” operation designed to improperly
“freeze” the space in Olympus Hills and to force customers to its new location. Furthermore,
Olympus Hills argues this bad faith conduct was inconsistent with its right to have Smith's select
a reasonable use for the leased space. When viewing the facts most favorably to Olympus Hills,
reasonable minds could differ as to whether Smith's acted in bad faith in changing the use of the
leased space to the warehouse box store, in violation of Olympus Hills's justified expectations. . .
. Thus, the trial court properly submitted the issue to the jury. . . .
1. Evidence presented by Olympus Hills
Olympus Hills presented the following evidence pertaining to whether Smith's acted in
bad faith in changing the use of the leased space to the warehouse box store, in violation of
Olympus Hills's justified expectations:
In the late 1970s, during negotiations with Thomas Welch, Smith's corporate counsel,
Welch told Olympus Hills of Smith's desire to make the Olympus Hills store Smith's “flagship”
store. Olympus Hills advised Smith's that Smith's presence in the shopping center would
determine the shopping center's success and it was important that they operate as a supermarket.
Welch advised them that Smith's would be operating a supermarket at Olympus Hills beyond his
or Olympus Hills's attorney's lifetimes.
Smith's was the “anchor tenant” at the center, generating significant customer traffic,
necessary to the financial health and operation of the shopping center. Smith's received favorable
lease terms and conditions because of its central role. For example, Smith's minimum rent was
below the break-even point for the shopping center's operating costs. Smith's had a substantial
and direct affect on the vacancy rate, rent return, ability to retain and attract tenants, and the
overall viability and value of the shopping center.
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Smith's own market studies reflected that Olympus Hills was a strong, profitable store. There
was never any discussion during negotiations concerning a non-supermarket use of the leased
space.
After purchasing the site for its new store, Smith's decided to select a business for the
Olympus Hills location that would not compete with its new grocery store. By this tactic Smith's
reasoned that it would garner the shoppers that had previously used its Olympus Hills store.
Smith's conceded that it “intentionally selected a use that would not be in direct competition”
with its new store.
Smith's chose to operate the Buy 'N Save without any market analysis, a clear departure
from Smith's historic practice. Smith's had never operated a warehouse box store before and it
did not have any personnel trained or qualified to operate such a store.
Experts testified that to be reasonably successful, a warehouse box store should be
centrally located in a marketing area so it can draw bulk-purchasing traffic from all directions.
The Olympus Hills Shopping Center was not strategically located for warehouse box store
operations, but rather was in the nature of a neighborhood shopping area with the barrier of the
mountains directly to the east.
Smith's designed and inventoried the warehouse box store so it did not reasonably appeal
to repeat weekly customers. Smith's did not design or operate the warehouse box store with an
expectation that it would achieve a break-even point in operations or produce any percentage rent
payments to Olympus Hills.
Michael Williams, Smith's employee assigned to create and design the warehouse box
store, did not know what the target market area was for the store. Smith's in-house marketing
research department, nationally recognized for its accuracy and reliability, did not conduct any
feasibility study of the warehouse box store at Olympus Hills.
For bookkeeping purposes, Smith's characterized the Olympus Hills property as “surplus”
during the pendency of Olympus Hills's action. The warehouse box store intentionally did not
carry any fresh produce, bakery products, fresh meat, non-food products found in an ordinary
retail grocery store, or any pharmacy items.
Smith's had never operated any type of warehouse box store prior to Olympus Hills.
Smith's did not want its name associated with the warehouse box store. Customer traffic was
down sixty percent after the opening of the Buy 'N Save.
Smith's box store manager, Mr. Kano, testified that he was uncomfortable operating the
warehouse box store at Olympus Hills and attempted to meet some of the customer needs by
installing a miniature produce stand. However, he was ordered by Smith's management to
remove the stand. Smith's used no radio or television advertising for the store.
Smith's projected the Buy 'N Save break-even point at between $70,000 to $97,000 in
gross weekly sales. Experts opined that it would have to generate between $100,000 to $200,000
in sales per week to be profitable. The actual average weekly sales through trial were $16,800.
Smith's supermarket, on the other hand, had the following gross sales at the Olympus Hills
location: $9,479,000 in 1986; $13,380,000 in 1987; $16,225,000 in 1988; and $16,758,000 in
1989.
Smith's expert testified that if a leased property is not put to its reasonable economic use
and if there is an obligation to keep the property operating, “then very likely the use that will be
put in there will be an artificial use.”
2. Evidence presented by Smith's
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Smith's presented the following evidence concerning its choosing to operate the Buy 'N
Save in the leased space:
Before it closed Smith's at the shopping center, Smith's looked for a suitable subtenant to
operate a retail business from the space. Smith's proposed for approval to Olympus Hills a
potential sublease to REI, a national sporting goods chain. Olympus Hills rejected that request,
indicating that it would not approve any subtenant that was not a supermarket. Not wanting to
relinquish its undepreciated investment in the leased space, exceeding one million dollars, and
not wanting to turn over the property to a competing supermarket, considering the customer
traffic Smith's had built up over twenty years, Smith's decided to operate a retail business on the
premises itself.
Smith's spent at least $75,000 in remodeling the space into the Buy 'N Save. The Buy 'N
Save also contained $45,000 in new equipment, $383,000 in equipment previously used on the
premises, and about $578,000 in inventory. The store was operated between the hours of 9:00
a.m. and 9:00 p.m., six days a week, and used all the leased space.
The Buy 'N Save accounted for about 900 customer trips each day during its start up period and
would have generated approximately $870,000 in sales its first year given its initial weekly
average sales. Smith's presented evidence that its Olympus Hills' store was its second least
profitable store in the area because of flattening sales, insufficient floor space, and a limited
geographic customer base. The Smith's superstores being built and operated in 1990 generally
required between 72,000 and 80,000 square feet of space.
Smith's examined other discount warehouse stores in Salt Lake and other states in
connection with its opening of the Buy 'N Save. Witnesses stated that the Buy 'N Save was not a
typical warehouse discount store because it carried a large variety and selection of products,
including convenience items such as dairy products and meats, and had a nicer decor than the
typical store. Smith's testified that it treated the Buy 'N Save as an “evolving concept” and had
planned to modify the format as needed to improve sales. Smith's also opened a similar store in
Clearfield, Utah and determined that long-term development of this type of store would depend
on the ultimate success of the Clearfield and Olympus Hills stores. Smith's believed that the Buy
'N Save could ultimately make a profit at Olympus Hills.
Former supermarket space has historically been converted into a variety of secondary
uses, including discount drug stores, fabric shops, and hardware stores.
Viewing the above evidence in a light most favorable to Olympus Hills, we agree with
the trial court that reasonable minds could differ as to whether Smith's had breached its covenant
of good faith and fair dealing by choosing to operate the Buy 'N Save. The evidence viewed most
favorably to Olympus Hills could show that Smith's decision to change its use of the premises to
a warehouse box store was without market analysis, demand, or even the possibility that the
manufactured use would be economically successful. The evidence could also reasonably show
that Smith's motive was to “freeze” or “down-use” the Olympus Hills premises and block
reasonable commercial operations on it to support its marketing efforts at its new location.
Reasonable minds could also differ as to whether Smith's use of the space-contrary to market
demand and commercial business judgment-deprived Olympus Hills of its justified expectations
under the lease. Thus, the trial court properly denied the motions and allowed the issue to go to
the jury. . . .
C. Jury Instructions
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Smith's asserts the trial court improperly refused to instruct the jury that (1) there could
be no duty different from or contradictory to an express right under the lease, (2) the lease did
not require Smith's to operate an anchor-type business, and (3) Olympus Hills's benefit of the
bargain under the lease was the operation of a “lawful retail selling business.” . . . .
First, Smith's is correct that courts will not infer duties different from or contradictory to
express rights of a contract. . . . However, a more correct statement of the law in this case is that
when a party has been granted discretion under a contract, that discretion may not be “exercised
capriciously or in bad faith.” . . . Rather, the law imposes a duty to exercise that express
contractual discretion in good faith. . . . In this case, Smith's has been granted discretion under
the contract to determine what type of retail selling business to operate in the leased space. Thus,
the trial court was correct in refusing to give the requested instruction, instructing the jury,
instead, that “[w]here a contract confers on one party a discretionary power affecting the rights
and interests of the other party, that discretionary power cannot be exercised arbitrarily,
unreasonably, unfairly or in bad faith.”
Second, the trial court was also correct in refusing to instruct the jury that the lease did
not require Smith's to operate an anchor-type business. Even though the lease provided that
Smith's was not required to generate a specific amount of percentage rentals for Olympus Hills,
the covenant of good faith and fair dealing required Smith's to select a reasonable economic use
for the leased space. . . . By definition, a reasonable business from Smith's perspective might
have required them to operate as an “anchor tenant,” considering the location of the shopping
center and the amount of space leased by Smith's. This was a decision left for the jury. Thus, we
find it was correct for the trial court to refuse to instruct the jury that Smith's was not required to
operate as an anchor tenant.
Third, Smith's asserts that the trial court should have instructed the jury that Olympus
Hills's benefit of the bargain under the lease was the operation of a “lawful retail selling
business.” Smith's was attempting to instruct the jury that Smith's could breach the lease only if
the Buy 'N Save was not a lawful retail selling business, that Olympus Hills's justified
expectation under the lease was only that Smith's would operate a retail selling business. As
stated above, this proposition is incorrect. Our courts have determined that a party must exercise
express rights awarded under a contract reasonably and in good faith. . . . Thus, Olympus Hills's
benefit of the bargain, as Smith's conceded before the jury, was that Smith's select a retail selling
business in good faith. Accordingly, the trial court properly refused the requested instruction. . . .
. Accordingly, we affirm the determinations of the trial court.
BENCH, Judge (concurring and dissenting): . . . I dissent, however, from the main opinion's
holdings regarding (1) the implied covenant of good faith and fair dealing . . ..
The main opinion recognizes that “Smith's is correct in its statement of the law that courts will
not imply duties that are different from or contradictory to express rights in the contract.”
However, the main opinion then completely ignores its own statement of the controlling law and
sanctions the use of the implied covenant of good faith and fair dealing as a tool to create duties
and obligations in direct conflict with express contractual provisions. . . . An implied covenant
of good faith and fair dealing may not, however, be used to create a duty that is inconsistent with
express terms of the contract. . . .
In the present case, the Use Clause in the lease provided:
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Lessee may use the demised building for conducting therein the business of a
supermarket, drug store and pharmacy or any other lawful retail selling business not
directly in conflict or competition with another major tenant in the shopping center.
Lessee's use as a supermarket, drug store and pharmacy shall be exclusive in the Center,
so long as lessee operates as a supermarket, drug store or pharmacy.
Under this express provision, and as recognized by the trial court, Smiths's operation of “any
lawful retail selling business” would satisfy the provisions of the lease so long as the use did not
compete with “another major tenant.”
The trial court correctly held that Smiths complied with this express provision of the
lease, as a matter of law, when it opened its Buy 'N Save store in the leased premises. There is
no dispute that the Buy 'N Save store was a “lawful retail selling business” not in direct
competition with “another major tenant” of the shopping center. Smiths complied with the
express covenants of the Use Clause and, as a matter of law, there can be no implied covenants
that are inconsistent. . . . Since the express covenants or promises did not require Smiths to
operate anything more than a “lawful retail selling business” that did not compete with another
major tenant, there could be no implied covenants or promises compelling Smiths to do
otherwise. . . . Therefore, I would hold that the trial court erred in denying Smiths's motion for
summary judgment on the issue of the implied covenant of good faith and fair dealing.
Because the main opinion erroneously upholds the trial court's denial of Smiths's motion
for summary judgment on the covenant of good faith and fair dealing, it also erroneously upholds
the trial court's decision to admit evidence going to the alleged breach of the covenant of good
faith and fair dealing. Specifically, the trial court erroneously allowed the following evidence to
be admitted: (1) evidence that traffic counts at the shopping center were sixty-percent lower after
Smiths's change of use; (2) evidence that another business in the shopping center was adversely
affected by Smiths's change of use; and (3) evidence that the highest and best use of the premises
was as a full-service supermarket.FN3 The trial court admitted this evidence on the ground that it
was relevant to determine whether Smiths had breached its covenant of good faith and fair
dealing. Smiths correctly argues that this evidence was both irrelevant and highly prejudicial
because it allowed the jury to evaluate the decision to open its Buy 'N Save store from the
perspective that Smiths had the duty act to as an “anchor tenant” in order to benefit all tenants of
the shopping center.
FN3. The main opinion rewrites the contract to include a “reasonable” economic use
provision, and then holds that the Buy 'N Save was not such a use and that Smiths
therefore breached its duty of good faith and fair dealing. Perhaps, in retrospect, the Buy
'N Save was not the best economic use of the leased premises. However, this fact,
whether accurate or inaccurate, is immaterial. Nothing in the lease mandates that Smiths
make the best possible use of the premises. The main opinion goes on to hold that the
“highest and best use” of the premises was a full-service supermarket rather than a
discount supermarket. The lease, however, does not require Smiths to operate a
supermarket of either type. The unambiguous language of the lease simply does not
support the main opinion's position. . . .
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