A recent Utah case, adopting a “termination clause rule,” may have tenants in Utah reconsidering condemnation provisions in leases. In UDOT v. Kmart, 2018 UT 54, the Utah Supreme Court denied a condemnation award to a tenant because the lease automatically terminated upon condemnation. The Court found the tenant had no interest for which it should be compensated based on a terminated lease. Accordingly, a lease provision ensuring that a tenant is not liable under a lease following condemnation also has the negative effect of foreclosing any award a tenant may be entitled to for the value of its leasehold interest.
In the Kmart case, while the Court acknowledged the general rule that a tenant is entitled to a condemnation award if the value of the leasehold interest is diminished or terminated by “a governmental exercise of the eminent domain power,” it held such right could be “altered, waived, or terminated” by the lease. Specifically, the Court adopted a “termination clause rule” whereby a tenant is not entitled to a condemnation award when the lease terminates on its own provisions because “any continuing interest in the leased property . . . has been extinguished under the lease agreement’s terms.”
The Court acknowledged that a tenant has a protectable property interest in a lease, so, for example, if a lease has five remaining years on the term when the leased property is condemned, the condemning authority must compensate the tenant for the value of those five years. However, where a lease contains a clause terminating the lease upon condemnation, the tenant’s rights are for the stated “lease term or until the property is condemned.” The tenant therefore has no protectable (and compensable) property interest after condemnation.
However, the Court included one caveat to the termination clause rule, stating that if a lease has a termination clause, the tenant’s right to compensation in a condemnation award is extinguished “unless otherwise reserved by contract.” In support of this caveat the Court cited Metropolitan Airports Commission v. Noble, 763 N.W.2d 639 (Minn. 2009), which allowed the parties to the lease to allocate the award, even where the lease (and therefore the tenant’s interest) was automatically terminated.
Based on Utah’s adoption of the termination clause rule, but with the implication that it will honor allocation clauses, tenants will need to carefully evaluate lease provisions providing for automatic termination on condemnation. Tenants may want to limit the termination only to certain obligations and not to the lease as a whole, or focus on an affirmative allocation of the award to the tenant based on what would have been the remaining lease term but for the condemnation.