In a recent case the Arizona Court of Appeals starkly illustrated how lack of specificity in a commercial lease can end up being very expensive for a tenant. In ABCDW LLC, et al., v. Lloyd E. Banning, Sr., (1 CA-CV 15- 0261 Ariz.App., 2016), Lloyd Banning (“Banning”) farmed alfalfa on land that he leased from ABCDW, LLC (“Landlords”). The lease was set to expire at the end of the fifth year, at which point Banning had a general right of first refusal. The applicable lease provision stated: “If the Lessor [Landlords] intends to lease the property beyond five (5) years, Lessee [Banning] shall have the right of first refusal.” Unfortunately the right of first refusal provision did not include any specifics regarding the value of any plants or crops Banning planted or whether or not those plants/crops would be considered fixtures and therefore property of the Landlords. During the last two years of the lease, Banning planted about 900 acres of alfalfa. Two months before the end of the lease, Landlords advised Banning that, subject to Banning’s right of first refusal, they were going to lease the land to a new lessee at a rental rate of $275.00 per acre. That rental amount was specifically conditioned upon the alfalfa stands Banning had planted remaining and continuing to produce. (The court noted that the parties agreed that the useful life of alfalfa was “at least from 3 to 5 years.”) Banning declined to exercise the right of first refusal and notified the Landlords he was going to harvest the last cutting of alfalfa and that after that the new lessee could purchase the alfalfa stands from him. He also informed them that if he wasn’t paid for the stands he would plow them under. The Landlords told Banning that the alfalfa stands belonged to them and that Banning was not going to be paid for them. Banning then plowed under the alfalfa stands. Landlords thereafter renegotiated the new lease with the new lessee for $125.00 per acre and sued Banning for intentional interference of contract, unauthorized destruction of a crop under A.R.S. §3-114, conversion and breach of contract. Banning countersued for breach of lease and breach of the implied covenant of good faith and fair dealing.
Due to the lease’s silence on the issue, the Court had to decide whether the alfalfa roots (stands) belonged to the Landlords as fixtures or to Banning as personal property. The Court set forth three requirements that must be met in order for personal property to become a fixture: (1) annexation of the item to the realty; (2) adaptability or application of the item as affixed to the use of the realty; (3) intention to make the item a permanent part of the property, citing the case of Fish v. Valley Nat. Bank of Phx., 64 Ariz. 164, 170 (1946). The Court found that the first two requirements were easily met, but determined that the lease left Banning’s intent unclear. Using the “doctrine of away-going crops” (which provides that a tenant with a lease for a fixed term of years who plants a crop that will produce beyond the term of the lease implies by his actions that he intended for the plants and any future crops harvested therefrom to remain with the property), the Court ruled that Banning’s planting of the Alfalfa plants which would produce for 3 to five years after his lease expired, evidenced his intent for the plants to remain with the property. Based on that inferred intent, the Court ruled that the plants were fixtures that belonged to the Landlords. The Court then held that by destroying the stands, Banning breached the lease, intentionally interfered with the contract with the new lessee, violated the provisions of A.R.S. §3-114 entitling the Landlords to an award of up to twice the market value of the crops, and, was liable for the Landlords’ attorneys’ fees. Ouch.
So, what does this mean for commercial tenants? Whether you are renting a farm, office suite, or restaurant space, make sure the terms of your lease are specific! Don’t rely on boilerplate or standard form language. If the lease grants a right of first refusal make sure it precisely sets forth how the improvements you make will be valued and how that value will be applied to the right of first refusal. Additionally, make sure it is specifically delineated which improvements will be treated as fixtures and which will be treated as personal property. For example if you add a walk-in refrigerator, kitchen hood exhaust system or historic bar to a restaurant, or install decorative wood railings, a planter or granite countertops to an office space – spell out who owns each of those items at the end of the lease. The lease must make your intent clear, so a court won’t have to decide it later! If during the term of the lease you choose to make an improvement that was not addressed in the lease, get the lease amended so it clearly states whether or not the improvement is a fixture. As the Banning ruling illustrates, specificity matters and the lack thereof can cost thousands and thousands of dollars!