Fighting Fire with Fire: Eliminating Commercial Restrictive Covenants and the Unintended Consequences of “Dark Store” Legislation

Matthew W. Heron, Esq.
Cummings, McClorey, Davis & Acho, PLC

Introduction

In the recent past several large retailers have scored significant victories in challenging real estate tax assessment values on commercial property through what has been called a “dark store” argument. A retailer making this argument contends that its store is essentially a single-use building, and, therefore, once constructed has very little value on the open market as it has no other viable use. Because there would be few uses for the building once the initial builder discontinued retail operations, it is argued, an assessment of the property that is based on the cost to construct the building does not accurately reflect the true, diminished, value of the property. This argument is then supported by deed restrictions, often self-imposed, which can limit the potential market for the property; for example by preventing a subsequent owner from being able to sell the property to a competitor of the initial retailer. The retailer can then contend that due to the smaller pool of potential buyers, the value that the property owner could receive in an arms-length exchange with a new owner is reduced, requiring a downward adjustment of the property’s assessed value. The retailer then argues that the property should be assessed based on values for vacant properties with similar deed restrictions – thus the term “dark store.” The legislature has moved quickly to attempt to counter this argument and prevent municipalities from losing millions of dollars in tax revenue. Unfortunately, however, the legislature’s efforts could cause more harm than good, and could decrease commercial property values.

Background

In 2014 Menards challenged the assessed value of its Escanaba location and won, entitling the retailer to a refund of $280,000 for overpaid taxes in 2012 and 2013. Lowes won a similar argument in early 2015 based on the assessment of its Marquette Township store, requiring that a total of $1.3 million be refunded to Lowes by Marquette Township, Marquette County, and the local school district. In order to pay for the refund, the Township closes its library on Sundays. Further, while the “dark store” argument was initially presented by large “big box” stores, due to its success it appears to have gained traction with smaller retailers who are likewise looking for ways to reduce costs.

There are several concerns that have been raised as a result of the success achieved by the “dark store” argument. Some argue that this exposes an issue with a municipality’s reliance upon large retailers for its tax base, instead of focusing on the development of downtown areas or mixed-use developments not dependent on a large retailer. The primary, and immediate, concern for others, including the municipalities directly affected, is that this argument could destabilize the tax base for communities throughout Michigan, and require that millions of dollars in tax revenues that have already been collected be refunded to the retailer presenting the argument. In other words, there is a concern that the “dark store” argument will be used to undermine the tax base for communities throughout Michigan.

In an effort to combat this tactic, legislators have recently introduced bills in the Michigan House and Michigan Senate designed to prevent retailers from relying upon the “dark store” argument. State Senator Tom Casperson (R-Escanaba) and State Representative John Kivela (D-Marquette) have introduced tie-barred bills to address the issue. Senator Casperson’s bill (Senate Bill 524), would attempt to accomplish this by amending the General Property Tax Act, Act 206 of 1893, codified at MCL 211.1, et seq. Representative Kivela’s bill (House Bill 4909), however, would amend the Zoning Enabling Act, Act 110 of 2006, codified at MCL 125.3101, et seq., to preclude negative use restrictions that prohibit occupancy or use of the property when the use would otherwise comply with the local zoning ordinance.

HB 4909 would apply to single retail establishments of single, freestanding structures of 7,000 square feet or more which sell consumer goods to the public. For perspective, many pharmacies, including CVS, Rite Aid, and Walgreens, average between 10,000 and 12,000 square feet. The average grocery store is about 50,000 square feet, and the average Home Depot, Lowes, and Menards stores average in excess of 100,000 square feet. A 7,000 square foot building is roughly the size of a family-style restaurant. Olive Garden restaurants average approximately 8,000 square feet, Outback Steakhouses average roughly 6,200 square feet, and Chili’s restaurants average between 5,200 and 7,000 square feet.

In relevant part HB 4909 states as follows:

SEC. 502A. (1) A NEGATIVE USE RESTRICTION ESTABLISHED AFTER THE EFFECTIVE DATE OF THIS SECTION THAT PROHIBITS OCCUPANCY OR USE THAT IS OTHERWISE LAWFUL UNDER A ZONING ORDINANCE OF A VACANT STRUCTURE THAT WAS A SINGLE RETAIL ESTABLISHMENT, OR OF LAND IN A COMMERCIAL DISTRICT, IS, BEGINNING 90 DAYS AFTER THE RESTRICTION IS ESTABLISHED, AGAINST THE PUBLIC POLICY, VOID, AND UNENFORCEABLE.
. . .
(5) AS USED IN THIS SECTION:
(A) “NEGATIVE USE RESTRICTION” MEANS A RESTRICTION OR COVENANT IN A DEED, LEASE, CONTRACT FOR THE SALE OF REAL PROPERTY, OR OTHER WRITTEN AGREEMENT THAT OPERATES TO PROHIBIT OR LIMIT THE USE OF PROPERTY BY AN OWNER OR OCCUPANT. NEGATIVE USE RESTRICTION INCLUDES A TERM IN A COMMERCIAL LEASE THAT PREVENTS THE OWNER FROM LEASING THE PROPERTY TO ANOTHER RETAILER.

The Michigan Zoning Enabling Act allows municipalities to regulate the development and use of land pursuant to a zoning power granted by the state. By attempting to amend the Zoning Enabling Act to prohibit negative use restrictions and restrictive covenants in commercial developments, HB 4909 attempts to undercut a retailer’s argument that the market for its property has been reduced by a restrictive covenant precluding the sale (or lease) of the property to its competitors. While this approach may address the immediate argument being raised by retailers, it contradicts decades of Michigan jurisprudence pertaining to restrictive covenants.

In Michigan, a restrictive covenant or “…deed restriction represents a contract between the buyer and the seller of property.” Bloomfield Estates Improvement Ass’n, Inc v City of Birmingham, 479 Mich 206, 212; 737 NW2d 670, 674 (2007). Michigan real estate law has long been based upon the premise that property owners have great flexibility in the use and enjoyment of their property, and in their ability to impose deed restrictions and restrictive covenants against their property–on the basis that such restrictions increase property values. For example, in Terrien v Zwit, 467 Mich 56, 71; 648 NW2d 602 (2002), the Michigan Supreme Court reaffirmed the “strong” public policy in Michigan which the Court indicated “is well grounded in the common law of Michigan, supporting the right of property owners to create and enforce covenants affecting real property.” Id. (emphasis in original). In this respect, the Court stated:

It is a fundamental principle, both with regard to our citizens’ expectations and in our jurisprudence, that property holders are free to improve their property. We have said that property owners are free to attempt to enhance the value of their ‘property in any lawful way, by physical improvement, psychological inducement, contract, or otherwise.’ Covenants running with the land are legal instruments utilized to assist in that enhancement. A covenant is a contract created with the intention of enhancing the value of property, and, as such, it is a ‘valuable property right.’ The general rule [of contracts] is that competent persons shall have the utmost liberty of contracting and that their agreements, voluntarily and fairly made shall be held valid and enforced in the courts.

Terrien, 467 Mich at 71 (quoting Johnstone v Detroit, G H & M Ry Co, et al, 245 Mich 65, 74-75; 222 NW 325 (1928); City of Livonia v Dep’t of Social Services, 423 Mich 466, 525; 378 NW2d 402 (1985)).

HB 4909 appears to have at least thirteen (13) sponsors, and as a tie-barred bill with SB 524, HB 4909 appears to enjoy strong bi-partisan support in the legislature. Furthermore, and as should be expected as the result of the tax appeals in the Escanaba Menards and Marquette Lowes cases, these bills are supported by municipalities and governmental entities throughout Michigan. The Michigan Municipal League, the Michigan Association of Counties, and the Michigan Townships Association appear to be advocating for this legislation.

From a real estate perspective, however, the means by which HB 4909 attempts to prevent retailers from reducing the taxable value of their respective properties is to eliminate a fundamental tool of property owners that has long been used to enhance property and increase property values. In other words, to combat the immediate argument that deed restrictions limit the market for large retail stores thereby reducing taxable property values, HB 4909 would eliminate deed restrictions altogether even though this approach would contradict two fundamental principles of Michigan jurisprudence: (1) that contracts will be enforced; and (2) that contracts restricting the use of property tend to increase property values.

Summary

It appears that if enacted HB 4909 would significantly affect a retailer’s ability to succeed on a “dark store” argument, assuming that such an argument was based on a deed restriction limiting the sale of the property. It also appears, however, that HB 4909 would have an impact on the development of commercial property by preventing developers from utilizing one of the most powerful tools available to enhance property values. In other words, by focusing on the argument being presented at this moment by certain retailers, legislators may inadvertently reduce property values for a significant portion of the commercial property in the state.

Matthew W. Heron is an attorney with the law firm of Cummings, McClorey, Davis & Acho, P.L.C. where he focuses his practice on dispute avoidance, condominium law, commercial litigation, commercial real estate, land use, large contractual disputes, and title litigation. He has extensive litigation and trial experience in state and federal courts involving commercial litigation issues and real estate matters. He can be reached at (734) 261-2400 or mheron@cmda-law.com. You can also follow him on Twitter at @mwheron75.