The New York City Council approved a bill on Thursday, November 30, that impacts thousands of small business owners located south of 96th Street in Manhattan. The bill modifies the threshold that businesses must meet in order to be exempt from paying the 3.9 percent New York City commercial rent tax, which is imposed upon businesses located south of 96th Street in Manhattan. Businesses operating in the Bronx, Queens, Brooklyn and Staten Island are not subject to the tax and are not impacted by this legislation. Though Mayor Bill de Blasio initially opposed the bill as it is projected to remove $38.6 million in revenue in fiscal year 2019, it is expected that he will sign the bill into law. The measure also had the support of Council Speaker Melissa Mark-Viverito. Once signed, it will become effective July 1, 2018.

Prior to the bill’s passage, businesses who paid more than $250,000 a year in base rent were required to pay the tax. The bill will raise this threshold, allowing businesses who make $5 million or less in annual income and pay less than $500,000 in annual rent to be exempt from the tax. The bill also provides a partial, sliding credit for (1) businesses making $5 million or less a year and paying between $500,000 and $550,000 a year in rent and (2) businesses making between $5 million and $10 million a year and paying less than $550,000 in annual rent.

The bill also provides exemptions for not-for-profit organizations and businesses located in certain areas, such as the World Trade Center area or those areas impacted by the Lower Manhattan Commercial Revitalization Program.

A credit for businesses that pay between $250,000 and $300,000 in annual rent, without consideration of annual income, is left unchanged.

In a recent tax court case, Holy Trinity Baptist Church v. City of Trenton (Docket No. 015909-2014, February 2, 2017), the court overturned the findings of the County Board of Taxation and upheld the tax exemption for religious/charitable use of properties pursuant to N.J.S.A. 54:4-6.3.  This statute exempts properties from taxation where “buildings [are] actually used in the work of associations and corporations organized exclusively for religious purposes, including religious worship, or charitable purposes.”  The Holy Trinity decision comes at a time when municipalities are aggressively challenging tax exemptions and was preceded by two other significant tax court cases discussed below.

Commencing with the tax court’s decision in AHS Hospital Corp. v. Town of Morristown, 28 N.J. Tax 456 (Tax 2015), involving the Morristown Memorial Hospital, it appears that elevated scrutiny by municipalities is calling the exempt status of many non-profit organizations into question.  In Morristown Memorial, the tax court found that the hospital’s entanglement with for-profit activities undermined the hospital’s ability to satisfy the well-recognized three prong exemption test.  This test requires an organization to establish that:  1) The organization is a New Jersey non-profit entity; 2) The non-profit entity is acting consistent with its charter in the performance of religious/charitable functions; and 3) The activities performed on the property are not conducted for profit.  Paper Mill Playhouse v. Millburn Township, 95 N.J. 503 (1984).  In reaching its conclusion the court in Morristown Memorial focused on the hospital’s failure to satisfy the third prong of the test.  In part, the court concluded that the activities conducted and services provided by the many private, for-profit physicians, dictated a finding that a significant portion of the hospital facilities were in fact being used for profit.  The court there also concluded that it was unable to distinguish and segregate those portions of the hospital facilities where the involvement of for-profit activities did not apply.  Consequently, other than in the most distinct and limited areas (e.g., the hospital parking garage, auditorium and in-house fitness center), the hospital facilities were deemed to be taxable.

More recently, the tax court was asked to focus on the exemption afforded non-profit universities.  In Fields v. Trustees of Princeton University, a group of third-party taxpayers challenged the exemption afforded Princeton University.  Although that matter was resolved without a trial, it appears the settlement may have been precipitated by the University’s concern with what has been widely perceived to be an increasingly unfriendly environment for the exempt treatment of non-profits in the aftermath of the Morristown Memorial decision.  The settlement, which only temporarily resolves the ultimate exemption question, requires the University to pay over $18 million dollars in payments to third-parties and contributions to the municipality (in the form of payments in lieu of taxes) through the year 2022 when the University’s settlement obligations expire.

With this recent history and the presence of numerous pending cases specifically attacking the exemptions afforded non-profit hospitals throughout the state, the tax court’s decision in Holy Trinity may offer non-profits, at least religious organizations, some solace from what appears to be a concerted effort on the part of municipalities to challenge the efficacy of real property tax exemptions in all areas.  Importantly, the Holy Trinity court concluded that despite evidence indicating that religious activities on the subject church property had diminished (as the church purchased a new property for its operations and had already commenced the process of shifting its activities to this new location), the church continued to make actual use of the property in furtherance of its religious purposes.  In particular, the Holy Trinity court found that the church continued its schedule of weekly meetings, made the space in question available for future meetings and gatherings, conducted receptions, and stored books at the location in connection with its religious/charitable functions.  As a result, the continued application of the tax exemption was determined to be appropriate in Holy Trinity.

The Holy Trinity court also made clear that neither an intent to sell the property nor diminished use of otherwise exempt property in of itself will destroy the tax exemption.  The court’s decision is consistent with City of Hackensack v. Bergen County, where the listing of the property for sale and removal of certain items to increase the marketability of the property were found to be insufficient to undermine the exemption.  Id. 405 N.J. Super. 35 (App. Div. 2009).  Further, the Holy Trinity court acknowledged that a property remains exempt even where a property’s use is limited to the occasional storage of goods used in furtherance of religious and charitable purposes.  Borough of Hamburg v. Trustee of Presbytery of Newton, 28 N.J. Tax 311, 319-320 (Tax 2015).

Consequently, in the current ratable hungry environment, non-profit organizations must now be more vigilant in ensuring that their properties continue to be used for the organization’s exempt or charitable purposes.  Only by regularly reviewing the entity’s activities and documenting continued property usage for its non-profit purposes, can these organizations improve the prospect of preserving the significant benefits that flow from application of this statutory exemption.

The Third Circuit Court of Appeals issued a precedential opinion last week when it ruled that a New Jersey real estate developer had standing to pursue antitrust claims against the owner of a nearby ShopRite who engaged in anti-competitive activities designed at blocking the developer from bringing a Wegmans to its property.

In the case of Hanover 3201 Realty, LLC v. Village Supermarkets, Inc., et al., a developer, Hanover 3201 Realty, LLC (“Hanover Realty”), signed a contract with Wegmans to develop a full-service supermarket at its Hanover, New Jersey property.  The contract required Hanover Realty to secure all necessary governmental permits and approvals within two years, otherwise Wegmans could walk.  Soon thereafter, Village Supermarkets, Inc. (“Village”), the proprietor of a ShopRite supermarket in Hanover (in addition to two dozen others throughout New Jersey), took actions purportedly aimed at frustrating Hanover Realty’s efforts to obtain all requisite government approvals.  Such actions included: (i) filing an appeal with the New Jersey Department of Environmental Protection (“DEP”) concerning a flood hazard area permit that had been awarded to Hanover Realty, (ii) challenging a wetlands permit already awarded by the DEP to Hanover Realty, (iii) filing an objection with the New Jersey Department of Transportation suggesting that Hanover Realty, on top of making certain improvements to the intersection near the proposed Wegmans, should be compelled to construct an extensive highway overpass near the project, and (iv) commencing a state court lawsuit to nullify a rezoning approval Hanover Realty had obtained from Hanover Township in order to use the property for retail purposes.  These acts, all of which were either largely denied or rejected by the respective administrative or judicial authorities, led Hanover Realty to file a federal lawsuit alleging that the efforts of Village (along with its wholly-owned subsidiary that owns the ShopRite site) were anti-competitive shams designed for no other purpose than to unfairly block its efforts to bring Wegmans to that market space.

After the District Court first dismissed the suit, Hanover Realty appealed and the Third Circuit Court of Appeals reversed in part, holding that Hanover Realty’s injuries were “inextricably intertwined” with the noted anti-competitive conduct, and Hanover Realty thus met the legal standard for asserting a valid antitrust claim.  The Third Circuit found that the end goal of the misconduct was designed to injure Wegmans by keeping them out of the market.  In doing so, Hanover Realty, the party tasked with obtaining all necessary permits and approvals, was targeted by the sham petitions and was forced to unnecessarily incur substantial attorneys’ fees, costs and delays in its development plans.  While the Third Circuit limited its holding to allow Hanover Realty to pursue anti-monopolization claims in the market for full-service supermarkets (and not including the market for full-service supermarket rental space because the parties were not deemed “competitors” in that space), the Court also determined that the wrongful activities triggered the “sham exception” to the Noerr-Pennington doctrine, which ordinarily affords broad immunity from liability to those who petition the government for redress of their grievances.  The Court found that the anti-competitive activities that were intentionally lodged with no purpose other than to thwart Hanover Realty’s development activities with Wegmans were substantial enough to overcome this otherwise widely-applied privilege.

Whether or not Hanover Realty’s claims ultimately prove successful in the lawsuit, the Third Circuit’s ruling carries a meaningful warning for commercial landlords and tenants seeking to block the entry of a competitor in its market space.  Any such efforts must be strategically and tactfully employed with a legitimate purpose, in contrast to the borderline frivolous legal and administrative challenges from Village and ShopRite against Hanover Realty and Wegmans.  Though these types of anti-competition claims are still somewhat of a rare species in the commercial real estate arena, the Hanover Realty decision will certainly provide frustrated developers and landlords with another ace in their sleeve to fight against existing competitors trying to remain the only game in town.

On October 21, 2015, the New Jersey Appellate Division affirmed a trial court ruling that a South Jersey landlord did not violate a coffee-related exclusivity provision in its lease with Starbucks when it subsequently rented space in the same strip mall to McDonald’s – another purveyor of coffee products.

In Delco LLC v. Starbucks Corporation, Delco, the owner-operator of a shopping center in Rio Grande, New Jersey had rented space to Starbucks.  The Starbucks lease contained an exclusivity clause that essentially barred any other tenant at that shopping center from selling coffee, espresso and tea drinks.  However, an exception to this provision was allocated for “any tenant . . . occupying twenty thousand contiguous square feet or more . . . and operating under a single trade name.”  Starbucks’ coffee exclusive at the shopping center became an issue when Delco sought to bring in McDonald’s as a tenant, and Starbucks voiced an objection.  Though there was no question that McDonald’s sells coffee and tea at its fast food restaurants, Delco envisioned leasing 40,000 square feet of contiguous space to McDonald’s – more than twice the size needed to satisfy the exception to the exclusivity provision under the Starbucks lease.  Based upon the clear and unambiguous lease language, the Appellate Division summarily affirmed the trial court’s determination that Starbucks’ objection to the McDonald’s lease lacked any merit, and that Delco was also entitled to attorneys’ fees.

While the Starbucks decision did not establish new law, it is an invaluable reminder for commercial landlords and tenants to carefully negotiate all lease terms, including exclusivity provisions.  Particularly on the tenant side, if a party to a lease is concerned about being “the only game in town” – such as Starbucks being the only tenant selling coffee products at a shopping center – then that party must cautiously negotiate and craft the terms that are ultimately memorialized in the governing lease documents.

The Financial Accounting Standards Board and the International Accounting Standards Board are proposing significant changes to real estate lease accounting. At the prodding of the Securities and Exchange Commission, the Boards are attempting to ensure that the assets and liabilities associated with leases are more accurately reflected on a company’s balance sheet, thereby creating more transparency of financial information and permitting easier comparability of balance sheets.

The Boards’ proposed new regulations would in effect treat all leases as an asset with respect to the use of the leased property for the lease term, and a liability with respect to the obligation to pay rent, thereby eliminating the classification of leases as either operating leases or finance leases.

The following are some of the highlights of the proposal:

  1. Leases with a term greater than one year would be affected.
  2. Rent for the entire lease term due under a lease would be discounted to present value using the tenant’s incremental borrowing rate and would be included on the tenant’s balance sheet as a liability.
  3. A lease with a renewal option would be treated as if the renewal option will be exercised if it is likely that the tenant will exercise the renewal option.
  4. Contingent rental agreements (i.e., percentage rent in a retail lease) would require the tenant to forecast its future sales and include on its balance sheet the percentage rent based on such sales forecast together with minimum rent payable during the lease term.

The effect of the proposed changes could significantly impact the leasing market. Tenants may be inclined to negotiate shorter lease terms (including foregoing renewal options) in order to avoid increasing their debt. Commercial condominiums may gain in popularity as prospective tenants turn to purchasing their space rather than leasing it. Percentage rent deals may disappear altogether as retailers will not want to carry increased debt on their balance sheet based on speculative sales forecasts. Potentially there will be more breached debt covenants on loan documents. Clearly, the balance sheets of companies with hundreds or thousands of lease locations will be adversely affected as their debt levels would increase significantly.

The Boards are still in the process of taking comments on their proposals and will soon resume discussions to develop new standards for landlord accounting. The tentative effective date for the revised accounting standards is the second quarter of 2011. We will continue to monitor the development of the new accounting standards as the comment process unfolds.