Whose Interest is it Anyway?: How the Town of Kearny, N.J. Stumbled on the Condemnation of a Leasehold Interest

Last month, the New Jersey Supreme Court issued an opinion in Town of Kearny v. Discount City of Old Bridge, which refined and further complicated the process of condemning a leasehold interest. The decision also called into question condemnation provisions in existing leases.

The atypical facts in the case likely led to the complex conclusion. The Town of Kearny designated an industrial area as an area in need of redevelopment pursuant to the Local Redevelopment and Housing Law. At least one property owner, who leased its property to various lessees, objected to the designation and subsequent adoption of the redevelopment plan and designation of a redeveloper. Years later, after the original redeveloper dropped out, Kearny designated the complaining landlord as the redeveloper. The landlord then requested that Kearny condemn the leasehold interests on the property so that the landlord could hold the property free and clear of the leasehold interests.

The landlord, acting on behalf of Kearny in the condemnation proceeding, offered one of the tenants $250,000, including $50,000 for relocation costs, for the value of its leasehold. The tenant submitted a counteroffer of $3 million, which was rejected. No appraisals or further negotiations took place.

Kearny moved forward with the condemnation of the tenant’s leasehold interest. The trial court found the condemnation to be valid, among other issues. The Appellate Division affirmed the trial court’s decision, but remanded to the trial court for a finding of what just compensation was due to the tenant.

On remand, the trial analyzed the Condemnation Clause in the tenant’s lease, which stated in relevant part:

If the Complex of which the Premises are a part, or any portion thereof, shall be taken under eminent domain or condemnation proceedings, or if suit or other action shall be instituted for the taking or condemnation, or if in lieu of any formal condemnation proceedings or actions, Landlord shall sell and convey the Premises of any portion thereof, to the governmental or other public authority, agency, body or public utility, seeking to take said land or any portion thereof, then this lease, at the option of the Landlord, shall terminate, and the term hereof shall end as of such date as Landlord shall fix by notice in writing; and Tenant shall have no claim or be entitled to any portion of any amount which may be awarded as damages or paid as the result of such condemnation proceedings or paid as the purchase price for such option, sale or conveyance in lieu of formal condemnation proceedings.

The trial court concluded that the condemnation of the leasehold interest triggered the Condemnation Clause, which terminated the lease and dictated that the tenant was not entitled to any compensation. The Appellate Division affirmed. On appeal to the Supreme Court, the tenant argued that it had been deprived of its property interest without due process of law and just compensation.

As initial matters, the Court confirmed that (1) the tenant was not entitled to notice of the initial designation of the property as in need of redevelopment; and (2) leasehold interests can be condemned “separate and apart from, and without condemnation of, the fee simple.” With those rulings as the backdrop, the Court tackled whether the condemnation process was proper and whether the tenant was entitled to compensation under the lease.

The Court noted that “where a fee simple is being condemned, negotiations will take place with the fee owner alone,” but found that “it is obvious that where the fee is not at issue, the holder of the interest that is actually at stake is the party with whom negotiations must take place.” Because, among other things, the landlord failed to undertake the required appraisals and to make an appropriate offer of just compensation, the negotiations were fatally flawed and violated the bona fide negotiation requirements set forth in N.J.S.A. 20:3-6.

The failure to enter into bona fide negotiations was sufficient to invalidate the condemnation; however, the Court also evaluated whether the Condemnation Clause of the lease relieved the landlord and the Town from having to compensate the tenant. The Court determined that because the clause could work a forfeiture on the tenant, it should be strictly construed. Thus, “unless the clause [was] crystal clear, forfeiture should not occur.”

The Court interpreted the Condemnation Clause as depriving only the tenant of compensation upon condemnation of the fee. Because Kearny was only seeking to condemn the leasehold interest, the Court determined that the tenant was entitled to compensation.

Justice LaVecchia, joined by Justice Rivera-Soto and Judge Stern (t/a), filed a dissenting opinion, stating that the majority took an “unduly narrow interpretation” of the Condemnation Clause of the lease and that no portion of the fee was required to be condemned for the Clause to result in a forfeiture of tenant’s interest. In short, whether a condemnation touched a physical portion of the fee or a portion of any property interest in the fee (e.g., a leasehold interest), it triggered the Condemnation Clause. The parties negotiated the lease in an arms length transaction, and, therefore, should have known the terms to which they were agreeing.

Furthermore, the dissenting justices thought that the majority had elevated form over substance in this case. Both sides acknowledged that if Kearny had condemned the entire fee and then conveyed it back to the landlord, the lease would have been terminated, and the tenant would not have been entitled to compensation.

There are several items to take away from this case. First, leasehold interests undoubtedly can be condemned separate and apart from fee interests. Second, when the fee interest is not being condemned, a condemning authority must follow all of the statutory requirements for bona fide negotiations with the impacted tenant. Finally, tenants and landlords should review their existing condemnation clauses, with a focus on the nuances of the clause, which could determine whether a tenant receives a condemnation award or not.