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McDonald’s at key Prospect Heights site won preliminary ruling in battle against landlord, which seeks to upzone site for large, mostly residential building

A potential brake on the percolating plan for an upzoning to enable a large, mostly residential building at the southeast corner of Atlantic and Vanderbilt avenues—opposite the Atlantic Yards/Pacific Park site—is that McDonald’s, which runs the drive-through restaurant at the site, has sued its landlord, the entity seeking the upzoning. 

(Stay tuned for more coverage of that upzoning plan, which first surfaced in August 2019.)

So far, McDonald’s has won a first skirmish—though such cases, I suspect, more likely end in settlement rather than go through the full legal battles.

As I reported 12/2/19, while McDonald’s had an option to extend its lease for 20 years in 2019, it claimed the landlord proposed an unfairly high rent, based on a misreading of the value, in an effort to eject the restaurant.

It went to court, seeking a judgment that landlord Vanderbilt Atlantic Holdings had not cooperated in good faith with the dispute resolution procedure eegarding the rent.

After multiple volleys in court, U.S. District Judge Dora Irizarry ruled 9/30/20 against the landlord, which had sought to compel arbitration of the claims and to dismiss or stay the action pending arbitration. (See decision at bottom.) That doesn't resolve the dispute, though.

The background

As the judge summarized the case, McDonald's original lease with Anthony Musto was signed 3/18/98, with a 20-year lease term starting 4/9/99 and with rent re-setting every five years. (That, of course, was a different generation in Prospect Heights and Brooklyn, before the real-estate market took off. and before Atlantic Yards was announced in December 2003.) 

The rent in the last five-year period was $13,941.00 per month, according to the original complaint.

Before the end of the original 20-year term, Vanderbilt Atlantic Holdings on 11/30/17 took over as landlord, after paying a seeming $7 million for a 99-year lease. (The full contours of the transaction, which apparently includes Musto and other partners, remain unclear.)

The dispute concerned rent calculation for the automatic extension, which began 4/9/19. McDonald’s was to pay $16,032.58 monthly, representing another increase of 15%, or a higher rent: 80% of the newly-assessed fair market value (“FMV”) of the premises as of 4/8/19. After that, the rent would increase 15% every five years.

Initially, apparently without an appraisal, the landlord set FMV at $65,000 per month, based on a FMV of $975,000, with annual rent totaling $780,000, or 80%, according to the complaint.

McDonald’s didn't agree with that valuation and pursued an appraisal process set forth in the lease. The landlord's appraiser assessed an even higher valuation, resulting in rent of $89,867/month--a 545% increase--while the tenant's appraiser contended it was worth $23,333.33/month.

But before proceeding to a third appraiser, as established in the lease, McDonald’s went to court, arguing that Vanderbilt Atlantic Holdings had not acted in good faith, failing to use the appropriate methods or to let the parties’ appraisers work with a third appraiser.Vanderbilt Atlantic, which has said McDonald's appraiser used inappropriate comparables, argued that the case should go to mandatory arbitration.

The judge’s conclusion

McDonald’s, wrote the judge, “maintains that the parties’ arbitration clause is narrow and grants the appraisers the authority only to appraise the value of the property,” while the landlord had argued that arbitration addressed all disputes regarding the renewal. 

The judge agreed with the plaintiff, McDonald's.

Judge Irizarry also noted, “As the arbitration clause does not encompass Plaintiff’s claims regarding the Defendant’s lack of good faith in the appraisal process and the role of the third appraiser, Defendant’s motion to compel arbitration and to dismiss or stay the action pending arbitration is denied.”

Next steps

Vanderbilt Atlantic has filed an appeal, and also continued to argue its case in court, saying that the tenant’s appraiser “used inferior sites.”

One interesting line from a defense motion: “Instead, in an effort to extract nuisance value and prevent Vanderbilt Atlantic from realizing the market value of the property, McDonald’s commenced this action.”

Surely the market value of the property is constrained not by the appraisal issue but by the low-rise manufacturing zoning, which could be replaced by a rezoning that allows a high-rise building with residential and other space.

According to a legal filing, the parties have set up a schedule for discovery—the pre-trial procedure of obtaining evidence—that ends next August, the same month that depositions of experts should be finished.

Meanwhile, a settlement conference will be held by phone on 2/3/21. That sets up the possibility that the full legal jousting will be averted by a mutual agreement.

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