Judge refuses to dismiss claim by McDonald's that landlord at 840 Atlantic Ave. acted in bad faith. Will developer of tower at site raise buyout offer?

A developer in September 2021 got City Council rezoning approval for an 18-story building at the southeast corner of Atlantic and Vanderbilt avenues, largely occupied by a long-running drive-through McDonald's.

But plans to develop 840 Atlantic have hit a setback--or maybe have just become more costly--as a federal judge has sided (opinion at bottom) with the fast-food tenant in a preliminary ruling in its legal battle with landlord/developer Vanderbilt Atlantic Holdings (VAH).

The delay in 840 Atlantic has nothing to do with the advisability of constructing a denser building at a key crossroads, one that, upon the entry of McDonald's in 1999, was not ripe for development. 

(It's directly across the street from the eastern boundary of the Atlantic Yards/Pacific Park project, announced in December 2003, though that parcel, known as B10, remains unbuilt and requires an expensive platform over the railyard below. Meanwhile, in the past decade, landlords and developers have explored developing parcels east of Vanderbilt Avenue shackled by outdated manufacturing zoning, getting spot rezonings and a pending area rezoning.)

Rather, it has to do with the price of getting McDonald's to leave, which has likely just gotten higher.

Instead of getting summary judgment on its claims, VAH now must appeal the decision or go to a full trial, despite what U.S. District Judge Dora Irizarry called "credibility concerns" in the landlord's conduct. Or VAH must increase whatever offer it may have made to evict McDonald's. 

Another factor: the expiration of the 421-a tax break. While VAH likely qualified the site for 421-a benefits thanks to preliminary foundation work in a parcel within the site but beyond McDonald's, buildings must be completed by June 15, 2026, unless an extension--as Gov. Kathy Hochul proposed, unsuccessfully, earlier this year--is granted by the state Legislature.

Case background

The case began in November 2019, when McDonald's filed suit, claiming that VAH failed to cooperate in good faith in setting the new rent for its tenant, as required by their lease. McDonald's contended the increase should be modest, while VAH--despite the constrains of zoning, which as of then did not allow high-rise development--requested a sharp increase.

The difference in rent was enormous: from about $16,000 or $23,333 to $90,000 a month.

While VAH moved to dismiss the action and compel arbitration, that was denied by the judge and affirmed on appeal. Then VAH not only responded to its tenant's complaint but sought a judgement that McDonald's failed to cooperate. That was denied.

The history

As summarized in the decision, McDonald's and landlord Anthony Musto signed a lease for 20 years, beginning 4/9/99, with the tenant having the right to up to four five-year extensions. On 11/30/17, Musto's M.M.B. Associates entered into a 99-year ground lease with VAH, which then became the restaurant's landlord.

Under an Option Rent Addendum (ORA), which governs how rent is set, McDonald's was to pay either an annual rent of $192,391, or an annual rent equal to 80% of the Fair Market Rental Value (FMV) of the property 

The two parties couldn't agree on rent, so the ORA’s dispute resolution process began, in which each party appoints an appraiser. If the two appraisals are within 15% of each other, then they can be averaged. If not, the two appraisers are supposed to appoint a third appraiser.

If either party “fails to cooperate" in that process, then the opposite party's appraiser prevails.

Fair market questions

So what's Fair Market Rental Value? It depends on the uses to which the property can be put and requires "standard market data" based on comparable leases. But if the latter aren't available, the appraiser should use a "land residual technique," which considers the income associated with hypothetical improvements.

While the McDonald's appraiser, Sharon Locatell, estimated an FMV of $350,000, the VAH appraiser, Thomas Tener, estimated $1,348,000. 

But the parties did not appoint the third appraiser, Mark Nakleh, "as they could not agree on the propriety of the methods Tener and Locatell had used for calculating the FMV or on the process for involving Nakleh," according to the judge's summary.

McDonald's argued that Tener's initial estimate was improperly prepared because, he didn't consider the constraints on the property, notably the restaurant's right to continue in its lease. Also, the plaintiff argued that Tener's analysis compared the property with sales of comparable properties, rather than rental data.

As noted by the judge, the parties dispute whether VAH wrongly instructed Tener to use the sales comparison analysis. 

Curiously enough, when Tener redid his analysis using a different formula, the property’s FMV remained unchanged, thus justifying the same high rent.

"Plaintiff argues, and Defendant disputes, that Defendant had motivation to retain the high FMV estimate that Tener had reached originally," wrote the judge. "This alleged motivation bears on whether Defendant undertook the ORA dispute resolution process in good faith."

McDonald's points out that, under the 2017 Ground Lease between Musto's M.M.B. and VAH, the latter must pay M.M.B. all the restaurant's rent, providing a major incentive for VAH to evict the tenant, start building, and finally reap revenue.

Issues in dispute

McDonald's argued that Tener's final estimate, provided in September 2019,, still wasn't compliant with the ORA. Nor could they agree on hiring the third appraiser.

Then McDonald's went to court. As the judge notes, summary judgment is appropriate only when there's no genuine dispute--and there is one.

While VAH argues that its posture with Tener regarding his initial FMV estimate does not constitute a failure to cooperate, McDonald's, according to the judge, has compiled evidence "from which a reasonable fact finder could conclude that Tener, at Defendant’s direction" misapplied legal guidance, "constituting a failure to cooperate in good faith."

Also, according to the judge, testimony from the plaintiff’s expert "raises a triable issue as to the credibility of Tener’s Final FMV Estimate as the expert opined that the internal inconsistencies throughout Tener’s analysis could indicate a failure to undertake proper analyses as opposed to mere differences in opinions."

Did Tener’s failure to consider the VAH/M.M.B. Ground Lease constitute a failure to cooperate? The record, according to the judge, "is replete with material factual disputes." For example, there's evidence that VAH initially rejected requests from Tener seeking copies of its lease with M.M.B.

So it's "a triable issue of fact as to whether Tener’s noncompliant analyses resulted from intentional efforts to manipulate a result as opposed to a mere difference of opinion," according to the judge.

"Significantly, Plaintiff also has put forth evidence creating a triable issue of fact as to whether Defendant intentionally refrained from informing Plaintiff that it would have Tener rework his FMV estimate in accordance with the guidelines and law until it could confirm that Tener’s final FMV estimate would remain the same, or at least not decrease in value," the judge wrote.

Also in dispute are questions over the process appointing the third appraiser.