Lawyers for Edgewood Shopping Center developer Sand Hill Property Company and the City of Palo Alto went head to head on Monday before an independent judicial magistrate over whether the city has any right to fine the company for failing to maintain an operating grocery store at the historic retail center located at 2125 St. Francis Drive.
The city has been ratcheting up the fines since September 2015 after the company did not replace the departing grocer The Fresh Market after the grocery chain pulled out of the shopping center in March 2015. Sand Hill received a Planned Community zoning approval from the city, which included building 10 homes on the commercial property in exchange for certain "public benefits," the centerpiece of which is maintaining a local grocery store as the anchor enterprise.
Developer John Tze said the company grossed about $30 million from the sale of the homes, which sold for about $3 million each. The company was not able to build and sell the homes until a grocer was signed to lease the property and the store was operational.
The Fresh Market opened to great fanfare in the renovated center in June 2013. But one year and nine months later it abruptly closed on March 31, 2015, after the company, which is based on the East Coast, decided to pull out of the California market and retreated back to its southern and Midwestern turf.
Since then, Tze said his company, along with commercial realtor Cushman & Wakefield, have reached out to between 65 and 70 prospective grocers to fill the space. Although they have come close to finding a sub-lessee, a couple of times (Andronico's and Lucky Supermarkets) all of the prospects have failed.
Sand Hill says its hands are tied; Fresh Market holds a 10-year lease and calls the shots regarding who can sublease the property and at what price. The company has not been willing to relinquish the lease, Tze said.
Meanwhile, Sand Hill continues to receive about $33,000 a month from Fresh Market for the lease. Frustrated community groups said they felt the developer has not done enough to put a new grocer in the spot. Sand Hill is in violation of its PC zoning ordinance, they said. Residents pushed the city to fine Sand Hill for violating the terms of its zoning ordinance, which, the city said, requires that Sand Hill have an operating grocer on the site as a public benefit.
On Sept. 30, 2015, the City Council began fining the developer $500 a day under municipal code for violating a zoning law; that sum rose to $1,000 a day starting in October 2015. The council voted to raise the fine again in November to $2,500 per day with the possibility of doubling the fine to $5,000 daily if a grocery store is not operational soon.
So far, the company has paid $630,500 in fines; additional fines have been stayed by the city until after Administrative Officer Lance Bayer determines what, if any, fines are appropriate for Sand Hill to pay.
Sand Hill attorneys David Lanferman and Alyssa Bussey said the company should not have to pay any fines, and if it does, the current fines are excessive. Lawyers said the fines are unconstitutional because they require the developer to go beyond land use and require the developer to maintain an operation.
Bayer said ruling on constitutional grounds goes beyond the scope of the hearing. He found there was enough evidence for the hearing to move forward. His rulings would be confined to the violation and the amount of the penalty.
The Sand Hill attorneys argued that the zoning ordinance requires the developer to only provide the building for grocery use, but it does not provide any provision stating that the developer has an ongoing obligation in perpetuity to provide an operator at the grocery store.
"The land uses in the ordinance call for and anticipate a public benefit providing a grocery store use. There can be no dispute of facts that Sand Hill has done that," Lanferman said. "The city implies a guarantee for the operation."
The city is trying to enforce "an illusory condition," he added.
But Terence Howzell, an attorney for the city, noted that the revised zoning ordinance, which was put in place in November 2013 after Sand Hill erroneously demolished one of the historic Eichler buildings it was supposed to restore, says, "The commercial property owner shall ensure the continued use of the 20,600-square-foot building as a grocery store for the life of the project."
Bayer seemed to agree with that interpretation, noting the clause's "shall ensure" language.
Pressed by Bayer about whether he was aware of that clause, Tze said he had not read the draft revised zoning ordinance prior to the City Council's hearing and approval.
"I didn't recall if it was made available to me as a draft -- I just don't recall," he said.
He said that although he has paid the fines for a year, he did not dispute them initially because he was trying to cultivate a good relationship with the city for potential new projects and he did not want an adversarial relationship to develop.
He said he never viewed the payments as a concession to the violations.
The city's attorney, Howzell, attempted to chip away at Sand Hill's claims of its "good faith" efforts to find a grocer. He maintained that Sand Hill didn't care about the fines as long as they were covered by the monthly rent the developer receives from Fresh Market, but now that the daily fine exceeds that amount, the developer is paying attention.
He pointed out that Tze knew as early as 2005 or 2006 that there would be challenges to get a grocery tenant to stick, based on the site's past history. Tze admitted he knew the site's location and configuration put it at a disadvantage.
Bayer said he was concerned about a 10-year-lease that allowed the developer to continue to receive payments. In deciding if the penalties are reasonable, he has to balance the continued flow of money to the developer with the proportionality of the fines.
"I do believe it can be imposed on a daily basis and it can probably be increased," he said. "Is there a reason why the city should not receive a substantial portion of what Mr. Tze receives?"
He asked both sides to come back with compelling cases for how an appropriate penalty will get to bringing about a grocery store or how to utilize the funds in a way to expedite getting a store.
Tze said the retail grocery store industry is in a tough spot.
"We've even recently seen stores like Whole Foods closing down locations. Contributing to this issue are the fact that retail grocery stores operate on low margins, and the fact that grocery delivery is becoming more and more popular." Edgewood's grocery space is difficult to lease largely because its 20,600-square-foot size is too small for big chains, and too big for most smaller operators.
The Fresh Market is currently drafting a sublease for a new operator for the space; Sand Hill is doing everything it can, including providing more than $300,000 in financing for the new potential operator and the developer is talking with a farmers market to operate in the parking lot one day each week until a grocery store is operational in that space, he said.
The hearing was continued for final arguments on March 6 at 9:30 a.m. in the City Council Chambers, 250 Hamilton Ave.