At a time when the locations of key data centers wield immense influence, two global data center titans, Equinix (NASDAQ: EQIX) and Digital Realty (NYSE: DLR), found themselves entangled in a protracted legal battle lasting more than four years. These companies have been tightly intertwined for decades, with Equinix at times leasing more than 25 data center locations from Digital Realty. However, their once symbiotic relationship began showing signs of strain following a disagreement over lease terms in Chicago, leading to a legal conflict that has the potential to redefine the competitive dynamics of these two industry heavyweights.
The heart of the dispute lies at 350 East Cermak Road in the South Loop neighborhood of Chicago, Illinois. This 1.1 million-square-foot, 9-story data center is owned by Digital Realty but heavily occupied by Equinix. The building is especially attractive to high-value colocation customers due to its interconnected ecosystem, which provides connections to hundreds of network providers, making it one of the most important “carrier hotels” in all of the United States.
However, tensions escalated between Equinix and Digital Realty when a significant space on the building’s third floor became vacant, leading Equinix to file a lawsuit in February 2019, which was litigated until April 2023. But this feud extends beyond a simple lease disagreement. It underscores the broader relationship between the two companies across numerous data centers, encompassing commitments totaling over $500 million in rent. Although the lawsuit has only recently ended, the strained relationship between Equinix and Digital Realty could impact how these two giants compete in the years to come.
Background of Data Center Operations: Equinix and Digital Realty
Equinix operates a global network of 248 data centers, which comprises 346,100 cabinets of power capacity across 29.4 million square feet. On the other hand, Digital Realty manages an even larger network of 314 data centers, providing 2,352 megawatts of IT load capacity in white space and 38.8 million net rentable square feet.
Equinix’s operating model involves leasing large spaces from wholesale data center operators, such as Digital Realty. Equinix then subdivides these extensive areas, providing smaller, retail colocation services to its customers through short-term licenses. These services offer the necessary space, power, cooling, physical security, and connectivity for customers to operate and interconnect their IT equipment. Of significant note is the fact that many of Equinix’s colocation data centers enable businesses to connect to a variety of network service providers, reducing cost and complexity.
Leasing Relationship Between Equinix and Digital Realty
Equinix, while owning some data centers, often leases facilities on a wholesale basis from companies such as Digital Realty. For instance, at the 350 East Cermak Road location in Chicago, the building is owned by Digital Realty, but Equinix leases suites on multiple floors for its data center operations.
Equinix and Digital Realty share a substantial relationship. At present, Equinix leases space at 17 locations owned by Digital Realty. The total annualized contractual base rent paid by Equinix to Digital Realty amounts to $88.0 million, and the average remaining lease term is 6.7 years. This rental revenue contributes to 2.3% of Digital Realty’s total recurring revenue.
However, as illustrated in the chart below, the economic relationship between Equinix and Digital Realty reached its peak at the end of 2020. During that period, Equinix leased space at 26 locations owned by Digital Realty – 9 more locations than today. Equinix paid an annualized contractual base rent of $94.3 million – equivalent to $6.3 million or 7% more than today. Finally, Equinix’s average remaining lease term was 8.4 years during that time – 1.7 years longer than today.
Equinix and Digital Realty’s Tenant-Landlord Relationship: 2014 to Present
Equinix’s Tenancy and Expansion at 350 East Cermak Road
Since its initial occupancy in September 1999, Equinix has been a significant tenant at the 350 East Cermak Road building in Chicago, leasing space from Digital Realty. The company began with a 140,000 square foot lease on the fifth floor. Over the next decade, Equinix expanded their footprint by subleasing an additional 107,299 square feet on the sixth floor in July 2005 and leasing from Digital Realty a further 19,400 square feet on the eighth floor in July 2009. Notably, all of Equinix’s leases in this building have been extended over time.
Equinix then sub-licenses parts of the fifth, sixth, and eighth floors to its own customers. The company currently manages three colocation data centers within the building: CH1, CH2, and CH4. These facilities occupy a combined total of nearly 133,500 square feet of colocation space. Overall, Equinix maintains a substantial presence within Digital Realty’s property at 350 East Cermak Road, with leases spanning multiple suites on several floors.
Equinix’s Interconnected Ecosystem and Importance of 350 East Cermak Road
The 350 East Cermak Road building, and especially Equinix’s area within it, holds a significant appeal for high-value colocation customers from diverse sectors like carrier, financial services, banking, content providers, network, cloud computing, and enterprise industries.
Equinix’s ability to host these users in close proximity to each other amplifies the appeal of its space. This proximity substantially enhances the value of any connected space within the building that is part of Equinix’s colocation “ecosystem”. Equinix’s leased area within the building is usually fully occupied by colocation users desiring to be part of this interconnected ecosystem.
To provide some context, Equinix’s colocation facility at 350 East Cermak Road offers connectivity to over 195 network providers and more than 300 total participants, making it the most ‘dense’ carrier hotel in the Chicago data center market. This term ‘dense’ refers to the high concentration of network providers and connections in a single location.
Prelude to Lawsuit Between Equinix and Digital Realty
The legal dispute between Equinix and Digital Realty was centered around a Right of First Offer (ROFO) clause in their lease agreement for premises at 350 East Cermak Road in Chicago, Illinois. This clause granted Equinix the option to expand its leased space within the building whenever any additional space became “available for lease”. As per the clause, Digital Realty was obligated to inform Equinix about such opportunities as and when they became available. The underlying purpose of the ROFO clause was to facilitate Equinix’s growth in its colocation business within the 350 East Cermak Road building.
A significant development leading up to the legal dispute took place in June 2018 when a large space on the third floor of the 350 East Cermak Road building became vacant. In this space-constrained building, the third floor uniquely connected to Equinix’s existing occupancy on the fifth, sixth, and eighth floors.
This vacancy offered a prime opportunity for Equinix to expand its operations within the building. This third floor space provided a sizable contiguous area ideally suited for Equinix’s expansion plans, unmatched in size and cohesiveness by any other space within the building.
Disagreement over Lease Conditions – Trigger for the Legal Conflict
However, failure to execute a lease amendment led Digital Realty to issue a Right of First Offer (ROFO) notice to Equinix in January 2019 for the third floor space. Digital Realty classified the space as “improved” and “landlord-managed”, stipulating it was available for lease at a rate of $200 per kW per month. Equinix, on the other hand, disputed this rate and the classification of the space in a response letter. They insisted that the space was “unimproved” and “non-landlord managed”, and therefore, should be leased at the same rate per square foot as their current powered shell lease on the sixth floor of the 350 East Cermak Road building.
In its view, Equinix had decided to lease the third floor space, but proposed a different lease rate and additional conditions. Whereas Digital Realty interpreted Equinix’s response as a counteroffer with modified terms and conditions. Consequently, Digital Realty rejected it in a letter sent in early February 2019, claiming that the ROFO acceptance period had elapsed. Digital Realty’s refusal to acknowledge Equinix’s decision set off the ensuing legal conflict, with Equinix filing a complaint in late February 2019.
Equinix Commits $500m for Extended Leases at Digital Realty’s Data Centers
The legal dispute between Equinix and Digital Realty wasn’t simply about lease conditions at 350 East Cermak Road in Chicago, Illinois. It was more complex. Equinix argued that the Right of First Offer (ROFO), coupled with similar ROFOs in various other leases for different data centers leased from Digital Realty throughout the U.S., prompted them to prolong their lease terms and commit to paying Digital Realty more than $500 million in rent throughout those extensions.
To elaborate, Equinix not only increased its lease commitment to Digital Realty for space within the 350 East Cermak Road building but also at several other data centers leased from Digital Realty. These locations included Dallas, Texas (2323 Bryan Street); Los Angeles, California (600 West 7th Street); and Miami, Florida (36 North East Second Street). In these data centers, Equinix was also granted similar ongoing ROFO rights.
Therefore, the ROFO rights at 350 East Cermak Road and at the various other Digital Realty-owned data centers nationwide served as significant incentives for Equinix to pay more rent and extend their leases.
To fully grasp the intricacies of the Equinix and Digital Realty dispute, we need to journey several years into the past. In the following sections, we will trace the conflict’s origins and evolution, examining the events that led to this legal standoff. This exploration will highlight both companies’ motivations, providing insight into this prolonged legal struggle. Let’s rewind the clock now.
Backstory to Lawsuit between Equinix and Digital Realty
Before filing the lawsuit in February 2019, Equinix and Digital Realty conducted extensive analysis and negotiations over the third floor space at 350 East Cermak Road.
History and Evolution of the Third Floor Space
The third floor’s infrastructure was initially constructed in 1999 by a tenant who subsequently went out of business. Digital Realty, the owner of the space and infrastructure, then leased it to Fidelity National Information Services (FIS) and Computer Sciences Corporation (CSC), now known as DXC Technology. Rather than managing the third floor as a turn-key data center, Digital Realty allowed FIS and CSC to share and co-manage the infrastructure. These co-tenants were responsible for the necessary maintenance, testing, servicing, and repair of the infrastructure.
Starting in 2003, FIS utilized the north suite of the third floor as a data center, while CSC operated its data center in a neighboring suite, occupying the remainder of the third floor.
Throughout their tenure, neither FIS nor CSC significantly upgraded the original infrastructure, which had been installed in 1999. According to Equinix, by the end of FIS’ occupancy, the equipment had reached, or even exceeded, its useful life. It was obsolete and unsuitable for a modern data center and would need to be demolished. Modern colocation data center customers demand extremely reliable and secure operations. To Equinix, the outdated equipment used by FIS presented an unacceptable risk of failure and business interruption.
2014 – Lease Negotiations Between Equinix and Digital Realty
In August 2014, Equinix secured a Right of First Offer (ROFO) clause from Digital Realty in their lease agreement for the building at 350 East Cermak Road in Chicago, Illinois. At this time, Digital Realty’s primary business was leasing wholesale space to retail colocation providers such as Equinix and other large users. Equinix was leasing space on the fifth, sixth, and eighth floors of this building.
The types of spaces leased were reflective of the two kinds of lease agreements Equinix held in the building when the ROFO clause was introduced:
- Unimproved and Non-Landlord Managed: For the fifth and sixth floors, Equinix was responsible for carrying out the necessary improvements to make the space suitable for a data center, meeting the demands of its colocation business. Here, Equinix was both the owner and the manager of the infrastructure it deployed. As such, the space on these floors was leased from Digital Realty as unimproved and non-landlord managed
- Improved and Landlord-Managed: Conversely, for the eighth floor, a turn-key lease agreement was established. Under this agreement, Digital Realty was responsible for developing the infrastructure according to the specifications mutually agreed upon with Equinix, and also managing that infrastructure as a turn-key data center. Hence, the eighth floor was leased as an improved and landlord-managed space
In August 2014, Glenn Benoist and Bryan Marsh, former Vice Presidents of Digital Realty’s Portfolio Management Group, were primarily accountable for the leasing operations at the 350 East Cermak Road building. They reported directly to Jeff Tapley, then a Senior Vice President at Digital Realty, who also held a significant role in the leasing process.
Extensive negotiations were held between Tapley and officers from Equinix, including discussions about the broader lease agreement and the space on the third floor. These Equinix representatives included Stuart Thompson, the former Director of Real Estate for the Americas, Howard Horowitz, the former Vice President of Real Estate and Senior Vice President of Global Real Estate, and Mark Adams, the former Chief Development Officer.
2015 – Digital Realty’s Strategic Expansion into Retail Colocation
Digital Realty, known for its primary business strategy of leasing wholesale space to colocation providers such as Equinix, underwent a significant expansion and transformation after acquiring Telx for approximately $1.9 billion in October 2015. Telx, which provided retail colocation services mirroring those of Equinix, consequently positioned Digital Realty as a direct competitor to Equinix’s retail colocation business.
Following this acquisition, Digital Realty began diverting space in its data centers to Telx, to bolster its new retail colocation business and reduce competition, including within the 350 East Cermak Road building. In essence, Digital Realty’s venture into retail colocation created an impetus for the company to reserve space within the 350 East Cermak Road facility, among others, for its own operations.
2016 – Equinix is Bypassed on the First Floor and Negotiates for the Third Floor
Before their disagreement over the third floor space, Equinix pointed out an alleged instance where Digital Realty began diverting space within its data centers to Telx on the first floor of the 350 East Cermak Road building.
Equinix Accuses Digital Realty of Bypassing ROFO on the First Floor Space
In June 2016, four suites on the first floor, specifically Suites S120A, S120B, S120C, and S130D, were collectively identified in a Right of First Offer (ROFO) notice to Equinix. In this ROFO notice for the first floor space, Digital Realty declared its intention to allow an existing third-party tenant to assign its tenancy to an affiliate of Digital Realty, named Digital Lakeside 2, LLC. This affiliate was expected to utilize part of the first floor space.
Digital Realty then produced a colocation license agreement between two of its subsidiaries, Digital Lakeside 2, LLC and Telx-Chicago Lakeside, LLC, a colocation entity, for a portion of the space. The tenant in place, Digital Lakeside 2, subleased the space to Telx, thereby becoming a sub-tenant. Said differently, Digital Realty had one of its affiliates take over excess space relinquished by an existing third-party tenant.
Equinix argued that Digital Realty, in an attempt to bypass Equinix’s ROFO rights, elected to offer the space as subleases rather than direct leases. Digital Realty, on the other hand, retorted that Equinix voluntarily chose not to lease certain suites on the first floor. Furthermore, they claimed that Equinix failed to respond to the ROFO notice within the stipulated 12-business-day acceptance period outlined in the ROFO rights. It was only after this period, and once Equinix chose not to exercise its ROFO, that Digital Realty leased the space to its affiliate.
Digital Realty Begins Negotiations with Equinix on the Third Floor Space
Separately, in December 2016, Digital Realty informed Equinix that their tenant, Fidelity National Information Services (FIS), who was occupying a portion of the third floor of the 350 East Cermak Road building, would be vacating the space when their lease ended on June 30, 2018. Anticipating this vacancy, Digital Realty initiated negotiations with Equinix to potentially lease all or part of the vacating third floor space.
2017 – Digital Realty and Equinix Assess and Negotiate for Third Floor Space
In 2017, Digital Realty and Equinix negotiated leasing terms and redevelopment strategies for the third floor space in the 350 East Cermak Road building.
Digital Realty’s Report Reveals Upgrades Needed to Third Floor Space
In March 2017, representatives from Equinix and Digital Realty toured the third floor space. In the subsequent month, a director from Digital Realty’s design group, supported by colleagues from the company’s asset, tech operations, design & construction, property operations, and sales engineering teams, prepared an internal “Property Condition Report.” This document, dated April 10, 2017, evaluated the potential for reusing the existing infrastructure that the current tenant, Fidelity National Information Services (FIS), was operating in the third floor space.
The Property Condition Report revealed that all of the mechanical equipment had reached the end of its useful life and required replacement. Additionally, the data center’s distribution piping also needed replacing, the electrical equipment was antiquated, the power density of the space was very low, and the layout of the white space was inefficient.
The internal report continued that if Digital Realty decided to reclaim the space, significant time and money would be necessary to make it suitable for use or re-lease. This process would involve the architectural demolition of walls, floors, and ceilings, along with a complete reconfiguration of the space to optimize its use.
The report concluded that it was reasonable to assume that Equinix would hold a similar viewpoint. As such, Equinix claims that Digital Realty, through this report, acknowledged that the existing FIS equipment was unsuitable for the operation of a colocation data center and instead fulfilled the role of an enterprise data center for FIS’ own use.
Digital Realty Commissions Feasibility Study for Third Floor Redevelopment
Given the outdated state of the third floor infrastructure, Digital Realty hired an external engineering consultant named exp to develop an Analysis and Feasibility Study on the space. This study detailed the proposed improvements necessary to transform the third floor space into a functional data center. In October 2017, Digital Realty provided a copy of this feasibility study to Equinix.
The study by exp proposed several potential redevelopment options for the third floor space. Following this study’s recommendations and its own internal analysis, Digital Realty budgeted costs for each redevelopment option. One of these options, which would convert the space into a turn-key data center, was estimated to require a capital investment of $33.53 million.
Digital Realty’s Lease Proposals to Equinix for the Third Floor Space
On October 13, 2017, Digital Realty made a strategic decision to extend lease proposals to Equinix for the third floor space instead of sending them a Right of First Offer (ROFO) notice. They presented several proposals via email on the same day.
In one proposal, Digital Realty offered to undertake a comprehensive redevelopment of the entire third floor space, transforming it into a turn-key data center capable of providing 6,600 kilowatts (kW) of total power. This redevelopment would involve investing tens of millions of dollars into infrastructure upgrades and new equipment, all borne by Digital Realty. Following the redevelopment, Digital Realty would manage the facility and its equipment and lease the upgraded third floor space to Equinix.
In a contrasting proposal, Digital Realty offered Equinix the opportunity to redevelop and manage the third floor space at its own expense. Here, the space would be leased to Equinix as “unimproved” and “non-landlord managed”, as opposed to the “improved” and “landlord-managed” offer presented in the first proposal by Digital Realty.
Equinix’s Counterproposal for the Lease and Redevelopment of the Third Floor Space
On December 20, 2017, Equinix conducted a tour of the operational Fidelity National Information Services (FIS) data center located on the third floor, inventoried the equipment on site, and estimated its value.
On the same day, Equinix made a counterproposal for a potential lease of the third floor space, conveyed through its broker Cushman & Wakefield. This counterproposal was influenced by exp’s feasibility study, site visits, and Equinix’s own engineering and budget assessments.
Equinix’s counterproposal included a draft term sheet, a layout of how Equinix would redevelop the third floor space into a 4,000-kilowatt (kW) data center, and a spreadsheet indicating that the depreciated value of the existing FIS equipment was minimal.
Equinix declared that the current premises, being over 17 years old, was past its useful life. The company planned to demolish the entire space and start from scratch. They anticipated the cost of the redevelopment project to be approximately $28 million.
Equinix’s counterproposal offered to lease the third floor space at a reduced gross rent, as compared to Digital Realty’s earlier offer in October 2017. This counterproposal from Equinix based the rent calculation to be equivalent to the triple net rent per square foot, with added estimated operating expenses and property taxes.
In response to Digital Realty’s assertion during negotiations that the existing FIS equipment held some residual value, the counterproposal also suggested a minor “infrastructure rent” per square foot, calculated based on the depreciated value of the current equipment.
Discovery Process Uncovers Digital Realty’s Lease Negotiations with Equinix
Based on evidence that Equinix later revealed during the discovery process, it was disclosed that Digital Realty executives understood that “leasing the space to Equinix at a lower price meant Equinix would pay for the improvements, and leasing at a higher price meant Digital would pay for the improvements”. As such, Equinix was proposed with two options:
- $200 per kW per month with Digital Realty being “responsible for buildout” and “operations”
- $145 per kW per month with Equinix responsible for buildout, reduced to $135 per kW per month if Equinix also operated the space
It was also revealed in emails from Digital Realty’s Jeff Tapley that he stated “put together an LOS to get approval” of a deal leasing the third floor space to Equinix at a rate of $125 per kW per month for which “Equinix does all of work to upgrade space”.
2018 – Internal Dissent and Competitive Tensions Influence the Leasing Deal
In 2018, internal opposition at Digital Realty impacted the lease negotiations with Equinix over the third floor space in the 350 East Cermak Road building, leading to an eventual breakdown in negotiations.
Internal Opposition Alters Equinix and Digital Realty’s Lease Negotiations
In January 2018, senior executives from Equinix and Digital Realty convened at Digital Realty’s San Francisco, California offices to negotiate over potential lease terms for the third floor space in the 350 East Cermak Road building. Following this meeting, Digital Realty sent a revised version of Equinix’s preliminary lease agreement to Equinix. This updated draft proposed to lease the third floor space to Equinix “as is” – essentially as a powered shell – and it omitted any reference to infrastructure rent.
During January and February 2018, Digital Realty’s sales team and analysts involved with the colocation business, formerly Telx, learned about the potential lease agreement with Equinix for the third floor space. Several of those team members expressed their objections to the deal, citing concerns about enabling Digital Realty’s largest competitor and consuming crucial inventory that Digital Realty could otherwise utilize to expand its recently-acquired colocation business, Telx.
Equinix claims that due to this internal opposition, Digital Realty’s Jeff Tapley “re-traded” and modified the proposed lease terms on February 27, 2018. Specifically, Digital Realty reduced by about half, the amount of the third floor space they were prepared to lease to Equinix. The space was still offered as unimproved and non-landlord managed, but at an even lower $ per kW per month rate.
Digital Realty’s intention was to keep the remaining half of the third floor space for its own colocation business or to lease it out to other “scale” customers. Allegedly, Digital Realty’s colocation group wanted the space, in part, to prevent Equinix from expanding within the building. This could serve as a selling point for Digital Realty, demonstrating to its own colocation customers that space in the building was very limited.
Based on evidence that Equinix later obtained during the discovery process, it was revealed that Digital Realty knew that Equinix “do[es] not want to lose the space” because “[i]t is the only large space becoming available for years” and further noting that Equinix was “out of capacity” at the 350 East Cermak Road building.
On April 10, 2018, Equinix responded to Digital Realty’s modified lease terms and expressed their interest in accepting half of the space on the third floor, but they requested a price reduction. Equinix justified this requirement by explaining that the construction costs for a smaller area, combined with the decreased critical power load, would result in a loss of economies of scale.
Former Tenant, FIS, Vacates the Third Floor Space
During the Spring and Summer of 2018, Equinix and Digital Realty continued their negotiations. One of Equinix’s proposals was for Fidelity National Information Services (FIS) to leave its operational equipment behind after vacating the leased space, which they did when their lease ended on June 30, 2018.
FIS had exclusively utilized the third floor space and its equipment for its own use as an enterprise data center and had never offered colocation services to customers in this area. Therefore, the existing equipment was not adequate to support the distinct requirements of a colocation business like that of Equinix. In addition to this, the existing equipment on the third floor was between 14 and 18 years old at the time of FIS’ lease termination, necessitating a complete renovation.
Following FIS’ departure, Digital Realty and Equinix dedicated the Summer of 2018 to crafting a term sheet. This document outlined the conditions under which Equinix would lease a portion of the third floor space previously occupied by FIS.
Negotiations over the Leasing and Refurbishment Terms for the North Suite
On July 18, 2018, Digital Realty and Equinix executed a non-binding term sheet to lease half of the third floor space, specifically the north suite. The base rent was set at $100 per kW per month, a figure mutually agreed upon by both parties rather than derived from the Right of First Offer (ROFO) provision. Notably, this rate was half of what Digital Realty would later assert as the “market rate” for the same space just six months later.
The term sheet outlined that Equinix would lease the north suite “as is.” It was Equinix’s responsibility, not Digital Realty’s, to demolish the existing outdated infrastructure, upgrade necessary equipment, and commission the north suite as a modern data center. Equinix projected the refurbishment for the colocation data center to cost approximately $28 million.
According to Equinix, the north suite required new uninterruptible power sources, computer room air handling units, a building management system (BMS), air containment and fire suppression systems, as well as new telecom and security facilities.
Digital Realty, however, contended that the current equipment, including power distribution units (PDUs), uninterruptible power source units, generators, air conditioning units, switchgear, and cooling towers, was operational and well-maintained. Additionally, it was designed with a raised floor to facilitate overhead and underfoot cooling.
Overall, Equinix regarded the agreed-upon rate of $100 per kW per month as a compromise, considering it was higher than the rate they believed they were entitled to under their ROFO right for the “as is” north suite. They reasoned that because they had to install their own improvements, the suite was unimproved, and non-landlord managed, thus commanding a lower rate. Conversely, Digital Realty considered the rate a discounted market rent, reciprocating for other concessions, and on par with improved space.
The non-binding term sheet also contemplated further negotiation toward a binding lease amendment.
Breakdown in Lease Negotiations between Equinix and Digital Realty
In August 2018, Digital Realty presented Equinix with a draft lease amendment for the north suite. The following month, however, negotiations came to a halt due to Digital Realty’s unexpected decision to “re-trade” the deal, which meant renegotiating previously agreed-upon terms. As a result, despite their efforts, Equinix and Digital Realty failed to finalize a binding lease amendment that adhered to the previously agreed non-binding term sheet.
What led to this situation? According to Equinix, Digital Realty wanted to divert data center space to its affiliate, Telx, intending to minimize competition within the 350 East Cermak Road building.
Based on evidence that Equinix later obtained during the discovery process, it was revealed that emails from Digital Realty’s Jeff Tapley stated “[i]f this was anyone but Equinix, the deal on the table would be a no-brainer”.
Throughout these negotiations, Equinix and Digital Realty had been pursuing an agreement for Equinix to lease part or all of the third floor space, independent from the Right of First Offer (ROFO) provision. When these negotiations reached a deadlock, Digital Realty was obligated to formally present the third floor space to Equinix as per the terms of the ROFO provision. However, Digital Realty’s formal notice under the ROFO provision was not issued until several months later, in January 2019.
Early 2019 – Emergence of the Conflict Between Equinix and Digital Realty
Digital Realty Offers the Third Floor Space to Equinix Under the ROFO
In a letter dated January 4, 2019, Digital Realty informed Equinix about the availability of Suites S300N, S300E, and S300S in the 350 East Cermak Road building. Collectively, these suites formed the third floor space on offer by Digital Realty, comprising a total area of 53,194 square feet, which included data center, office, and ancillary storage spaces. Specifically:
- Data Center: Suites S300N and S300E, comprising UPS power of 2,700 kilowatts (kW), and 41,539 useable square feet
- Office: Suites S300E and S300S provided 8,003 rentable square feet
- Ancillary Storage / Office: Suite S300E featured 3,652 rentable square feet
Digital Realty proposed a rental rate of $200 per kW per month for the first 12 months, with 3% rental escalators annually thereafter.
The rental offer was based on Digital Realty’s assessment that the third floor space was “improved” and “landlord-managed”, functioning as a turn-key data center. The company considered the space to be ready for immediate occupancy, given that all of FIS’ previous data center infrastructure was still in place and fully operational. As such, the proposed rent was what Digital Realty considered to be the prevailing “market rate” for similar spaces.
In contrast, Equinix challenged this claim, arguing that the suites were “unimproved” and amounted to “non-landlord managed” raw powered shell space. Based on evidence that Equinix later obtained during the discovery process, it was revealed that emails from Digital Realty employees stated that Equinix “is never going to agree that is improved space” and “Equinix is not going to put customers in that space with the age of the equipment”.
This disagreement is crucial because the “market rate” proposed by Digital Realty substantially differed from Equinix’s rental expectations. Equinix perceived the rent for unimproved, non-landlord managed space to align with the per square foot rate of its current powered shell lease for the sixth floor space in the 350 East Cermak Road building. If adopted, Equinix’s view would result in a significantly lower rental rate than what Digital Realty was proposing.
Digital Realty Plans to Keep the Third Floor Space for its Own Use
On January 16, 2019, Alex Smith, Equinix’s broker from Cushman & Wakefield, communicated with Digital Realty in a phone call. Smith conveyed his belief that Equinix was unlikely to exercise its Right of First Offer (ROFO) in response to Digital Realty’s lease proposal. Digital Realty had hoped their ROFO notification would prompt Equinix to decline the space, thereby freeing it for use by Digital Realty’s colocation group.
After receiving this intelligence, Digital Realty promptly revisited its 2017 budget and exp’s feasibility study concerning the third floor space redevelopment. The company prepared a Development Investment Committee Memorandum (DICM) to authorize a comprehensive redesign and renovation of the third floor space and its associated infrastructure. The aim was to transform the space into a modern colocation data center as soon as the time for Equinix to exercise its ROFO right expired.
Digital Realty’s DICM recognized that much of the equipment on the third floor was reaching the end of its useful life and required replacement. It envisioned that the space would undergo phased redevelopment and then be handed over to Digital Realty’s colocation team, unless larger-scale customer demands emerged. This memorandum was finalized and internally approved by Digital Realty on January 22, 2019.
Equinix’s Response to Digital Realty’s Offer Letter
In a letter dated January 24, 2019, Equinix communicated to Digital Realty its election to lease the third floor space. However, this decision was based on Equinix’s interpretation of the current lease terms and conditions.
Equinix proceeded to express its dissatisfaction with Digital Realty, accusing them of not fulfilling their obligations under the lease. The primary point of contention was that the offered space was “unimproved” and “non-landlord managed,” which Equinix believed they were entitled to lease at the existing per square foot rate, as specified in the lease agreement. Additionally, Equinix disputed Digital Realty’s calculation of the “market rate,” which was offered at $200 per kW per month, calling it unreasonable.
Digital Realty’s Final Letter Declines to Lease the Third Floor to Equinix
In a final letter dated February 8, 2019, Digital Realty argued that Equinix had not accepted its lease proposal. Instead, Equinix’s reply amounted to a counteroffer, stipulating various terms and conditions, which included different pricing and terms than those initially proposed by Digital Realty.
Digital Realty argued that Equinix had substantially changed the terms during their acceptance by labelling the third floor space as “unimproved” and “non-landlord managed” space, with pricing conditions different from those originally specified in Digital Realty’s offer notice. Additionally, Equinix demanded that lease amendments include certain additional rights, such as “street connectivity access rights,” not addressed in Digital Realty’s initial offer or the Right of First Offer (ROFO). These rights would enable direct carrier connections from Equinix’s suite, bypassing the ROFO’s requirement to make all such connections within the building’s Meet-Me Room (MMR) in Suite 255/260.
Reaffirming its characterization of the space as “improved” and priced at a “market rate”, Digital Realty asserted that the window for Equinix’s acceptance of its ROFO had expired. Consequently, Digital Realty declined to lease the space to Equinix and rejected Equinix’s counteroffer.
Equinix Does Not Respond and Decides to Sue
Equinix believed that Digital Realty failed to recognize their decision to lease the third floor space. Following the perceived breach of their Right of First Offer (ROFO) agreement and Digital Realty’s rejection of their counteroffer, Equinix decided to file a lawsuit.
Overview of the Lawsuit and its Resolution
On February 25, 2019, Equinix filed its original complaint against Digital Realty’s subsidiary, Digital Lakeside, LLC, in the Circuit Court of Cook County, Illinois – County Department, Chancery Division, under the case number 2019CH02475. Equinix was legally represented by Katten Muchin Rosenman LLP and Larsen and Larsen LLP, while Digital Realty was advised by Jones Day.
Equinix alleged two counts of breach regarding the Right of First Offer (ROFO) in their lease agreement for the third floor space in Digital Realty’s 350 East Cermak Road building. This dispute stemmed from the characterization and pricing of the leased space, with Equinix asserting the description and market rate stipulated by Digital Realty were either inaccurate or unreasonable.
Notice of Lis Pendens Hinders the Property
On February 25, 2019, Equinix also filed a Notice of Lis Pendens, a Latin term meaning ‘lawsuit pending’, in the Circuit Court of Cook County, Illinois, concerning the real estate at 350 East Cermak Road in Chicago, Illinois. This legal notice, recorded with the county clerk, flags a pending lawsuit potentially affecting the property’s title and serves as a warning to potential buyers, lenders, or tenants about the ongoing dispute.
While the Notice of Lis Pendens did not stop Digital Realty from using or leasing the third floor space, it effectively deterred third parties, as they might have to vacate the space if Equinix won the lawsuit.
Timeline and Developments in the Legal Battle
In August 2019, Equinix’s original complaint was dismissed, but it was subsequently amended in September 2019. This amended complaint was answered by Digital Realty with defenses that were initially dismissed for lack of factual support, then re-pled with defenses throughout 2020, and upheld by the court, despite Equinix’s repeated attempts to dismiss them.
As such, Equinix filed a second amended complaint in December 2021, which Digital Realty responded to and re-pled its affirmative defenses and filed for summary judgment on a count of Equinix’s complaint. In March 2022, the court granted Digital Realty’s motion for summary judgment on one count of Equinix’s second amended complaint and struck parts of Digital Realty’s affirmative defense.
Planned Legal Showdown Between Equinix and Digital Realty
A number of high-profile senior executives and board members from both Equinix and Digital Realty were slated to be called upon to testify in court as witnesses to support each party’s case. The executives and board members were expected to testify on a wide range of topics, including the negotiations and honoring of lease and ROFO terms, the condition and usability of the third floor space and the equipment left behind, the strategy of their respective colocation businesses, and the importance of the 350 East Cermak Road building, among many others.
Examples of the high-profile senior executives and board members from both Equinix and Digital Realty that would or may be called upon included:
- Equinix: Charles Meyers (Chief Executive Officer), Keith Taylor (Chief Financial Officer), Peter Van Camp (Executive Chairman), Karl Strohmeyer (former Chief Customer and Revenue Officer), Mark Adams (former Chief Development Officer)
- Digital Realty: Bill Stein (former Chief Executive Officer) and Andy Power (former Chief Financial Officer, current Chief Executive Officer)
In preparation for the trial, Equinix and Digital Realty exchanged over 100,000 pages of documents, including emails, lease documents, and proposals relevant to these issues. The two parties conducted more than two dozen fact depositions. Additionally, numerous discovery disputes were litigated, with many others resolved without the need for court intervention.
Originally scheduled for March 2022, the trial was twice postponed, with its final rescheduled date set for May 2023. Despite these delays, the trial never ultimately occurred.
Resolution – Legal Dispute Between Equinix and Digital Realty Ends
On April 24, 2023, the Circuit Court of Cook County, Illinois, dismissed the case between Equinix and Digital Realty with prejudice, thereby bringing the legal dispute to a conclusive end. Each party was held responsible for its own legal fees.
The court’s decision indicated that both parties had reached a mutual agreement or settlement, thus resolving all outstanding issues and controversies. Subsequently, on April 25, 2023, Equinix terminated its Notice of Lis Pendens on the property located at 350 East Cermak Road in Chicago, Illinois.
Implications of the Lawsuit for Equinix and Digital Realty
The legal battle between Equinix and Digital Realty has most likely strained their relationship, potentially hindering future partnerships and negotiations. In the following section, Dgtl Infra presents potential implications in two key areas concerning the prospective relationship between Equinix and Digital Realty.
Tenant-Landlord Relationship between Equinix and Digital Realty
The tenant-landlord dynamic between Equinix and Digital Realty underscores a crucial aspect of their partnership. Presently, Equinix leases space in 17 locations owned by Digital Realty, contributing $88.0 million in annualized base rent with an average remaining lease term of 6.7 years. Despite suggesting a robust relationship, it’s worth revisiting the chart presented earlier in this piece. This chart illustrates the economic interplay between Equinix and Digital Realty over time and sheds light on their evolving dynamic.
Equinix and Digital Realty’s Tenant-Landlord Relationship: 2014 to Present
The chart above illustrates a continual decrease in Equinix’s weighted average remaining lease term (WALT), as measured in years, over the past decade. Various factors could be contributing to this decline. These may include Equinix being forced to sign shorter-term leases by Digital Realty, the sale of Equinix-occupied properties with longer WALTs by Digital Realty, or simply the passage of time reducing Equinix’s WALT if no new longer-term leases are signed.
Notably, Equinix’s WALT has been in steady decline, particularly since 2016, implying that Digital Realty might be permitting these leases to expire naturally without seeking to renew or replace them with longer-term leases. This pattern suggests that Digital Realty may be planning a significant shift in their property use strategy, possibly expanding its own retail colocation business, a topic we will explore next.
Historically, there are instances where Digital Realty, acting as a landlord, decided not to renew Equinix’s lease upon its expiration. Conversely, there have also been cases where Equinix willingly chose not to renew its lease, leading to its departure from Digital Realty’s property. Below are three examples of these instances:
1. Dallas, Texas – DA10
In the Dallas data center market, Equinix previously leased its DA10 facility, situated at 1232 Alma Road, Richardson, Texas, from Digital Realty. According to deposition transcripts from Alex Para, the Senior Director of Commercial Finance at Equinix at the time, this lease was terminated in March 2021, leading Equinix to vacate the facility.
2. Silicon Valley, California – SV6
In the Silicon Valley data center market, Equinix previously leased its SV6 facility, located at 444 Toyama Drive, Sunnyvale, California, from Digital Realty. Since 2007, Equinix held a lease for this 42,083 square-foot, two-story powered shell data center, which ended on July 31, 2022. At this point, Equinix vacated the facility.
3. Atlanta, Georgia – AT2 and AT3
In the Atlanta data center market, Equinix has indicated it doesn’t plan to renew its leases for the fifth and sixth floors of 56 Marietta Street NW, Atlanta, Georgia. These leases, set to expire on July 31, 2024, are housed within another building owned by Digital Realty. Referred to as the AT2 and AT3 data centers by Equinix, these facilities are situated in close proximity to Equinix’s AT1 data center at 180 Peachtree Street NW, in downtown Atlanta, Georgia.
Equinix’s Transition from Leased Properties Highlights Flaws in their Business Model
Digital Realty suggests that Equinix is strategically moving away from leasing buildings from third-party landlords, including Digital Realty, in favor of properties that it owns. Equinix’s situation in Chicago, along with the cases in Dallas, Silicon Valley, and Atlanta, underscore the inherent flaws of Equinix’s leasing strategy, particularly their lack of ownership of key data center locations in markets like Chicago and Atlanta.
As a tenant, Equinix is constrained by the terms of their lease agreement and may also be influenced by changes in their landlord’s business strategy, which, in the case of Digital Realty, will be discussed next.
Digital Realty’s Strategic Shift into Retail Colocation
Digital Realty’s evolution from primarily leasing wholesale space to also offering retail colocation services became evident after it acquired Telx for approximately $1.9 billion in October 2015. This move was solidified by Digital Realty’s subsequent acquisitions of global retail colocation providers, notably:
- Interxion: Digital Realty purchased this European colocation provider for $8.4 billion in March 2020
- Teraco: In August 2022, Digital Realty acquired a 61% stake, valued at $3.3 billion, in Teraco Data Environments, a colocation provider in South Africa
Interestingly, Equinix had intended to call two of its executives, Stuart Thompson and Mark Adams, to testify in court had the legal dispute gone to trial. They would have been called as witnesses to support Equinix’s case concerning “Digital’s demand for access to Equinix’s ecosystem”. This ecosystem, particularly in the 350 East Cermak Road building, encompassed high-value colocation customers from a variety of sectors including carrier, financial services, banking, content providers, network, cloud computing, and enterprise industries.
Digital Realty’s interest in this ecosystem may have signified its intent to gain access to Equinix’s customer base, a direct competitor in the retail colocation market. This would provide Digital Realty with invaluable market insights regarding pricing and customer preferences, insights into Equinix’s business strategy, and potentially even the opportunity to convert some of Equinix’s customers to its own retail colocation services.