Articles Posted in commercial lease

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Lease Options are commonly seen in California. The agreement gives the tenant an irrevocable right to buy the property under certain conditions, and usually have restrictions based on tenant defaults. Sacramento real estate attorneys most often see issues arise regarding how the option is exercised, tender of the option price, and what the purchase price will be. Easiest is when the option specifies the purchase price or provides an easy formula to determine it. More contentious is setting the price at ‘fair market value,’ because buyers and sellers seldom agree, and an expensive process of multiple appraisals may be required, along with court intervention. Such was the situation in a recent decision concerning a commercial property.

Sacramento-lease-option-attorneyIn Petrolink, Inc. v Lantel Enterprises, The parties had entered a lease concerning a gas station at Cajon Junction in San Bernardino County. The original lease was with Tosco, so it probably involved the 76 station now visible on Google maps. The Lease gave the tenant the right (or option) to buy the property at “fair market value.” The provision stated:

“21. RIGHT TO PURCHASE. As long as the Tenant is not in default of this Agreement, Tenant will have an option to purchase the property at any time after the first Ten (10) years of the lease term at a price equal to the fair market value of the property based on an appraisal.”

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In larger commercial real estate leases, the tenant occasionally needs a loan to build the premises or finance major transactions. The tenant does not own the real property, but has the lease, which is both an interest in real property and a contract. This results in two sets of rights and obligations – those from the interest in the property (“privity of estate”), and those provided in the lease (“privity of contract”). If the tenant allows another party to take possession of the premises, that party has privity of estate with the landlord, but is not responsible for the obligations of the lease. This is why the lessor requires, in the lease, that any assignment be approved and the new tenant sign an acceptance of the assignment and the obligations of the lease contract. The Lessor will also require that any lender secured by the lease agrees to assume all the obligations of the Lease if it forecloses.

But what happens when the leasehold lender forecloses, but nobody makes sure that the Lender actually assumed all the lease obligations? That was the issue in a recent decision when the lender foreclosed on a lease in a shopping center

Sacramento-privity-of-estate-attorneyIn BRE DDR BR Whittwood Ca LLC v. Farmers & Merchants Bank of Long Beach, a shopping center tenant needed a loan to finance construction. The lease allowed the Tenant to encumber its leasehold interest through a mortgage, but presumed that a mortgage lender who succeeded to Tenant’s interest assumed Tenant’s obligations. The lease stated:

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In the ordinary real estate or business sale escrow, the escrow officer owes duties to the parties to only the parties to the escrow, and not to third parties. There are a few exceptions, such as when the parties real estate sale escrow instructions require following a third party’s instructions, such as lender’s instructions for closing a loan. But it is generally difficult to prove that an escrow holder owes a duty to a third party, the breach of which would result in a finding of negligence. Such was the case in a recent decision which resulted from a misguided and tangled effort to avoid the “no assignment” clause in a commercial lease; parties concerned with suck lease provisions should consult with a real estate attorney.

Sacramento-escrow-liability-attorneyIn Alereza v. Chicago Title, the plaintiff Bobby wanted to buy a gas station which was on leased property, which would require assignment of the lease to the buyer. Escrow #1 was opened, but the landlord required a personal guaranty to allow assignment and the plaintiff did not want to do that. The plaintiff formed an LLC and assigned the purchase contract to the LLC, but the landlord still wanted a personal guaranty. Escrow #1 was cancelled.

The parties had a new idea – plaintiff would buy the interest in the seller’s LLC, thus the tenant would not change, and there would be no assignment. They opened escrow #2. The landlord found out, and said he would consider it a breach of the lease. Escrow #2 closed, and the plaintiff was not a party to the escrow. The escrow officer obtained an insurance certificate for the purchased business, but incorrectly got it in the name of the plaintiff’s LLC (created for escrow #1), not the Seller’s LLC. The parties were not speaking at the time, and nobody knew what was happening. The insurer sent a notice of cancellation of the original policy, and the landlord demanded a personal guaranty. It was not given, and there was an eviction action. The plaintiff gave the personal guaranty, and sued the escrow company for negligence. The court found that, as the individual plaintiff Bobby was not a party to the escrow, there was no liability.

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Leases often have terms allowing extension or renewal for additional time (the difference between extension and renew discussed below). Sacramento real estate attorneys may be called on to interpret the terms of the renewal option when they are not clearly drafted; sometimes it takes a court ruling to reach a result. A well-composed lease will provide a way to determine the new rent, but otherwise the same lease terms generally will apply. However, what happens when the number of optional new terms is not clear?

Sacramento commercial lease option attorneyThat was the case in Ginsberg v. Gamson, where the parties entered a lease for a commercial property for sale of textiles and clothing on South Le Brea Avenue in Los Angeles. The parties got in a dispute, and the right to renew the lease was an issue. Of course, the landlord said the lease provided for only one renewal, the tenant that there were unlimited renewals. The “Option to Extend Renewal” which was under review is set out at the end of this blog.

California Courts apply two rules that apply to interpreting lease provisions that look like they allow perpetual renewals:

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California real estate purchase and sale contracts often incur in conjunction with a written lease, such as in the case of a lease- option or both a lease and a contract entered together that reference each other. The lease-option includes a purchase contract that with instructions in the option as to how to exercise the option and make the purchase contract binding. The combo lease-contract will (at least should) be clear as to what payments are exclusively applied to the rental, and what rights the owner has to evict the tenant-purchaser. Sacramento area real estate attorneys frequently prepare these types of agreements usually in cases where the buyer-tenant cannot immediately obtain financing to buy the property outright. In a recent case with perhaps a too-complicated purchase contract, the defaulting buyer was disappointed to find out that it was really a tenant. Maybe it was complicated in order to disguise the fact from the buyer, but the court provided a guide to create such a deal while ensuring the seller can evict the buyer.

Sacramento commercial lease attorneyIn Jon Taylor v. Nu Digital Marketing Inc., Taylor was the owner and seller, Bu was the buyer. They entered a document entitled “Contract of Sale Residential Property.” It required the buyer to consummate the sale within 60 months by payment of $1.25 million. It also required (full details set out at the end of this article) that the buyer make “Probationary Installment” payments of $2,300 per month for 60 months, which covered the seller’s adjustable rate mortgage, and would increase if the mortgage adjusted. None of the probationary installment was applied to the purchase price. It also required a down payment (“additional Probationary Installment” of $500 per month. Lastly, it gave buyer immediate possession of the property and provided that if the buyer defaulted on probationary payments, the seller could serve a five-day notice.

Auburn commercial lease attorneyThe buyer defaulted, and the seller brought an unlawful detainer. The buyer claimed that it could not be evicted, because this was a contract, not a lease. The court of appeal disagreed.

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In California, every contract includes an implied obligation not to do anything that prevents the other party from benefiting from the contract, and to cooperate if necessary for the other party.  This is called the implied covenant of good faith and fair dealing.  It does not create a new obligation but applies to those obligations which have been agreed on.  The Restatement of Contracts comments provide that the bad faith may be overt or may consist of inaction, and fair dealing may require more than honesty.  Sacramento Real Estate attorneys see the argument come up often in real estate contracts which end up falling out of escrow, and occasionally commercial leases in which the parties fail to cooperate.  Courts generally allow parties to use unfettered discretion, without restriction of the covenant, if the contract provides for unfettered discretion, and there is adequate consideration (162 Cal App. 4th 1107, 1121).  In a decision involving an office lease at 595 Market Street in San Francisco the tenant wanted to sublease the premises, and thought that the landlord breached the implied covenant by terminating the lease.  But the lease provided that the landlord could do so, so the tenant had covenanted away its argument.

covenant of good faith attorneyIn Carma Developers (Cal) Inc. v. Marathon Development, Carma entered a lease of the 30th floor of the building for ten years.  Carma’s business changed, its headquarters moved to Houston, and Carma submitted a proposal to the lessor to sublease a portion of the premises.  The Lease had a provision (set out below) that in such a case the lessor had the right to terminate the lease.  The Court first noted that it has been suggested the covenant requires the party holding such power to exercise it “for any purpose within the reasonable contemplation of the parties at the time of formation-to capture opportunities that were preserved upon entering the contract, interpreted objectively.”  It repeated to principles that have emerged:

1, breach of a specific provision of the contract is not a necessary prerequisite, and

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In the past, when multiple parties were obligated under the same commercial lease, they were presumed to be jointly liable. They are each responsible for their share of the total. If the other side wanted to enforce the agreement, they had to name all the jointly liable parties in the same lawsuit (the compulsory joinder or all-or-none rule). If you filed suit but couldn’t locate one of the lessees, they were off the hook. But over time the Courts changed the rule by converting “joint” obligations into “joint and several” obligations. These are considered to be a contract that is made both separately with each promisor and jointly with all the promisors. Civil Code section 1659 provides “Where all the parties who unite in a promise receive some benefit from the consideration, whether past or present, their promise is presumed to be joint and several.”

Sacramento commercial lease lawyer.jpgParties who are jointly and severally liable may be sued together in one lawsuit, or names in separate lawsuits, brought at different times. Nothing short of satisfaction of the debt bars any further actions against other parties. But, what happens to the rule of res judicata, or claim preclusion? Judgments are generally conclusive. The doctrine of res judicata precludes parties from relitigating a cause of action that has been finally determined by a court of competent jurisdiction. Any issue necessarily decided in such litigation is conclusively determined as to the parties or their privies if the issue is involved in a subsequent lawsuit on a different cause of action. Sacramento real estate attorneys rarely see issues of claim preclusion raised in commercial lease practice. However, in a recent decision the commercial landlord scored a judgment of over $2 million against one of three co-signors on the lease. The landlord then sued the other two tenants, who argued res judicata – there was already a judgment on the lease, and further action was prohibited. Both the trial court and court of appeals agreed with the tenants forgetting a key element of the res judicata doctrine. It took the Supreme Court to straighten them out.

In DKN Holdings LLC v. Wade Faerber, Caputo, Faerber, and Neal leased from DKN a commercial space in a shopping center to operate a fitness center for ten years. The lease stated that the parties who signed the lease “shall have joint and several responsibility” to comply with the lease terms. Caputo alone sued DKN for fraud, and DKN counter-claimed for rent. DKN did not bring the other tenants into the lawsuit. After trial, all the tenant’s claims were rejected, but the landlord was awarded over $2.8 million.

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Last week I discussed a cotenancy provision in a California commercial lease, where the court found that the rent abatement aspect – if the specified cotenant was not operating, the tenant’s rent is reduced or eliminated – was found to be an unenforceable penalty. That court also looked at whether the provision was unconscionable, and thus unenforceable. Unconscionability (codified at Civil 1670.5) has no specific legal definition, but generally means extreme unfairness. Business and real estate attorneys often see a situation where one party gets a really bad deal, but that alone does not make it unenforceable. California courts have developed an analysis requiring two elements, “Procedural,” and “Substantive.” In the decision being addressed here, the court found that Procedural element was not fulfilled so the cotenancy provision was not unconscionable.

Sacramento commercial lease unconscionable attorney.jpgIn Grand Prospect Partners, LP, v Ross Dress for Less Inc., Ross entered a lease in a commercial center in Porterville, CA. The lease required that Mervyn’s be open when the Ross store opened, and Mervyn’s was to remain in operation for the term of the Ross lease. If Mervyn’s was not operating, Ross could cease paying rent, and also terminate the lease. Mervyn’s filed for bankruptcy before opening in this center, so the cotenancy requirement was unfulfilled, and Ross declined paying rent. In the ensuing lawsuit, the Landlord claimed that the cotenancy provision was unconscionable, and thus should not be enforced.

Procedural Unconscionability.

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Cotenancy provisions are often required by larger retail tenants in shopping centers of all sizes. They require other specified stores in the center to be open and operating, on the assumption that these other stores will draw the desired mix of potential customers. They come in two flavors; opening requirements, meaning that the requirement is fulfilled before the tenant is required to open; and Operating requirements, meaning that the tenant’s obligations continunue only so long as the named tenants remain in business. Parties to a commercial lease may need to consult with a Sacramento real estate attorney to clearly define the cotenancy requirements in their lease, so that they do not face any surprises, as one tenant faced in a recent decision when their cotenancy provision was found to be an unenforceable penalty because the tenant had never really considered what its harm would be if the named store did not open.

Sacramento commercial lease attorney.jpgIn Grand Prospect Partners, LP, v Ross Dress for Less Inc., Ross was negotiating with a shopping center owner Porterville, in Tulare County. Ross wanted a cotenancy provision that required a Mervyn’s to opening and running before Ross was required to open. If Mervyn’s did not open, or ceased operating, Ross would not owe rent, and did not have to open a store. (The terms of the lease are more fully set out below). Two months after the parties signed the lease; Mervyn’s filed bankruptcy, and never opened its store in the Portville center. Eventually Ross notified the landlord that it was going to terminate the lease under the cotenancy provision. This lawsuit ensued, with Grand Prospect, the landlord, claiming that the lease was unconscionable, and the cotenancy rent abatement provision was an unenforceable penalty.

Under California law, an unenforceable penalty lacks a proportional relationship between the forfeiture compelled and the damages or harm that might actually flow from the failure to perform a covenant or satisfy a condition. The test requires a comparison of

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Let’s get this out of the way – the only essential terms for a real estate sale contract are the identities of the buyer and seller, the property in question, and the purchase price. Essentially, that is the law in California. Of course, the courts have found ways around the rule, but the trend of the law favors carrying out the parties’ intent once the court has determined that the parties had intended to make a contract. The courts will hear evidence of the parties’ intent to explain essential terms. (Okun v. Morton, 203 Cal. App. 3d 805) Sacramento real estate attorneys are occasionally asked about contracts in which all the standard details are left out, and asked how to enforce, or deny, the contract. When there is no time for payment specified, I always advise the “a reasonable time” is inferred, whatever that means in the circumstances. Such a situation was addressed by the Supreme Court when a tenant wanted to enforce a purchase option that was included in the lease.

sacramento real estate purchase attorney.jpgIn Patel v. Liebermensch, the tenants leased a condo in San Diego. The lease included the following purchase and sale option:

“Through the end of the year 2003, the selling price is $290,000. The selling price increases by 3% through the end of the year 2004 and cancels with expiration of your occupancy. Should this option to buy be exercised, $1,200.00 shall be refunded to you.”