DIRT DEVELOPMENT for Wednesday, August 19, 2009
Daniel B. Bogart
Donley and Marjorie Bollinger Chair in Real Estate Law
Chapman University School of Law, Orange, California
VENDOR/PURCHASER; TIME FOR PERFORMANCE; EXTENSIONS; BOOD FAITH AND FAIR DEALING: Seller under Land Sales Agreement Required to Extend Date for Escrow; Duty of Good Faith and Fair Dealing:
Peak-Las Positas Partners v. Bollag, 90 Cal. Rptr. 3d 775 (Cal Ct. App. 2009)
The Contract for sale of property included a provision allowing extension of escrow “by mutual consent of Buyer and Seller, which mutual consent shall not be unreasonably withheld or delayed.” The seller violated this good faith requirement by denying buyer’s request for extension where the buyer had paid 98% of the purchase price and extended millions of dollars in project development costs.
At the time of the opinion, Peak-Las Positas (“PLP”) owned a 10 acre tract of land in Santa Barbara, California. PLP intends to develop the property. PLP’s neighbour was Bollag. Bollag’s property consisted of 86 acres and included his ridge top home. According to the facts as presented in the opinion, in 1999 PLP and Bollag entered into a Purchase and Sale Agreement for 4.5 acres of land adjoining PLP’s property with a purchase price of $475,000. The parties opened escrow on July 23, 1999, when PLP paid a non refundable deposit of $150,000 to Bollag.
The Purchase Agreement required approval of a land lot adjustment by no more “than two years after Opening of Escrow, unless extended by mutual consent of Buyer and Seller.”
Unfortunately, the process of obtaining a modification to the land lot did not move quickly (in fact, it barely moved at all). Although surrounded by the incorporated City of Santa Barbara, the PLP and subject properties actually sat in an unincorporated area. A series of bureaucratic impediments – none perhaps insurmountable, but certainly the kind that try the patience of property developers – presented themselves to PLP. Essentially the City intended to incorporate the properties, but the county would not adjust the land lots. Therefore the property would have to be annexed by the City, which would then adjust the lines. Furthermore, the City required PLP to treat the property as a planned residential development – this designation added complexity and cost to obtaining the land lot adjustment. (Recall that all of this effort was expended for 4.5 acres of property.)
Bollag and PLP were intent on completing the transaction, notwithstanding the administrative hurdles associated with the land lot lines. To this end, the parties executed an amendment to the Purchase and Sale Agreement in 2001. This Amendment contained crucial language. The Amendment extended the escrow period by five years, and allowed for additional extensions “by mutual consent” which consent “shall not be unreasonably withheld or delayed.” PLP paid Bollag $315,000 at execution of the Amendment, with the understanding that the money would be applied to the sale price at closing.
After execution of the Amendment, PLP set about the task of satisfying the City in a variety of project changes, in order to obtain the land lot adjustment. These changes included work to mitigate traffic congestion, restore a creek, and mitigate the likelihood of landslides. (The reader should note that the latter worry is pretty reasonable; a survey of the news from time to time will show one California neighbourhood or another sliding down a hill.) In total, this project work amounted to approximately $5 million dollars.
Despite this extensive development work, the City Council voted against the project on March 8, 2006. PLP then met with representatives of the City and agreed to additional project work, all with the purpose of obtaining the land lot adjustments. However, this work required PLP to submit its changes to the City, and this would take even more time.
PLP therefore requested that Bollag agree to an extension of escrow, pursuant to the language of the Amendment. At this point in time, PLP had paid almost the entire purchase price to Bollag ($465,000 of the $475,000 purchase price), in addition to costs expended to obtain the land lot adjustment.
Bollag refused to grant the extension. The initial $150,000 and later $315,000 payments were non refundable. Therefore, Bollag’s refusal amounted to a declaration that it intended to retain title and the money. Not surprisingly, PLP filed a suit for declaratory judgment and specific performance, asked the court to order Bollag to extend the escrow date. The trial court agreed with PLP; the California Court of Appeals affirmed.
Bollag argued that PLP accepted at the outset that the money was at risk and failed to diligently go about obtaining the land lot adjustment necessary to closing. Furthermore, Bollag argued that agreeing to the extension was unnecessary: Bollag was doubtful that PLP would ever obtain the land lot adjustment. Finally, Bollag voiced concern over his personal liability if a landslide occurred; he worried that he would be liable even though he did not develop the property.
PLP responded that Bollag acted in bad faith, and the court agreed.
Bollag relied on Section 15.2 of the Restatement Second of Property, dealing with restraints on the assignment of leases. That section provides that a landlord must be reasonable in exercising its discretion, and that in doing so the landlord “must be objectively sensible and of some significance.” Bollag argued that his behaviour was in fact reasonable. As we will see below, this requires a fact dependant analysis, and the facts were not on Bollag’s side.
The appellate court rightly pointed out that PLP’s transaction involved a purchase and sale agreement and amendment covering escrow, and not a lease assignment. And in the words of the court, “no court … has held that section 15.2 of the Restatement Second of Property applies to escrow extensions for the sale of real estate.” (The Restatement’s approach to lease approval was applied by the California Supreme Court in the seminal lease assignment case Kendall v. Ernst Pestana, Inc., 40 Cal. 3d 488 (1985), and adopted by the legislature in California Civil Code.)
In any event, the court determined that Bollage was subject to an implied duty of good faith and fair dealing in carrying out his responsibilities under the contract. Quoting prior California case opinion in Locke v. Warner Bros., Inc., 66 Cal. Rptr. 2d 921 (Cal. Ct. App. 1997), the court stated that “Where a contract confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion in good faith and in accordance with fair dealing.” To this end, he could not just reject based on “fancy, taste or judgment” but must have some objective, real and substantial basis for doing so. And this requires investigation, diligence and understanding.
The contract amendment could have defined Bollag’s discretionary right to Bollag’s benefit; but the contract failed to do so. In the absence of such specific language, the court explained it would determine whether Bollag rejected the escrow extension on an objectively reasonable basis.
The court examined each of Bollag’s stated reasons for failing to extend escrow and determined that these were made in bad faith. Some of Bollag’s arguments are quite picayune. He claimed to reject the extension because PLP proposed to cut down eucalyptus trees on the subject property. Obviously, if PLP were to conclude the transaction, it could cut down any and all trees on the property, assuming no regulatory reason or servitude preventing it from doing so. Bollag also argued that extending escrow would cloud title. However, evidence presented at trial demonstrated that he successfully obtained two $5 million dollar loans and a substantial line of credit secured by the property. Thus the court concluded that the existing escrow agreement was not a significant cloud that would justify declining the extension of escrow. Bollag argued that the project drew trespassers and intruders to his property (which after all consisted of more than the subject 4.5 acres.) But the court
noted that Bollag never called the cops, and failed to maintain a gated fence that separated the project from his house.
Furthermore, evidence provided at trial suggested that Bollag informed PLP that he did not really care how long the project took to complete, so long as he received payment of the purchase price.
The reader can spend some time with the opinion, but what becomes clear is that Bollag fires just about every argument he can in PLP’s direction, hoping something will stick.
To rub salt in Bollag’s wounds, the court awarded PLP attorneys’ fees provided under the contract. The total amount of the fees was --- wait for it ---$511,282.50. This amount exceeded the purchase price of the property. Bollag vehemently argued that this award was unfair because PLP employed more lawyers, engaged in too much discovery, and hired an expert never called to testify.
The court concluded that the fees were made within the sound discretion of the trial court, and upheld the amount.
Reporter’s Comment 1: If the contract failed, Bollag would have received a tremendous windfall. This alone does determine Bollag’s bad faith, but it would appear to explain his behaviour. That said, this case is a nice example of one party acting in a deliberate manner and seeing its bad behaviour backfire with extra force; attorneys’ fees were provided in contract and supported by California Civil Code. There is no suggestion that Bollag had another purchaser in the wings for the property or a reason to force the issue.
Reporter’s Comment 2: The court began its opinion by refuting Bollag’s use of the lease assignment language in the Restatement of Property for purposes of determining the nature of good faith. What is interesting is that the court does not cite the Restatement of Contracts. This may have more to do with the attorney’s briefs and arguments (which the author has not had the chance to review), but it seems to the author that it is Section 205 of the Restatement Second of Contracts that really applies here. That section provides: “Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”
“Comment a” to Section 205 states: “Subterfuges and evasions violate the obligation of good faith in performance even though the actor believes his conduct to be justified. But the obligation goes further: bad faith may be overt or may consist of inaction, and fair dealing may require more than honesty. A complete catalogue of types of bad faith is impossible, but the following types are among those which have been recognized in judicial decisions: evasions of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party’s performance.
Under the rubric of the Restatement of Contracts, good faith performance of the contract is that performance which is not “bad faith.” The Restatement provides an open ended catalogue of bad faith, and numerous illustrations. (For the interested reader, the author has written about the overly ambitious use good faith arguments in his article: “Good Faith and Fair Dealing in Commercial Leasing: The Right Doctrine in the Wrong Transaction,” 41 John Marshall L. Rev. 275 (2008)).
In this case, Bollag appears to have acted in bad faith. Just one example: in its analysis of Bollag’s liability for landslide, the court noted that Bollag was aware of the problem when he signed the initial contract. Bollag was described as having “graphic” knowledge of the possibility. As a result, Bollag agreed to landslide mitigation measures, and for this reason allowed PLP an easement to do this work during the first extension. Thus, Bollag protested too much: he was quite aware of the problem early on and at peace with it. Using the language of the Restatement of Contracts, Bollag’s behaviour evaded the “spirit of the bargain.”
Editor’s Comment 1: The Editor is struck by the fact that the court appeared to rely entirely on the implied duty of good faith and fair dealing, which it concluded existed whether or not the parties stipulated such a duty, but ignored the fact that the contract in fact directly imposed the duty. Does this make a difference? Well, one would assume that specific contractual language ought to be evaluated in terms of the parties’ situation and bargaining objectives at time of contract, and such evaluation may have some features than might exist in the evaluation of a general implied duty. (Note that the Editor said ‘may.” Don’t require examples – he can’t think of any.)
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