Daily Development for Tuesday, April 15, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

LANDLORD/TENANT; TENANT'S REMEDIES; RESCISSION:
A   breach of landlord's title warranty in a lease that doesn't actually, as
opposed to hypothetically, increase the liability of the tenant or its
guarantor will not invalidate the lease or the guaranty, and if there has
been substantial performance under the lease, recision may be denied
because is an equitable and discretionary remedy.

Center 48 Limited Partnership v. The May Department Stores
Company, 355 N.J. Super. 390, 810 A.2d 610 (App. Div. 2002).

A department store entered into a lease at a shopping center.  In the lease,
the landlord warranted and represented that it was the owner in fee
simple of the leased premises.  The lease further stated that the tenant
was relying on that warranty and representation in executing and
delivering the lease.  Contemporaneously with the execution of the lease,
the tenant's parent company executed a guaranty agreement,
unconditionally guarantying the lease.  The guaranty expressly stated that
no modification of the lease would "in any way release [the parent
company] from liability [thereunder], or terminate, affect, or diminish the
validity of [the] Guaranty, except to the same extent, but only to such
extent, that the liability or obligation of Tenant [was] so released,
terminated, affected or diminished."  Notice to the guarantor of lease
modifications was waived.

In fact,  at the time that the department store signed its lease, the land
was actually owned by a third party and not the landlord.  The landlord
was negotiating to acquire the property to build the center.  At some
point, the landlord's transaction with the owner of the property changed
from a sale to a land lease due to capital gain considerations.

The tenant later asserted that it did not know that its landlord did not own
the land even though a memorandum of ground lease had been recorded.
The guarantor claimed that it and its subsidiaries "tried to avoid
subleasing property on which it operated a store because subleasing
created a risk that the subtenant might lose its right to occupy the
premises through no fault of its own, such as if the ground lease was
terminated or if the tenant under the ground lease defaulted."  In cases
where it did enter into a sublease, "it insisted on assurances, typically in
the form of a non-disturbance agreement with the landowner, whereby
the owner agreed that the subtenant may continue to occupy the premises
even if the lessee under the ground lease lost its lease with the owner."
But, as things developed, the tenant, without registering any objection to
the landlord's lack of ownership, and in fact, likely in ignorance of the
fact, took possession and commenced operation.   Tenant's possession of
the property was never in fact disturbed by the ground lessor or anyone
else.  The store continuously operated until Tenant filed for bankruptcy
and even thereafter, for a time.  Eventually, pursuant to a bankruptcy
court order, the tenant rejected the lease on the property.

The parent company guarantor no longer owned the department store
tenant.  Nevertheless, subject to a reservation of rights, it  honored its
guaranty and voluntarily paid all of the obligations.  When the landlord
finally found a replacement tenant, the new annual rent fell short of what
would have been payable under the old lease, and the landlord sought to
recover the difference from the guarantor.  Eventually, the matter of
exactly how much money the guarantor owed was presented to a court.
The guarantor argued that it was not liable at all, arguing "the guaranty
agreement was not enforceable because there had been no meeting of the
minds and that, alternatively, [the guarantor] was entitled to rescind the
agreement because of a unilateral mistake."

Specifically, the guarantor argued that "ownership of the underlying
property had been an essential material fact of the guaranty agreement
and because the lease agreement had warranted that the [landlord's]
predecessor was the owner, this was a risk fundamentally different than
what the guarantor had agreed to assume."   It further claimed that, as
guarantor, it had been prejudiced because its subsidiary "never received a
non-disturbance agreement from the property owner." The lower court
did not believe the guarantor's claims were sufficient to set aside the
guarantee.

On appeal, the Appellate Division was "called upon to decide whether a
modification of the underlying lease   whereby the lessor became a long
term leasehold rather than fee owner   operate[d] to discharge the
guarantor."  It concluded "that in order to effect a discharge of the
guarantor, an alteration or modification of the underlying lease must
either injure the guarantor or actually increase the guarantor's risk or
liability."  It determined that the modification "neither injured the
guarantor nor increased its risk or liability under the contract of
guaranty."

"It is fundamental that the guarantor is not bound beyond the strict terms
of its promise and its obligation cannot be extended by implication."  The
guaranty agreement "provided that it was made solely in consideration of
[the landlord] having entered into the lease at [the guarantor's] request."
Consequently, the Court rejected the argument that the guarantor "gave
its guaranty in reliance on the representation contained in the lease that
[the landlord] owned the land."  This left only the question as to whether
the change in the landlord's interest "from a property owner to a ground
lessee should have operated to discharge [the guarantor] from liability
under the guaranty."  Essentially, since the guarantor "expressly agreed
that any modification of the lease would not release it from liability or
'terminate, affect or diminish the validity of' the guaranty except if [its
subsidiary's] liability was 'released, terminated, affected or diminished,'
and while the change may have theoretically increased [the guarantor's]
risks under the guaranty, it never resulted in any actual injury or
prejudice to it."   In addition, the court recognized that had the ground
lease been terminated, the subsidiary would have been released from any
further obligation to pay rent and this would have operated to discharge
the guarantor from liability under the guaranty agreement.  Consequently,
"any increased risk ... was more illusory than real."

The guarantor also argued that "there was never was a meeting of the
minds, or alternatively, that a contract may be rescinded where there had
been a unilateral mistake."  Here, the alleged "mistake" was that it
thought the landlord owned the land.  Although, "[c]ontracts may be
rescinded where there is original invalidity, fraud, failure of
consideration, or material breach of default, ... [t]he remedy is
discretionary with the court and should not be granted where there has
been substantial performance of the contract."

Comment 1: Where was the "modification" of the lease?  There was
always a warranty of title.  We simply had a breach of that warranty.  But
the court, in light of all the circumstances, adopts a "no harm, no foul"
approach.

Note that the court says that the guarantor didn't rely specifically on the
warranty, but on the tenant's entering into the lease.  Problem is that the
tenant's lease said that the *tenant* was relying on the warranty.  So it is
quite possible there would have been no lease had the tenant known that
the warranty wasn't good.  It's not all that clear whether the tenant knew
at the time of the lease that the landlord didn't own the land, but intended
to acquire it.  But apparently the court concluded that the breach of the
warranty in any event was "innocent" on the part of the landlord.   And
there were no damages.

Comment 2: One suspects that there was already momentum toward
agreement here, and it is unlikely that the switch to the ground lease
would have effected a change.  But a substantial tenant would likely
demand, and get, at least a notice right and quite possibly a non-
disturbance right in any event.  It would be relevant to the editor to know
whether other tenants similar to this one got such agreement from the
ground lessor.    If not, and if the tenant had no knowledge that the
landlord was not the owner and did not become the owner, then we have
more than a breach of warranty.  We have a material misrepresentation,
and the guaranty, in the editor's view, should not be effective.
Rescission could be granted with the tenant liable for restitution of
benefits conferred in the form of rents paid.

Comment 3:  Certainly one object lesson here is that if tenants are serious
about these warranties, they ought to be checking title and timely raising
objections.

Readers are encouraged to respond to or criticize this posting.

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