Daily Development for Tuesday, June 3, 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

LEASES; OPTIONS; VALIDITY; "AGREEMENT TO AGREE:"
Option to lease 120 hospital beds in which "the location of the Premises
and the amount of rent" shall be subject to renegotiation at the option of
either party" is not void as an "agreement to agree" but rather imposes on
the Landlord an obligation to negotiate in good faith.

Lloyd Noland Foundation v. City of Fairfield, 837 So. 2d 253 (Ala.
2002)

In this complicated game of "hospital bingo" various groups were
jockeying for position to provide extended acute care services.  In order
to do that, providers are required to obtain a Certificate of Need from the
state health services licensing agency, and in this particular case that was
easier said than done.

Foundation, which owned and operated a hospital,  initially resolved to
seek a certificate to convert 120 beds to extended acute care beds.   These
would have been part of a special "hospital within a hospital" - a special
long term care operation.  The application for the certificate was denied,
and thus began a five year odyssey in search of a certificate, marked by
interventions of other parties seeking to get certificates for their own long
term acute care beds and cross interventions by Foundation.  Ultimately,
Foundation did obtain a certificate from an administrative law judge to
operate a smaller number of beds in several locations.

While the appeal of the initial denial was pending, Foundation elected to
sell its hospital by Tenhet.  The agreement with Tenhet included a
provision that was designed to preserve Foundation's ability to continue
to operate the "hospital within a hospital" separately although Tenhet
owned the rest of the facility.  The provision noted that there was an
application pending for 120 beds for extended acute care and that, should
the application be granted, Foundation reserved the right to repurchase
the beds (and apparently related licenses and other good things) for
$1.00.  Tenhet also agreed to cooperate with Foundation's application in
having the beds "relicensed, recertified or relocated for long term acute
care purposes at the Hopsital or at other sites."

The same day, the parties executed a lease agreement whereby Tenhet
agreed to lease to the Foundation 972 square feet of space, located on the
second floor of the hospital building, for purposes of operating the 120
beds.  The Foundation also got "an ongoing and continuing option to
expand to Premises" to include all or any portion of the remainder of the
second floor of the hospital at the same rate per square foot as set for the
original space (which was set at an initial  annual rate of $25 per square
foot subject to various adjustments).

The lease agreement including other language dealing with delays in the
licensing process, of which the parties were acutely aware at this point.
Probably it is best to set forth this language in the entirety:

     "2.1 Initial Term. [Tenet] agrees to deliver possession of the
     Premises to [the Foundation] no later than thirty (30) days
     following the receipt of notice from [the Foundation] that it has
     received a Certificate of Need to operate the [long-term-care
     services] at the Premises (the 'Notice Date').  The date upon
     which [Tenet] delivers possession of the Premises to [the
     Foundation] shall be referred to herein as the 'Commencement
     Date.' The term of this lease shall, unless sooner terminated as
     herein provided, continue for five years following the
     Commencement Date. [The Foundation] shall not be obligated to
     take possession of the Premises until after the Notice Date.
     [Tenet] may use the Premises for it[s] own purposes prior to the
     Notice Date so long as [it] keeps the Premises in good order and
     repair and permits no alteration of, nor waste, damage, or injury
     to, the Premises. . . .

     "2.3 Effect of Delay or Non-Occurrence of Notice Date. In the
     event the Notice Date shall not have occurred on or before March
     31, 1998, neither party shall be bound by the location of the
     Premises or the amount of rent established by the terms of this
     lease, and the location of the Premises and the amount of rent
     shall accordingly be subject to renegotiation at the option of
     either party.  In the event the Notice Date shall not have occurred
     on or before March 31, 2001, this lease shall be null and void and
     of no further force and effect."

As things came to pass, on March 31, 1998, Foundation was nowhere
close to getting final determination of what was then a reapplication for a
certificate.  Various other parties intervened, and litigation continued
throughout 1998 and 1999.  In 1999, further, Tenhet sold its position in
the hospital to Fairfield.   The agreement of sale was an "asset sale
agreement" and included language which (the court concluded here)
constituted an express assumption of Tenhet's obligations to Foundation
under the lease.

In early 2000, just when it appeared that Foundation was about to resolve
its problems and get a certificate for at least some of the beds it had
requested, with some of the beds to be located at the hospital, Fairfield
initiated litigation in which it sought a determination that it was not
bound by the option in the lease, and that Foundation had no right to
obtain the certificates when it held only an option to obtain the beds.

Fairfield's position as to the option was, first, that it had not expressly
assumed the obligations under the option (the court's analysis dismissing
this contention is not relevant here).  Fairfield then argued that, in any
event, the option was void for vagueness, since it amounted to nothing
more than an agreement to agree.  Fairfield noted that the agreement
provided that if Foundation gave notice after on April Fool's Day of
1998 or thereafter, either side was free to renegotiate with respect to both
price and location of the certificated  beds.  Note also that the number of
beds was not necessarily fixed, because the certification quite possible
would come in at a number less than 120 (which it ultimately did).

The Supreme Court of Alabama here ruled that the option in fact was
enforceable.  Foundation did not need to have anything more than an
option to seek certification.  Although, by the time of trial, the "drop
dead date" of March 31, 2001 had come and gone without certification,
the court noted that this was due to Fairfield's opposition to the
certificate application, something that was directly inconsistent with the
agreement to cooperate with the application that the court concluded
Fairfield had assumed.

With respect to the allegation that the option agreement was
unenforceably vague, the court noted that Alabama precedent establishes
that "agreements to later agree are not enforceable."  It went on to say,
however, that this principle had no application here anyway, since there
were already clear terms which would apply unless one of the two parties
opted to renegotiate.

The court then turned to the "cooperation clause," pursuant to which
Tenhet (and through it, Fairfield) had agreed to cooperate with
Foundation in obtaining the certification.  It stated that Tenhet would
"cooperate with [Foundation] in having the [beds] relicensed, recertified
or relocated for long term acute care purposes at the Hospital or at other
sites." [emphasis added] Since this meant that Foundation necessarily
had to have bed sites, Fairfield was obligated to cooperate in providing
those:
     "The cooperation clause vests the Foundation with the right - at
     its option - to operate all 120 of the [beds] at the Hospital, subject
     only to [certification].  Conversely, it encumbers Fairfield with
     the obligation to make available to the Foundation such space as
     is reasonable and necessary for the use of the beds.  It necessarily
     follows from the cooperation clause that Fairfield will lease the
     Premises, will act in good faith in doing so, and will not invoke
     other provisions of the agreement merely to defeat its obligations
     under the cooperation clause.  Thus, the parties do not have an
     agreement merely to agree later; they have an agreement."

The court goes on to cite language in other Alabama cases that appears to
stretch the rule of this case (at least the dicta) beyond only those cases in
which there is a specific duty to cooperate:

     "Where a contract fails to specify all the duties and obligations
     intended to be assumed, the law will imply an agreement to do
     those things that according to reason and justice the parties
     should do in order to carry out the purpose for which the contract
     was made." . . . "There is an implied covenant that neither party
     shall do anything which will have the effect of destroying or
     injuring the rights of the other party to receive the fruits of the
     contract ; . . . in every contract there exists an implied covenant of
     good faith and fair dealing."

Comment 1: At least one clear lesson to be drawn here is that parties in
Alabama can always dodge an allegation that a contract is void for
vagueness by providing for fixed terms which later can be renegotiated at
the option of a party.  As here, this will "cement in" other aspects of the
contract that may prove beneficial, such as the duty to cooperate with
licensure, which arose even before there could be any renegotiation.

Comment 2: As suggested the language cited at the end of the piece
suggests that the court is basing its conclusion on the duty to negotiate
here on the broad duty of good faith and fair dealing implied in every
contract, and not expressly on the "cooperation clause."  If that's true,
then the case has implications in every case in which terms are to be
negotiated later.  It's nice to say that there's a duty to negotiate in good
faith, but what does that mean?  If one's failure to agree to a proposed
price will leave the other side in a pickle, is the failure to agree a breach
of good faith and fair dealing - even if the pickle was (as here) totally
foreseeable?

Comment 3: Exactly at what point does Fairfield's negotiation position
become a breach of good faith?  Is there a limit on profit?  How much?
Can the court compare to other leases?  How in the world will it get
accurate information as to fair prices in transactions as unique and
complicated as the hospital game?

Readers are encouraged to respond to or criticize this posting.

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