Daily Development for Thursday, February 10, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

LANDLORD/TENANT; ASSIGNMENTS AND SUBLEASES; RIGHTS OF SUBLESSEE: Although master lessee cannot cooperate with master lessor to eliminate sublease, where master lease is terminated by surrender, but surrender is deemed "involuntary" due to preexisting defaults, sublease is also terminated.

Applebee's Northeast, Inc. v. Methuen Investors, Inc, 709 N.E.2d 1143 (Mass. App. 1999)

This was a typically elaborate shopping center deal with a typically elaborate failure. Metlife held a long term ground lease on the principle property, subject to a nonrecourse mortgage to Teachers. Metlife subleased a portion of the property to Applebee's, under a lease which still had six years to run with two additional five year options. (Applebee's claimed that Metlife represented to it that Metlife owned the fee, and that Applebee's was a prime lessee, not a sublessee, but the court held that Applebee's should have known better by checking the land records).

The mall's business basically fell into ruins the court speculates that it was due to competition from New Hampshire (sales tax free) a short distance away. All the tenants left or failed except for Applebee's. Metlife lost interest in the project, and fell behind on everything, even though the court admits that the company otherwise was "quite solvent." Metlife failed to pay real estate taxes ($650,000) and mortgage payments (another $670,000) and was a year behind on the ground lease. The ground lessor filed notice of default.

Enter the Developers. Developers saw an opportunity to convert the project into a more profitable use. It bought the lessor's interest in the ground lease for a stated consideration of $100,000 and acquired the Teacher's mortgage, originally $14 million, for $4 million.

After extensive negotiations with Metlife, and the execution of an agreement granting the Developers a number of options as to how to deal with the situation, the Developers elected simply to terminate MetLife's leasehold interest by notice. Although MetLife had cure rights under the lease, it did not exercise them, and did not resist the termination notice in any way. It apparently had earlier waived its purchase option in the ground lease. Following the termination announcement of the MetLife lease, Developers then sent a notice to quit to Applebee's and this litigation ensued.

Applebee's argued an elaborate conspiracy between MetLfie and the Developers to eliminate its sublease interest. The court dismissed it all as normal interraction between debtor and creditor which, although not "hermetically sealed" from one another, did not interract in a way that was inconsistent with typical workout arrangements. The court commented: [Ad]jectival abuse of the parties does not make conspirators of them." The court notes that Applebee's fails to take into account the point that MetLife had a nonrecourse position [the editor notes that the court's earlier statement of facts indicated a nonrecourse position only on the mortgage, and does not mention the lease and sublease.]

As to the question of whether MetLife should have worked harder to preserve the sublease, the court differentiates between "voluntary" and "involuntary" actions leading to the surrender of the master lease. In the former case, courts have refused to terminate the sublease and have vaulted it into prime position. In the latter case, courts have simply permitted the termination of the sublease to occur. As the court stated:

"In the situations supposed, when the termination of the prime lease occurs by act of the parties outside the terms of that lease, we can say (with some awkwardness) that the surrender foisted on the sublessee would be coming about by voluntary' acts of the fee owner and prime lessee whereas in case of ordinary forfeiture the surrender is by operation of the lease and the law and so is involuntary.'"

As to the distinction between "voluntary" and "involuntary" terminations, the court analyzed a number of cases from various jurisdictions, and posited this approach: "where ground for termination under the terms of the prime lease does not clearly exist, an agreement by the parties to that lease to end it is "voluntary" and a sublease survives." Further: "Where a cause of forfeiture has arisen, the fact that the lessee consents to the enforcement of the forfeiture does not render the transaction a surrender as distinguished from a forfeiture so as to bring it within the rule that a lessee cannot by a surrender affect the estate or the interest of third persons held under him."

The court concluded that MetLife's actions here were "involuntary" in that the landlord took action it was entitled to take under the lease in response to MetLife's default. It did not inquire into whether the default itself was "voluntary" in light of the fact that MetLife certainly had the wherewithal to pay the lease payments, since MetLife was (it can be inferred) a nonrecourse obligee under the lease.

Comment 1: Sublessees are probably the least favored parties in all of real estate law. The presumptions and doctrines tilt against them for more than against tenants, buyers, sellers, mortgagees or parties to servitudes. Most of the problems can be resolved by good lawyering and tough negotiating, but when one undertakes to be a sublessee, one had better be geared up to make use of these devices.

Comment 2: The analysis of this case basically ends with the conclusion that Applebee's here should have anticipated the issues, obtained strong counsel, and bargained for nondisturbance at the outset. But, of course, if MetLife actually did tell Applebee's that it was the owner of the fee, then Applebee's may not have seen the need. The court apparently refuses to believe Applebee's version of this representation, but its secondary answer, that Applebee's should have known better by checking the legal documents, strikes the editor as off the mark. Shouldn't Applebee's have been entitled to rely upon an express representation of MetLife that it was the owner?

Comment 3: The court's conclusion that MetLife's lease termination was "involuntary" involves questions of psychology and philosophy that reach far beyond this little dispute in Methune, Massachusetts. The issues are worthy of debate some distance south, at the Harvard Business School. Did MetLife make a contractual undertaking of good faith and fair dealing to Applebee's that it breached by failing to maintain its prime tenant status? Apparently the court concludes that Applebee's sole protection was the economic health of the center, and if that failed, Applebee's lease essentially meant nothing. On first blush, the editor is inclined to agree with the analysis, but there is a nagging uncertainty here.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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