Daily Development for Friday, February 4, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

LANDLORD/TENANT; EXTENSION AND RENEWAL; EXERCISE OF OPTION: Supreme Court of New Jersey discussed good faith and fair dealing principles in finding that where landlord stalled and mislead tenant until after option deadline had passed without telling tenant that it expected a lump sum price for lease renewal in simultaneous with  notice of exercise of tenant’s option, tenant’s failure to provide the lump sum was excused.

Brunswick Hills Racquet Club, Inc. v. Route 18 Shopping Center Assoc., 2005 N.J. Lexis 7 (1/25/05)

DIRT readers may recall the lower appeals court opinion in this case, which was the DD for 2/17/04, discussing an unpublished opinion forwarded to us by Atlantic Report reporter Ira Meislick.  In that case, the editor commented that he thought the case was wrongly decided, and here the New Jersey Supreme Court reverses, albeit, as usual, without crediting DIRT for the advance review.

Tenant operated an indoor tennis facility within the boundaries of a shopping center.  It had leased the ground within the center and spent over $1 million in constructing its facility.   The twenty five year lease contained an option to purchase the property for $150,000.  But the parties were concerned that the local authorities would not permit the subdivision of a parcel within an existing shopping center, so they fashioned an alternative method of providing for the tenant's continuation on the property.  The option gave a right "to purchase the Demised Premises or otherwise convert this Lease into a fully vested ninety-nine (99) year land lease. . . "  In the event the parties used the long term land lease, the tenant had the right to purchase the fee at any time for a dollar.

The option language went on to provide "that with respect to either a purchase or lease . . . Tenant shall pay to Landlord, upon exercise of its right hereunder, a purchase price or rental (fully paid in advance) of [$150,000.]" The option language included a kind of “time of essence” provision that said that if Tenant failed to exercise the option as provided, the land and improvements reverted to the landlord at lease end.

Over a year before the option was to expire, Tenant sent to Landlord a letter specifically exercising the option and asking Landlord to provide a form of 99 year lease and set a closing date.  Tenant further indicated that it was ordering a title search and would notify Landlord of any problems.  It should be noted that the Option provided that the terms of the 99 year lease would be identical to the existing lease and said nothing about a title contingency.  Landlord responded that it was forwarding Tenant’s letter to its counsel for review.

Tenant thereafter made frequent communications to Landlord or its counsel regarding the proposed closing.  Both Landlord and its counsel responded with what were, in retrospect, evasions.  They would acknowledge receipt and say that they were forwarding to either Landlord or Attorney, respectively, for review and response.

At one point, Landlord sent to Tenant an estoppel certificate in connection with a proposed financing of Landlord’s.  The certificate stated that Tenant had no options, and Tenant crossed it out and set forth in the certificate that it had exercised an option to extend for 99 years and also had an option to purchase.

Ultimately, of course, when the time for exercise finally came and went, Landlord “dropped the hammer and told Tenant that the attempted exercise was void for failure to simultaneously provide the $150,000 and later rejected the tender of the amount.

The trial court took testimony as to the trade practice of option exercise in situations like this and concluded, as a matter of fact, that simultaneous provision of the option price was required by the terms of the agreement, and upheld the Landlord’s actions.  An intermediate appeals panel agreed.

The Supreme Court of New Jersey, however, reversed in this opinion.  Although it concurred that the contract required simultaneous payment, it indicated that the full year of evasions and prevarications by Landlord and its agents in the fact of Tenant’s obvious belief that the option had been exercised amounted to a breach of the implied covenant of good faith and fair dealing. The court’s language is the most extensive the editor has seen in connection with analysis of a commercial lease dispute, and it is set forth here at length:

Every party to a contract, including one with an option provision, is bound by a duty of good faith and fair dealing in both the performance and enforcement of the contract.  See Wilson v. Amerada Hess Corp., 168 N.J. 236, 241, 244, 773 A.2d 1121 (2001) (holding that "[a] covenant of good faith and fair dealing is implied in every contract," including contract granting party unilateral discretion over pricing); see also Sons of Thunder, Inc. v. Borden, Inc., 148 N.J. 396, 420-21, 690 A.2d 575 (1997) (holding same for contract granting party unilateral right of termination); Restatement (Second) of Contracts § 205 (1981) ("Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement."); 23 Williston on Contracts § 63:22, at 506 (Lord ed. 2002) (same).

Good faith is a concept that defies precise definition. The Uniform Commercial Code, as codified in New Jersey, defines good faith as "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade." N.J.S.A. 12A:2-103(1)(b). Good faith conduct is conduct that does not "'violate community standards of decency, fairness or reasonableness.'" Wilson, supra, 168 N.J. at 245 (quoting Restatement (Second) of Contracts, supra, § 205 comment a). "'Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.'" Ibid. (quoting Restatement (Second) of Contracts, supra, § 205 comment a). The covenant of good faith and fair dealing calls for parties to a contract to refrain from doing "anything which will have the effect of destroying or injuring the right of the other party to receive" the benefits of the contract. Palisades Props., Inc. v. Br!

, 44 N.J. 117, 130, 207 A.2d 522 (1965) (internal quotations omitted); see also Wade v. Kessler Institute, 172 N.J. 327, 340, 798 A.2d 1251 (2002) (same).

Proof of "bad motive or intention" is vital to an action for breach of the covenant. Wilson, supra, 168 N.J. at 251. The party claiming a breach of the covenant of good faith and fair dealing "must provide evidence sufficient to support a conclusion that the party alleged to have acted in bad faith has engaged in some conduct that denied the benefit of the bargain originally intended by the parties." Williston, supra, § 63:22,   at 513-14 (footnotes omitted); see also Wilson, supra, 168 N.J. at 251; Sons of Thunder, supra, 148 N.J. at 420. As a general rule, "subterfuges and evasions" in the performance of a contract violate the covenant of good faith and fair dealing "even though the actor believes his conduct to be justified." Restatement (Second) of Contracts, supra, § 205 comment d.

We cannot catalogue the myriad forms of conduct that may constitute a violation of the covenant of good faith and fair dealing. Each case is fact-sensitive. This Court, however, has addressed the covenant in a number of different settings. See, e.g., Wilson, supra, 168 N.J. at 241, 244 (applying covenant to contract granting defendant unilateral authority to set and change prices); Sons of Thunder, supra, 148 N.J. at 398, 425 (applying covenant in case involving defendant's termination of contract that denied plaintiff its "reasonable expectations and right to receive the fruits of the contract"); Bak-A-Lum Corp. v. Alcoa Building Prods., 69 N.J. 123, 126-27, 129-30, 351 A.2d 349 (1976) (applying covenant to termination of at-will exclusive distributorship in which defendant intentionally misled and caused harm to plaintiff). Although those cases rest on facts different from those presented here, they yield a few salient principles relevant to our analysis. A defendant may b!

 e liab
le for a breach of the covenant of good faith and fair dealing even if it does not "violate an express term of a contract." Sons of Thunder, supra, 148 N.J. at 423. A plaintiff may be entitled to relief under the covenant if its reasonable expectations are destroyed when a defendant acts with ill motives and without any legitimate purpose. Wilson, supra, 168 N.J. at 251. Moreover, a plaintiff may get relief if it relies to its detriment on a defendant's intentional misleading assertions. Bak-A-Lum, supra, 69 N.J. at 129-30.”

The court concluded that, in light of the breach of the covenant of good faith and fair dealing by Landlord and its counsel in this case, the opportunity to exercise the option would be extended and Tenant would be permitted to exercise it.

“Defendant submits that a landlord does not waive its right to demand strict compliance with the terms of an option in a lease agreement absent an affirmative misrepresentation. Defendant also insists that it  did not engage in "delaying tactics" and that its "continued silence, in the face of repeated requests by plaintiff for affirmative action, could not reasonably have been construed as anything other than an implicit rejection." The record speaks otherwise.”

Note that this case is different from all others discussed by the court in that the party charged with the duty was not engaged in undertaking any optional conduct of its own.  This was simply a case of deliberately permitting the other side to flounder on the basis of its own mistake.  Note that the court agrees that in fact the tenant did make a mistake in assuming that no payment was necessary upon contract exercise.  And in fact Tenant and its lawyers repeatedly made that mistake as they continually reviewed the issue.

But the court, cognizant that it was doing something unusual, finished with a reaffirmation that most commercial law will be “hardball as usual,” even though the court is putting a “soft curve” into the mix of pitches.

“We are not eager to impose a set of morals on the marketplace. Ordinarily, we are content to let experienced commercial parties fend for themselves and do not seek to "introduce intolerable uncertainty into a carefully structured contractual relationship" by balancing equities. Brick Plaza, supra, 218 N.J. Super. at 105. But as our good faith and fair dealing jurisprudence reveals, there are ethical norms that apply even to the harsh and sometimes cutthroat world of commercial transactions. Gamesmanship can be taken too far, as in this case. We do not expect a landlord or even an attorney to act as his brother's keeper in a commercial transaction. We do expect, however, that they will act in good faith and deal fairly with an opposing party. Plaintiff's repeated letters and telephone calls to defendant concerning the exercise of the option and the closing of the ninety-nine-year lease obliged defendant to respond,  and to respond truthfully.

In concluding that defendant violated the covenant, we do not establish a new duty for commercial landlords to act as calendar clerks for their tenants. We do not propose that attorneys must keep watch over and protect their adversaries from the mishaps and missteps that occur routinely in the practice of law. The breach of the covenant of good faith and fair dealing in this case was not a landlord's failure to cure a tenant's lapse. Instead, the breach was a demonstrable course of conduct, a series of evasions and delays, that lulled plaintiff into believing it had exercised the lease option properly. Defendant acted in total disregard of the harm caused to plaintiff, unjustly enriching itself with a windfall increase in rent at plaintiff's expense. In the circumstances of this case, defendant's conduct amounted to a clear breach of the implied covenant of good faith and fair dealing.

We are mindful of the potential pitfalls in enforcing the covenant of good faith and fair dealing. If courts construe the covenant too broadly, it "could become an all-embracing statement of the parties' obligations under contract law, imposing unintended obligations upon   parties and destroying the mutual benefits created by legally binding agreements." Northview Motors, Inc. v. Chrysler Motors Corp., 227 F.3d 78, 92 (3d Cir. 2000). We have warned that "'an allegation of bad faith or unfair dealing should not be permitted to be advanced in the abstract and absent an improper motive.'" Wade, supra, 172 N.J. at 341 (quoting Wilson, supra, 168 N.J. at 251). "'Contract law does not require parties to behave altruistically toward each other; it does not proceed on the philosophy that I am my brother's keeper.'" Wilson, supra, 168 N.J. at 251 (quoting Original Great Am. Chocolate Chip Cookie Co. v. River Valley Cookies, Ltd., 970 F.2d 273, 280 (7th Cir. 1992)). We stress that wh!

 ile a
commercial party does not have to act with benevolence towards an opposing party, it cannot behave inequitably.”

Comment 1:   For an interesting good faith and fair dealing case, imposing such a duty on the tenant to warn the landlord of the legal consequences of its actions in an option context, see Market Street Assoc. v. Frey, 21 F.34d 782 (7th Cir. 1994) , where the tenant was held to have a duty to warn the landlord that if the landlord refused to finance the tenant's proposed improvement of the leased premises, the tenant would be able to buy the property at a "steal" price due to appreciation in values in the unexpectedly long time that had run before the tenant asked for the financing.  This case was the DD for 4/20/95 - one of the first DD's run on DIRT.

Comment 2: The editor absolutely hated the analysis and outcome in Market Street.  But he is less concerned about the outcome here.  Courts always find ways to do substantial justice when there is harsh dealing going on.  The editor is more concerned about the creation of a whole new code of conduct that lower court judges are likely to find parties continuously arguing in every case, leading to considerable uneveness in enforcement and, ultimately, in predictability.

Even worse is the possibility that the duty could infect the pre contract bargaining relationship, where it really should be incumbent on each party to look out for itself.  But we’re not there yet.  The case, in the editor’s view, can be contained.

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