DIRT DEVELOPMENT for Friday, January 23, 2009
Daniel B. Bogart
Donley and Marjorie Bollinger Chair in Real Estate Law
Chapman University School of Law, Orange, California

This is a Danny Bogart- authored DD that I'm  posting a little early because I'm travelling on Thursday.
LANDLORD/TENANT;  OPTION TO PURCHASE; CONDITIONS:  Landlord must specifically perform sale of property to tenant pursuant to option in lease, even though the parties had never agreed to terms for the time and manner of payment, leaving such matters to a disputed escrow arrangement.
Patel v. Liebermensch, 86 Cal.Rptr.3d 366 (Cal. 2008).

Liebermenschs owned a condominium unit in San Diego.  They purchased the unit hoping that one of their children would choose to live in it after completing college.  Their children disappointed them however;  none made use of the condominium.  As their Plan B, the Liebermenschs decided to lease the unit to Patel. The Liebermenschs drafted a “proposal” for a lease agreement with Patel for a one year lease at a rental rate of $1200 per month.  The proposal provided Patel an option to purchase, and set the purchase price at $290,000.  By its own terms, the option right terminated at the expiration of the lease term.  Liebermenschs asked Patel to accept the terms by signing and then faxing the form them, which Patel did.  However, Patel attached a handwritten amendment to the lease/option proposal that granted Patel a right to extend the term for an extra year.

The Liebermenschs signed the option proposal and initialed the handwritten amendment prepared by Patel.  Liebermenschs then created a lease agreement based on a form document, including a proviso that “Option to buy is attached".The case opinion suggests, but does not make entirely clear, that the referenced “Option” was the proposal signed by the parties. 

In July of 2004, by letter, Patel notified Liebermenschs that Patel was exercising its option to purchase the condominium unit.  It is at this point that problems began to arise.  In his letter, Patel clearly informed Liebermenschs that he wanted to close quickly because interest rates were at a very attractive, low level. The usual next step would be for the seller, in this case the Liebermenschs, to create a purchase agreement setting out the mechanics of the purchase transaction – inspection rights, title abstracting, and statement of closing date.  The Liebermenschs did so, but they demanded 1) that Patel take the property “as-is”; 2) that Patel pay a ten percent deposit on the purchase (to be given to the escrow company); and 3) that Patel allow Liebermenschs as many as 120 days to close, thereby permitting  Liebermenschs to exercise a 1031 like-kind exchange.  This was all news to Patel.

Indeed, at trial the Liebermenschs admitted that they never broached their like-kind exchange concern with their purchaser.  The case opinion does not indicate whether the ten percent deposit was discussed by the parties prior to creation of the purchase agreement, but it is not mentioned in the option language repeated by the court.

Patel wanted this property and was willing to give in to their sellers, to a point.  Patel accepted the as-is language requirement, but only to the extent Patel was “fully satisfied, and … if the seller required more than 30 days to close escrow, the deposit would be reduced to $5000” and in that event Liebermenschs would pay costs associated with escrow. Patel was informed by his broker that his interest rate could not be locked for 120 days. 

The Liebermenschs were not pleased with Patel’s response, and rejected the amended purchase contract offered by Patel.  They told Patel bluntly that Patel would have to buy the condominium unit on the seller’s terms, or not at all. In other words, Liebermensch demanded that Patel accept payment for the property at a time and in a manner of the seller’s choosing. Eventually, Patel gave in, and signed the purchase agreement as created by Liebermenschs, but to no avail. The seller ultimately declined to sell the property. 

Patel filed his suit seeking specific performance, and won a jury trial. The court held that a valid option contract existed between the parties and Liebermensches breached that contract.  As noted in a recent Development, exercise of an option to purchase real property transforms the option into a purchase contract.  Patel was therefore entitled to specific performance of this contract.

The court of appeals reversed, although over a strenuous dissent.  The court of appeals determined that the parties never reached a meeting of the minds. The court of appeals agreed with the seller that the manner and time of payment are essential elements of a contract and that the parties never reached an agreement regarding these elements in this transaction. The court declined to read “reasonableness” into the agreement between the parties to fill in the gaps.

The Supreme Court of California reversed the court of appeals and reinstated the result of the trial court.

The California Supreme Court admitted that disputes between parties to a contract after the contract is allegedly made “may be relevant in determining which terms they considered essential.”  But the court goes on to state that “few contracts would be enforceable if the existence of subsequent disputes were taken as evidence that an agreement was never reached.”  The Liebermenschs are the primary drafters here, and they could, according to the court, have provided for more detailed escrow arrangements.  If the like-kind exchange was important to them, they should have disclosed that fact.  They then could have provided for the extended escrow in the option and purchase agreement.  This would have allowed Patel to negotiate the term to protect tne favorable interest rate Patel desired.

Reporter’s Comment 1: The overall result seems appropriate to this reporter.  The Liebermenschs were looking for a way to walk on a deal when the buyers eventually caved in to all of the seller’s demands. 

Reporter’s Comment  2: Still, an issue exists whether there was really, truly a meeting of the minds on a contract.  For our purposes, the contract is the option agreement.  It did not contain the “extended escrow instructions” that the court suggests would have made seller’s needs clear.  But is there an argument that the absence of manner and time of payment language in this kind of contract should be essential elements of a meeting of the minds? 

True, a court can infer reasonableness in timing issues when the parties have reached an agreement.  But today timing and manner of payment are critical issues that most buyers and sellers think about when entering transactions.  Many aspects of a transaction are collateral and not central to the decision of parties.  The parties may choose not to detail these terms. One party may then act opportunistically, but in the end the court will enforce the contract. 

For example, consider a buyer and seller who do not specifically describe in their contract what type of deed the seller will provide at closing.  Seller arrives on the date for closing with a limited warranty deed and buyer refuses to close demanding a general warranty deed.  A court will specifically enforce the contract and require seller to deliver the type of deed according to customary practice in that legal community.  By contrast, how and when a buyer pays and seller receives several hundred thousand dollars may today be a more central issue, and one that is not as easily solved by resort to customary practice.  The court relies on its own precedent, King v. Stanley, 32 Cal. 2d 584 (1948) – an old case.  What if the shoe had been on the other foot?  What if it was the buyer – Patel – who wanted out of the contract? Would the court then hold that the manner and time of payment were not essential terms?  The reporter has a funny feeling that these terms look more essential from the buyer’s perspective – after all, he has to come up with the cash.  From a purely legal perspective, however, it should not matter.

Reporter’s Comment 3:  Patel must have really wanted the property.  A ten percent deposit is excessive; a contract would be supported by much less.  A ten percent deposit might enforced as valid liquidated damages, even though there is nothing in the arrangement to indicate that the parties really tried to ascertain what the reasonable amount of damages would be in event of breach.  A court might view this as a penalty. There is something almost biblical about ten percent and courts view the number as the dividing line between valid damages and unenforceable penalties.

Editor’s Comment:  Compare Brunswick Hills Racquet Club, Inc. v. Route 18 Shopping Center Assoc., 864 A. 2d 387 (N.J. 2005) (The DIRT DD for 2/4/05) where the opotionor took the position that, absent language in the option, the optionee was obligated to tender the purchase price along with the notice of exercise.  The lower court upheld this position, and the trial court ruled inferentially that it was correct as a matter of contract interpretation, but ruled that there was a duty of good faith and fair dealing to inform the optionee of the optionor’s interpretation while the optionee still had time to produce the funds with the option period.

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