Daily Development for Monday, June 4, 2001

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

LANDLORD/TENANT; ASSIGNMENTS AND SUBLEASES; ASSUMING ASSIGNEE: Assignee that unequivocally assumes obligations of lease that is subject to leasehold mortgage remains liable on theory of privity of contract even when leasehold mortgage forecloses and transfers leasehold to others. Vallely Investments, L.P. v.

BancAmcerica Commercial Corporation, 106 Cal.Rptr.2d 689 (Cal. App. 2001)

Balboa L.P. was an assuming lesee of a long term ground lease as lessee with Vallely as lessor. Balboa and Vallely modified the lease, and under the amended terms. Balboa could mortgage its leasehold and any mortgagee or foreclosure sale purchase would be obligated on the lease only upon foreclosure and then only to the extent of a bankruptcy order or privity of estate. Balboa mortgage its leasehold to Bank.

Later, Balboa had financial problems at a time when it was doing construction work on the premises. A foreclosure appeared imminent.

Balboa, desiring to protect its investors (presumably guarantors) from personal liability negotiated with Bank that the Bank would take a deed in lieu of foreclosure and waive any personal liability claims. Bank was not completely averse to this idea, because it wanted to get immediate possession of the property for purposes of preserving it, but Bank was concerned that if it took a deed in lieu it might take property encumbered by mechanics liens which would get elevated to senior position due to a merger of title. [The editor doubts that this was a real problem under the better decided cases, but the parties, according to the court, thought that it was.]

The parties arrived at the solution of transferring the property to BACC, a wholly owned subsidiary of the parent of Bank. BACC was to hold the leasehold and then suffer a foreclosure of the deed of trust, apparently under the notion that the mechanic's liens would not attach to BACC's title. [Although unfamiliar with California lien law, the editor surmises that this was possible only because the liens had not yet been filed as of the time of transfer, but he wonders why this would matter if BACC had knowledge of pending liens. The court does not explain why the parties believed the liens would be avoided.] In connection with its taking a transfer of the leasehold from Balboa, BACC expressly assume all the obligations of the Vallely lease, which indeed it was required to do by the terms of that lease (even though Vallely knew nothing about the transfer to BACC until much later).

BACC took immediate possession and commenced management of the property. Bank immediately commenced foreclosure proceedings, which it completed two months later. Under California law, it had no right to a deficiency judgment [if there were guarantors, Bank apparently waived its rights against them.] Bank bought the leasehold estate at the foreclosure and subsequently transferred the leasehold to Edgewater.

Vallely knew of the foreclosure and transfer from Bank to Edgewater, and in fact entered into a lease modification agreement with Edgewater that extended the time for payment of the 1996 rent in exchange for Edgewater's agreement to make certain improvements to the property.

In May of 1996, Edgewater missed a scheduled rent payment on the rent schedule agreed upon in the modification, and Vallely brought suit [apparently the suit was for the rent, and Vallely did not attempt at that time to cancel the lease.] Edgewater filed for bankruptcy, and ultimately the trustee did not assume the lease, and Vallely took possession of the property in 1998, apparently terminating the lease.

In the course of all this legal maneuvering, Vallely learned of the assignment to BACC and BACC's assumption. It brought suit against BACC for the balance of the rent [presumably reduced by the fair rental value of the premises under the California approach here.]

The trial court granted summary judgment to BACC and denied Vallely's summary judgment motion.

On appeal: held: Reversed. BACC, due to its assumption, was in privity of estate, and all of BACC's arguments to avoid liability on this assumption were, in the view of the court, "bootless."

Faced with arguments by BACC counsel, one of the leading real estate litigators in California, the court steers a remarkably true course through a minefield of arguments. It acknowledges that the issue of whether an assuming lessee remains liable when it loses the leasehold through foreclosure is a matter of first impression in California. The court acknowledges that, following the foreclosure, there was no privity of estate between BACC and Vallely. But it points out that an assuming assignee's liability is based upon privity of contract, not privity of estate, so the fact that the assignee passes out of possession of the leasehold is of no consequence, and the fact that such transfer of possession resulted from a foreclosure of a leasehold mortgage also is of no consequence as far as the lessor is concerned, since the lessor's rights are separate from and senior to the leasehold mortgage.

BACC argued that the overall intent was that BACC not be an assignee, but merely some kind of "holder" of the leasehold pending foreclosure. Response: then it shouldn't have executed an unequivocal assignment and assumption. BACC argued that, since the parties intent was that BACC have possession only for a short time, it couldn't be an assignee, and must be a sublessee. Response: This is probably incorrect, since the assignment gave BACC rights for the balance of the term, but even if the argument is correct, it means nothing, since a sublessee can assume and thus be bound for contract damages arising after its term has ended.

[Note that, although all of this is probably correct, the landlord, who was the third party beneficiary of the assumption promise, had no knowledge of it during BACC's entire tenure of the property, and found out only several years later.]

So far, so good, and right on target.

BACC then argued that, as an assuming prior assignee, it was merely a surety for Edgewater, and that the extension of time that Vallely gave to Edgewater amounted to a increase in liability for BACC and triggered a release of BACC under principles of suretyship.

The court held that there was no California authority making a prior assuming assignee a surety for subsequent lessees, and that consequently the suretyship rules did not apply. In any event, it held, even if BACC was a surety, there could be no release of BACC when Vallely had no knowledge of BACC's position as surety at the time it gave the extension to Edgewater.

BACC then played its last big card it argued that the bankruptcy court rejection of the lease and discharge of Edgewater's liability for future lease performance operated as a termination of the lease obligations of BACC. The court had little problem with this, since it had already established that the contractual obligation of BACC was not based upon the present tenant's continuing liability, but rather on the contract obligations it undertook to Vallely. The lease was still in existence, albeit in default, when the bankruptcy court rejected any interest in it.

Vallely properly had the right to terminate the lease for nonpayment and look to its contractual rights against BACC.

Comment 1: Most jurisdictions do recognize an assuming assignor as a surety, and the court's questioning this conclusion is somewhat troubling, but moot. The court correctly notes that an obligee cannot lose rights against a surety due to the granting of an extension of time for payment to the principal when the obligee is unaware at the time of the surety's existence.

Comment 2: The lease provided expressly that anyone taking the premises as assignee automatically would be viewed as having assumed the obligations of the lease. Fortunately, the landlord did not have to face a test of this language, since BACC expressly assumed the lease.

But one wonders if the court's arguments, all based on a contractual undertaking, would have been so forceful had there been no express agreement to assume.

Comment 3: The judge who wrote this opinion shows a quite remarkable grasp of the basic complexities of real estate law. Would that all complex California real estate cases be channeled his way.

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

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