Daily Development for Friday, November 5, 2004
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

LANDLORD/TENANT; ASSIGNMENTS AND SUBLETS; CHARACTERIZATION: Arkansas stands by its unique rule that sublessees and assignments should be differentated by the parties’ probable intent, and goes on to hold that sublessees are not entitled to the same protection of equity from the consequences of a default by the sublessor that an assignee would have from default by an assignor.

Abernathy v. Adous, 2004 Ark. App. Lexis 167 (Ark. App. 2/25/04)

Landlord entered into a “build to suit” lease arrangement with Tenant for a service station. The lease had an initial ten year term with six five year renewal options. Tenant paid bifurcated rent. Some rent went directly to Landlord’s lender and some went to Landlord.

About five years later, Tenant later entered into an agreement with Quran. The parties denominated this agreement “sublease” and there were references throughout the text to the fact that the agreement was a sublease. But it appears that the term of this agreement was the exact length of the term of the master lease. Quran was later substituted by Adous . Under their agreement Quran and later Adous paid rent to Tenant in an amount exactly equal to the amounts payable by Tenant to Landlord. There was no evidence that Landlord or its lender knew anything about the “sublease” until Tenant failed to remit the rent as required after receiving it from Adous.

Upon this default, by Tenant, Landlord initiated an unlawful detainer, but ultimately Adous paid rent to catch up the default and Landlord dismissed its action. A few months later, however, Tenant again defaulted, even through throughout Adous had been paying the required rent to Landlord. Landlord then initiated an unlawful detainer action and refused Adous’ offer to catch up the back rent and pay landlord directly.

The trial court found that the relationship between Adous and Landlord was an assignment, not a sublease, due to the fact that the term of Adous’ rights was coincident with the Landlord’s term on the master lease, and ruled that, as an assignee, Adous was entitled to greater protection against inequitable forfeiture than he would have had as a “mere” sublessee. As an assignee is in privity of estate with the landlord, the court reasoned, it was entitled to all the protections to which an ordinary tenant is entitled, including equitable considerations to avoid a forfeiture of its long term lease interests. The trial court found it significant that Adous was really an assignee, as it was of the view that a sublessee would not have the benefit of equitable defenses against the master lessee.

The appeals court agree with the distinction between sublessee and assignee with respect to the availibility of tenant’s equitable defenses. But it disagreed with the trial court as to the characterization of Adous’ rights. It noted that the established precedent in Arkansas remains Jaber v. Miller, 239 S.W. 2d 760 (1951), which established a unique Arkansas rule that the court will determine whether a lease is a sublease or an assignment based upon the parties’ intent, rather than upon whether the original tenant reserved any of its estate on transfer to the new tenant. Here, there was abundant evidence that the parties viewed themselves as engaged in a sublease, due to their frequent use of the term and the fact that the rent was paid directly to the tenant, rather than to the landlord. Finally, the court noted that the master tenant reserved a right of reentry in its agreement with Quran/Adous. This is not only indicative of an intent to create a sublease, as the court not ed, but has in and of itself been viewed in other states as the reservation of an portion of the leasehold estate by the transferor master tenant and thus as making the arrangement into a sublease even under the more traditional common law rule.

The court then went on to agree with the trial court that sublessees are not entitled to the same considerations against inequitable forfeiture that an assignee gets, and that Adous was therefore not able to avoid forfeiture by curing the master tenant’s defaults. Landlord got the property back.

There were two dissenters. One dissenting opinion, in which both dissenters joined, concluded, possibly as some readers of this piece have concluded, that it makes no sense to differentiate between a sublessee and an assignee for purposes of deciding whether equitable relief from forfeiture should be granted. Equity is equity, and not based necessarily upon cure contract rights to begin with.
“[Landlords] have received exactly what they sought - a lease of the facility over a long period of time with timely payment of rent. The inequity in this case lies in the fact that Adous, who has agreed to uphold the terms of the original lease and has paid rent in a regular fashion, must no forfeit the business he has operate simply because [the master tenant], who after 1997 was acting as a mere conduit, became unable to pay rent. This is the type of forfeiture that equity should prevent. . . .”

A second dissenter also questioned whether the court properly found that there was a sublease, rather than an assignment, emphasizing that the right of reentry reserved by the landlord was a right that could be exercised only through an unlawful detainer action. This dissenter also emphasized that virtually the whole estate of the master lessee had been transferred. [the fact that there was still about 30 days reserved by the master tenant became less significant because the options were also transferred, and, of course, the dissenter was still attempting to apply the “intent” test rather than the more rigid common law rule.

Comment 1: The Jaber case has long appeared in property casebooks as a kind of whipping boy for professors to use to point out the benefits of a characterization approach based upon clear and predictable guidelines. The instant case is a model. There likely wouldn’t have been a case at all if the distinction really turned on whether there was a sublease or an assignment and the parties could tell, without going to court, which arrangement they had created. In real estate law, where uncertainty is inconsistent with the public interest in maintaining the transferability of land, thus maximizing the ability of the market to put the public resource in land to its highest use, it is vital that court rules minimize uncertainty. Although one can argue that rigid rules impose on parties consequences that they didn’t actually intend, the same could be said of rules based upon a court’s ex post facto judgment of the parties’ intent in a case where the parities clearly are disputing what they intended. If parties are well advised legally, they can manipulate the lease/sublease rules to create the interest they intended. If they are not well represented, the liklihood that they’ll clearly understand the differences between the two types of relationships is quite low, so there is little to be gleaned from exploring their intent - their intent was, likely a pretty foggy thing.

Comment 2: That having been said, the editor tends to agree with the dissenters (as readers may have gathered) that there really ought to be no difference as to equitable reinstatement of a default of a transferring tenant by the possession tenant whether the party effecting the cure is a sublessee or an assignee. The editor likely would be pretty conservative about providing such relief in any event, but if there's going to be relief, he believes that the nature of the petitioner's interest - whether sublease or assignment -is not dispositive

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