DIRT DEVELOPMENT for September 1, 2009
Daniel B. Bogart Donley and Marjorie Bollinger Chair in Real Estate Law
Chapman University School of Law, Orange, California
LANDLORD/TENANT; CONSTRUCTIVE EVICTION; WAIVER: Tenant may assert constructive eviction claim against landlord's mortgagee, rents assignee based upon defects caused by assignor landlord notwithstanding UCC 9-4039(c), tenant’s  estoppel certificate or "hell or high water" clause in the recognition agreement.

Reliastar Life Insurance Company of New York v. Home Depot U.S.A., Inc., 570 F.3d 513 (2d Cir. 2009)
In late February of 1989, Home Depot entered into a lease with G&S Investors. G&S, as landlord, agreed to construct a building pad for the building, and Home Depot, as tenant, would build that actual facility. G&S constructed an "earthen" pad, and Home Depot constructed the store and opened in December of 1990.

In 1993, G&S mortgaged the property to North Atlantic Life Insurance Co.; Reliastar is the successor in interest to North Atlantic Life. The 1993 mortgage was guaranteed by an assignment of the Home Depot lease. The assignment assigned all rents, income and profits in connection with the lease to the mortgagee. In addition, it required Home Depot to recognize the assignment, and to make all of its rent payments directly to the mortgagee.

Home Depot complied. It executed a Recognition Agreement to Reliastar (this document was drafted by the lender.) It contained the following paragraph 7(a)(which the court calls a "hell or high water" clause):

"Tenant understands that a substantial inducement for Mortgagee to purchase the Notes is the continuing existence of the Lease, the income stream payable therefrom and the direct payment to the Mortgagee of all rents and other payments due under the Lease and that in furtherance thereof the Mortgagor has by the Assignment assigned its interest in the Lease, the rents and all other payments due under the Lease to Mortgagee as security for repayment of the Note. Tenant agrees that notwithstanding anything in the Lease or this Agreement contained to the contrary, until Mortgagee notify [sic] tenant that the Assignment has been released, Tenant shall be unconditionally and absolutely obligated to pay to Mortgagee in accordance with the Assignment all rents, purchases payments and other payments of whatever kind described in the Lease without any reduction, set off, abatement, or diminution whatever."

In addition, the Recognition Agreement included a tenant estoppel, in which Home Depot stated:
"d. Tenant has fully inspected the Premises and found the same to be as required by the Lease, in good order and repair, and all conditions under the Lease to be performed by the landlord have been satisfied; including but not limited to payment to Tenant of any landlord contributions for Tenant improvements and completion by landlord of the construction of any leasehold improvements to be constructed by the landlord; . . .

f. As of this date, the Mortgagor, as landlord, is not in default under any of the terms, conditions, provisions or agreements of the Lease and Tenant has no offsets, claims or defenses against the Mortgagor, as landlord with respect to the lease;"

In 1996, things turned sour. Home Depot discovered cracks in walls of the building; the cracks allegedly resulted because the foundation built by G&S was "settling unevenly." G&S refused to remediate the problem, so Home Depot attempted to make repairs. This cost Home Depot $750,000. However, the problems persisted. Home Depot vacated the premises and stopped paying its rent in August of 1999.

Reliastar pursued Home Depot in federal district. Home Depot claimed it had been constructively evicted. The District Court granted Reliastar’s motion for summary judgment, on the basis that the 'hell or high water" clause vitiated any constructive eviction defense.

On appeal, the Court of Appeals for the Second Circuit addressed three issues: 1) whether New York's U.C.C. 9-403(c) prohibited Home Depot from asserting its constructive eviction defense; 2) whether the estoppel language in the Recognition Agreement barred the assertion of constructive eviction; and 3) whether the "hell or high water" provision by its terms obligated Home Depot to make rent payments "absolutely and unconditionally." The Second Circuit rejected all of Reliastar's arguments and reversed the District Court.

New York's U.C.C. 9-403(c) provides that an "agreement by parties that the contract can be assigned free of any defenses which an account debtor may have against the assignor is enforceable by a good faith, for-value assignee against ordinary defenses, not including fraud, duress, or the like." The court acknowledged that Reliastar ordinarily would take free of many if not most of Home Depot's defenses under the U.C.C., but the court then equated constructive eviction with "fraud, duress or the like." The court explains "constructive eviction is similar to the defenses of fraud and duress in that it goes to the very existence of the agreement, rather than a failure to perform in accordance with the terms of the agreement."

Home Depot represented in the Recognition Agreement's estoppel that it had "fully inspected the Premises," and that further the Premises were in "good order and repair." The building pad constructed by the landlord was part of the Premises under the lease. However, the court held that the tenant estoppel did "no more than express Home Depot's knowledge at the time the certificate was executed." This conclusion was reinforced by the lease which required Home Depot to execute estoppels at the landlord's request covering "then existing defaults" of the landlord. The estoppel also limited itself to problems "as of this date." Home Depot's answers to the estoppel were honest and accurate representations because, according to Home Depot, it did not become aware of the problems in the building pad until two years after the execution of the Recognition Agreement.

Finally, the lease contained a provision - the "hell or high water clause" - that required Home Depot to make its rent payments to landlord "unconditionally and absolutely." These clauses are generally enforceable in New York when asserted by good faith assignees against sophisticated parties unhappy with some outcome of the contractual arrangement. Apparently, however, (at least as understood by the federal court of appeals) these provisions had only been interpreted in New York in the context of finance and equipment leases, and not real property leases. The court parsed the language very, very carefully: "The main force of the guarantee, however, is the payment of "all rents" and the description of "rents" as "due under the Lease."" According to the court, constructive eviction terminates the lease and relieves the tenant of rental obligations, and therefore, the hell or high water clause was held ineffective.

Reporter’s Comment 1: The court's very technical reading of the hell or high water provision suggests that landlord attorneys may need to be more specific about their intention to limit the tenant's defense of constructive eviction when drafting provisions unconditionally requiring tenant's payment of rentals. This is not necessarily an easy task. According to 29.3.3 of Friedman on Leases, provisions in which a tenant simply disclaims its right to assert the defense might be deemed to offend public policy. The treatise also cites 5.6 of the Restatement (Second) of Property that empowers the landlord and tenant to increase or decrease landlord's obligations and the remedies of the tenant unless the agreement is unconscionable or against public policy.

Reporter’s Comment 2: Early on, the court equates constructive eviction with defenses of duress and fraud. It is this comparison that allows the Home Depot to evade application of U.C.C. 9-403(c). The reporter is not entirely comfortable with the comparison. Constructive eviction grew from the more basic defense granted to a tenant when the tenant was physically evicted from the premises by the landlord. Physical eviction interfered with the single dependent covenant lease law recognized: quite enjoyment. In time, courts recognized that some failures of the landlord, while not actual physical evictions, might be so significant that they all but required the tenant's quick departure from the premises. Such constructive evictions also provided a defense to landlord's demand for rents. Today, tenant's constructive eviction does not usually result from landlord's tortious behavior (although the landlord's behavior in some instances might be tortious). Often, these evictions are at be

st just really bad breaches of the lease contract (failure to provide water, AC, etc.)
Reporter’s Comment 3:  The court vacates the district court's decision that Home Depot had no constructive eviction defense and remands for further determination. The factual record is therefore not fully developed in the opinion. That said, and based only on the facts presented in the opinion, the reporter wonders if Home Depot will sustain the defense. Home Depot became aware of the problem in the foundation and informed its landlord, which refused to take any remedial steps. Home Depot then spent hundreds of thousands of dollars on repairs, only to decide, based on the recommendation of its structural engineer, that the condition had not been fixed. Home Depot then ceased paying its rent and vacated. Presumably, Home Depot had a structural engineer make recommendations before doing its costly repair work, and would not have done so unless it was told that the repairs would or could be successful. Normal constructive eviction doctrine requires the tenant to vacate ASAP, or lose

the ability to assert the defense.
Reporter’s Comment 4:   It is worth noting that this is a federal court's interpretation of state property law. While valuable, it is not binding on the New York Court of Appeals.

Editor’s Comment: The law of independence of covenants, which gives rise to the constructive eviction doctrine (because an “eviction” is an exception to the rule of independence of covenants), is under assault in a number of quarters.  Massachusetts has already abolished it, and there have been some cases in New York as well. 

This case is based upon the traditional notion that a constructive eviction is a breach of possession that terminates the lease.  If the notion were simply that a major breach of lease affords a tenant a right of rescission, would the same analysis apply here.  Maybe.  But maybe also contract principles would be applied more carefully to the interpretation of waivers as well. 

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