Daily Development for
Thursday, November 21, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

The Reporter for today's development is Jim Stillman of Murphy, Weir & Butler in San Francisco.

BANKRUPTCY; AUTOMATIC STAY; BENEFICIARY'S ELECTION TO SUBORDINATE TO LEASE: A deed of trust beneficiary does not violate the automatic stay by unilaterally subordinating its deed of trust prior to foreclosure to an advantageous lease, in order to spare the lease from extinction at the foreclosure sale. In re 240 North Brand Partners, Ltd., 200 B.R. 653 (9th Cir.BAP 1996). The debtor reasoned that the beneficiary's conduct "robbed" it of the right to negotiate its own lease forfeiture consideration from the tenant. The Appellate Panel describes this as "a very unique argument," and holds instead that the beneficiary had a right to subordinate, and that it would be "inequitable" to force the lender to lose the lease at foreclosure (p. 658).

Reporter's Comment: The beneficiary's notice of election to subordinate has surfaced in CLE program materials as a preferred strategy for addressing the prospect of loss of over-market junior leases at foreclosure. This consequence was announced in California by Dover Mobile Estates v. Fiber Form Prods., Inc., 220 Cal.App.3d 1494 (1990), a case much commented on and, by this Reporter and others, criticized as to its reasoning. The standard form lease in this case actually granted to "any mortgagee" the right to subordinate to the lease. The outcome should be the same, even with no such clause in the lease.

Editor's Comment: Aside from noting that the phrase "very unique" is inappropriate (there are no degrees of uniqueness) the editor also has no quarrel with the bankruptcy court result.

The editor does not agree with the reporter, however, that deed of beneficiaries, without contract language providing such a right, ought to be able to be able to decide unilaterally whether a lease on foreclosed property will live or die.

The issue is not one of mortgagor's interests, however, but of lessee's interests. If a lessee is junior to a deed of trust lien, either by regular priority or through subordination, the lessee understands that if the landlord suffers a foreclosure, the lessee will be terminated, even if the lessee is innocent of any breach of its own lease and has nothing to do with the deed of trust default. A lessee may be willing to accept this consequence because it understands that many of the conditions that might lead to foreclosure (or flow from it) may in fact contribute to an unhealthy business climate for the lessee. The lessee may well have taken that result into account in agreeing to the lease (or at least to the subordination) in the first instance. Why should a foreclosing mortgagee, by unilateral action, have the power to alter that result, even when the lessee has not agreed by contract that the mortgagee could do this?

The issue, of course, is simply one of which party should have the responsibility to initiate bargaining to alter a status quo result. The editor sees no reason to shove all the cards to the mortgagee's side of the table at the outset. If the mortgagee (or the landlord) wishes to have the lessee be subject to the mortgagee's option to keep the lessee or terminate the lease, then the parties ought to spell out that option in the contract. Normally, consistent with Dover, the mortgagee ought to have a further duty to notify the lessee in advance of its intention.

The editor acknowledges that mortgagees in many judicial foreclosure jurisdictions have the option to preserve junior leases simply by failing to name them in the foreclosure sale. The editor has criticized this result in the past, and continues to feel that it is bad policy. But the result in judicial foreclosure proceedings may be said to stem from policy considerations dealing with the impact of a judicial proceeding on non-parties. In short, the result in judicial foreclosure settings may be the consequence of special considerations that need not affect non-judicial foreclosures.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last five years, these Reports annually have been collated, updated, indexed and bound into the Annual Survey of Developments in Real Estate Law, volumes 1-6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Stacy Walter at the ABA. (312) 988 5260 or stacywalter@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.