by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
LANDLORD/TENANT; SUBLEASES; EQUITABLE MORTGAGE: Where seller of business located on certain leased property subleases the business property to purchaser, and the promissory note executed in connection with the sale of the business provides that a default under the note is a default under the sublease, the transaction does not constitute a secured transaction, but rather a true sublease, and sublessor is entitled to maintain a summary proceeding under the New York landlord/tenant laws.
Salmat Pizza Enterprises v. Dezzara Restaurant Corp., 643 N.Y.S.2d 890 (Civ. Ct. 1996).
The deal was set up as a sublease until such time as the promissory note was paid, at which time there was an assignment of the balance of the sublandlord's interest to the subtenant. Until the note was paid, the arrangement between the parties was structured as a classic sublease, with a term ending almost a year before the end of the master lease term. But the subtenant agreed to make payments directly to the master landlord.
The court acknowledges that there exists New York precedent for the concept that parties who are actually in a debtor/creditor relationship will not be permitted to structure a security arrangement as a lease to avoid the equity of redemption.
Here, however, the court sees a separate and free-standing sublease, and perceives no problem with making performance of the note a condition of the sublease. It comments that the sublandlord's claim in the summary rent and possession action is for the back rent under the sublease, and not for the entire amount payable under the note.
Comment 1: The drafters of this arrangement "dodged a bullet" here. Cross defaulting the lease and the promissory note, so that a default in the note could result in a forfeiture of rights under the sublease, probably did constitute an attempt to set up the real estate rights in the sublease as security for the note. This would be a classsic equitable mortgage.
As the deal worked out, the "sublandlords" apparently decided to forfeit the lease because the "subtenants" had not even paid the sublease payments, let alone the payments under the note. Thus, although the transaction functioned as an equitable mortgage, the enforcement was focussed on the aspects of the deal that were a sublease. That the court let the parties get away with this, however, was pure luck. Don't try this at home, kids!!
Comment 2: The court, unfortunately, does not appear to recognize the signficance of the different terms of the two interests. Instead, it stresses the "characterization" language contained in the various documents to support its conclusion that the parties really had a sublease. In fact, in dicta the court says that the arrangement might have been characterized as an assignment had not this self serving language appeared in the documents. This part of the court's analysis departs from existing law, which emphasizes the term of a sublease as the principle defining characteristic and generally would ignore self serving characterizations as a sublease where the purported sublease is coterminous with the master lease.
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