Daily Development for
Friday, December 18, 1998

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

LANDLORD/TENANT; ASSIGNMENTS AND SUBLETS; NOVATION: Language in a long term gound lease stating that tenant shall be released from "direct obligations" under the lease upon assignment  does not result in an assignment constituting a novation because the tenant remains liable as a "surety" for the assignee's obligations. 

Grand Ave. Partners, L.P. v. Goodan, (160 F.3d. 580, affirming 1996 WL 1057517 (9th Cir. 1998).

This case is part of the continuing saga involving the interpretation of "gold clause" rent adjusters that commonly appeared in long term leases in the early part of the century and recently were invoked in some new attempts to "bite" recent assignees under these leases. 

The classic case was reported in the Quarterly Report for Summer, 1996, and as a DIRT DD on March 20, 1996.  In Trostel v. American Life & Cas. Ins. Co., 92 F.3d 736 (8th Cir. 1996), the Eighth Circuit Court of Appeals ruled that a clause in a 1917 lease providing that the landlord could demand rent in gold or gold equivalent was valid and binding upon a modern day assignee of the lease.  The case was complicated by the fact that in 1935 the U.S. Congress declared such gold clauses invalid, but then in 1977 proclaimed that such clauses would be valid if entered into after 1977.

The landlord in Trostel claimed, and the court agreed, that where a lease provided for release of a prior tenant upon assignment, the 1990 transfer to an assignee constituted a "novation" of the lease, and thus was a "post 1977 agreement" that was not affected by the 1933 legislation.  Hence, the gold adjuster clause was valid, leading to a huge jump in rent obligations for the assignee  over what the tenant would have paid in terms of the dollar figures reflected in the lease.  In Trostel, the difference was about a twentyfold increase in rent.  There was little question but that in Trostel the assignor and assignee, and probably also the landlord, had no concept that the gold clause would still be effective, even though the assignment specifically referred to and incorporated the old lease.

At the time, the editor predicted that other holders of ground lease interests might search their portfolios and try to identify other assignees who might be caught up in the "gold clause" trap.  This case is an example.  The original case was brought even prior to the Trostel decision.  The lease provided that the tenant's interest could be assigned if the assignee assumed the liabilities under the lease and included the following language regarding the continuing liability of the assignor:     

". . . any assignment of the leasehold estate . . . shall release the assignor from all direct liability hereunder accruing after the making of such assignment . . .; provided, however, that nothing herein contained shall be constreud to relieve any such assignor of liability hereunder while he remains in possession of the demised premises or any part thereof or of his stuatory or other liability as a stockholder of any corporate assignee."

The landlord argued that a post 1977 assignment resulted in a novation under this language and that, consequently, the gold adjuster clause in the original 1925 lease was "reinvigorated," resulting again in a gigantic increase in rent.

The court here ruled against the landlord, however, concluding that the parties' use of the term "direct liability" indicated that they did not intend to relieve the assigning tenant of liability as a surety for the assignee, but only for liability directly on the lease.  The court pointed out that sureties in California at the time of the lease had important rights, including the right of exoneration, and that judicial decisions at the time were unsettled as to whether an assignor tenant was exposed to continuing liability on the lease only as a surety or as both a surety and as a direct contracting party.  The court concluded that the parties', by their language, elected to hold the assignor to continuing liability only as a surety.   Consequently, because the modern day  assignor was not completely released from liability, the assignment did not constitute a novation and the bar of the 1933 legislation remained in effect.

Comment 1: Of course, one can argue that the fundamental purpose of the court's decision making here was to relieve both the assignee tenant and assignor tenant of unanticipated liability for increased rent under the lease, and nothing more.  But, as with every "result oriented" decision in common law decision making, there are consequences if the court bends the law to suit the equities. 

Although long term lease landlords no longer can chase old tenants under the gold clause, they now have an interpretation of lease language that permits them to track down assignor tenants and hold them liable as sureties when the assignee tenant defaults, even though in many cases all parties had anticipated that the assignor had been released when the assignment and assumption was carried out.

Comment 2: As noted in a DIRT posting in June of 1997,  the Trostel case ultimately was vacated and remanded by the United States Supreme Court for reconsideration in light of a subsequent federal enactment apparently intended to clarify the intent of the 1977 legislation and relieve an assignee of liability under a gold clause in circumstances in which the parties did not intend specifically that the the gold clause be revived.   Here is the gist of that posting:     

"This judgment was vacated and the case remanded to the 8th Circuit for consideration in light of the Economic Growth and      Regulatory Paperwork Act of 1996, P.L. No. 104208, Sec. 2609.      American Life & Casualty Ins. Co. v. Trostel, 117 S.Ct. 939 (1997)  That statute amends the federal statute dealing with gold clauses to provide that assignments and novations after the effective date of the 1975 federal law do not readopt the gold clause unless the parties make this clear. It is still not clear what happens to lawsuits brought before this recent amendment."

The editor was unable to track down the precise language of the 1996 omnibus statute that accomplished this result, but another DIRT poster indicated that the whole story was covered in Forbes Magazine, which reported that the consequence was that the long term lessor received an annual rent of around $40,000 for space that had a sublet value of around $1.6 million. 

Comment 3: It is one thing for Congress to undo what Congress did.  It is quite another for a court to reach conclusions about the meaning of contract documents in order to solve an immediate problem where these conclusions will ring through precedent, affecting many other transactions in the future. 

The notion that the original drafters of the lease in the instant case believed that the lessee was agree to remain liable as a surety upon assumption by a new assignee stretches credulity.  This was a ninetynine year lease.  The ordinary method of dealing with assignments in such long term leases is to permit release of the original tenant upon transfer to an acceptable assuming assignee.  Otherwise, each tenant in the chain remains  liable for decades and decades, long after they pass out of possession of the property.  The difference between liability as a surety and liability as a maker or assumer of the lease is, of course, meaningful, but liability as a surety is nevertheless significant liability. 

It also is unlikely that the parties would have used the simple term "direct liability" to connote the concept of contract liability versus liability as a surety.  Suretyship liability is not really "indirect liability," particularly in the case of a party who originally has contract liability, such as an assigning tenant.  Suretyship liability is "secondary," as opposed to the "primary" liability of the principal.  But courts should be very cautious to read the term "direct liability," without more, to mean only liability on the contract and not liability as a surety.

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 six years, these Reports have been collated, updated, indexed and bound into an 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 Maria Tabor at the ABA. (312) 988 5590 or mtabor@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. The same is true of all commentary provided by contributors to the DIRT list. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.