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Foreclosure Against a Commercial Landlord: Impact on Lease Rights

Foreclosure can often have tricky impacts on lease rights, as covered on Money and Dirt in prior posts.  See Eviction After Foreclosure: California Supreme Court Weighs In and When a Lender Forecloses on a Leasehold Interest….

An opinion recently published by California’s Second Appellate District — Gietzen v. Covenant RE Management, Inc. — addresses the impact of foreclosure on the rights of a third party beneficiary to a lease.

Facts: commercial tenant obtains judgment against landlord limited partnership; tries to amend judgment to include landlord’s general partner

Yolanda’s Inc. owned and operated a restaurant in the Seabridge Shopping Center in Oxnard, and leased space from a limited partnership (Rocklin Covenant Group, LP) and a related LLC.  Yolanda’s president Rod Gietzen personally guaranteed the lease.

During the lease negotiations, Rocklin failed to disclose to Yolanda’s that negotiations were proceeding to lease another space in the shopping center to a gym.  After the gym opened, its customers monopolized the shopping center’s shared parking lot, resulting in a loss of business for Yolanda’s.

Yolanda’s sued Rocklin for fraud and breach of lease, and obtained a judgment for almost $2 million plus attorney fees and costs.  After entry of judgment, Rocklin lost its interest in the shopping center through foreclosure.

Yolanda’s filed a motion to amend its judgment to add Covenant Real Estate Management, Inc. (CREM), among others, as a judgment debtor.  CREM was Rocklin’s general partner.  Yolanda’s argued that CREM was liable for the judgment under Corporations Code section 15904.04(a), which provides: “all general partners are liable jointly and severally for all obligations of the limited partnership….”

Trial court’s ruling: motion denied; CREM was a third party beneficiary of the lease and entitled to rely on the lease’s liability limitation provisions

The trial court denied Yolanda’s motion to add CREM as a judgment debtor.

The court held that CREM was a third party beneficiary of the lease and was therefore entitled to rely on article 39 of the lease.  Under article 39, Rocklin’s liability as landlord was limited to only the landlord’s “interest in the shopping center,” and Yolanda’s waived any recourse against Rocklin’s “partners” or affiliates.

Yolanda’s appealed.

Court of Appeal’s Opinion: foreclosure caused assignment of the lease to the foreclosing lender and terminated the landlord’s and third party beneficiary’s rights under the lease

The Court of Appeal reversed the trial court’s order and ruled in favor of Yolanda’s.

The court held that the foreclosure caused the assignment of the lease from the landlord to the landlord’s lender, terminated the landlord’s rights under the lease, and terminated the rights of the third party beneficiary general partner, CREM.  As such, CREM could no longer rely on the limitation of liability in article 39 of the lease.

The court emphasized the general rule that a third party beneficiary cannot assert greater rights than those of the contracting party.  Here, Rocklin lost its right to assert article 39 of the lease as a defense when the lease was assigned in foreclosure.  The court concluded: “Because CREM cannot have more rights than Rocklin, CREM also loses its rights.”

CREM argued that even after the assignment of a lease, some of the contractual obligations continue (including the tenant’s obligation to pay rent).  The court acknowledged that to be true, but noted that “CREM fails to distinguish between liabilities and rights. … Although the contractual liabilities of Rocklin, the assignor, may remain after assignment, Rocklin’s rights are extinguished.”   (Emphasis added.)

The court also rejected CREM’s argument that article 39 continued to apply because the judgment against CREM was final before the foreclosure and assignment.  The court held that “final does not mean dead,” and that as long as the judgment remained viable and unsatisfied, an assignment of the lease could affect the ability to enforce the judgment.

Lesson

Foreclosure can substantially impact commercial lease rights.  As in the Gietzen case, foreclosure agasinst a commercial landlord may cause the assignment of the lease to the foreclosing lender and the termination of the landlord’s rights under the lease.  Under that scenario, a third party beneficiary’s rights under the lease are likewise terminated.

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