Calif. App. Court (2nd Dist) Holds Bank Did Not Assume Lease by Being Successful Bidder at Foreclosure Sale

The California Court of Appeals for the Second District recently held that the mortgage lender’s purchase at foreclosure sale of a leasehold estate – identified in the deed of trust by reference to the lease – did not constitute an express agreement to assume the lease.

A copy of the opinion in BRE DDR BR Whittwood CA LLC v. Farmers and Merchants Bank of Long Beach is available at:  Link to Opinion.

In December 2006, the original owner of a shopping center entered into a 15-year lease with the tenant for restaurant space.  After a series of transactions, the shopping center was eventually sold to a limited liability company (the “landlord”).

The lease required the landlord’s consent to any transfer, sale, assignment, or other conveyance.  Additionally, the lease permitted the tenant to encumber its leasehold interest through a mortgage, but presumed that a mortgage lender who succeeded to tenant’s interest assumed the tenant’s obligations:

“Tenant shall have the right … to encumber Tenant’s leasehold interest under this Lease … through a Mortgage (“Leasehold Mortgage’) with an institutional lender … Landlord agrees that in the event the Leasehold Mortgagee succeeds to Tenant’s interest under this Lease (in which event it shall assume all of Tenant’s obligations under this Lease), Landlord shall, at the time of such succession, recognize such mortgage, trustee or lender as the then Tenant under this Lease upon the same terms and conditions contained in this Lease and for the then unexpired portion of the Term.”

Thus, the leasehold mortgagee had the right under the lease to acquire and succeed to the tenant’s interest through a foreclosure sale.

In January 2007, the tenant recorded a memorandum of lease in the Los Angeles County Recorder’s Office, executed by the original owner and the tenant.  It gave notice of the lease term of 15 years, and the memorandum notified successors of the transaction restrictions set forth in the lease.

A bank subsequently loaned funds to the tenant and recorded a construction deed of trust securing the loan.  The deed of trust identified the property as “[a]n unrecorded leasehold estate established by a memorandum of lease…”  The tenant assigned its right, title, and interest in all present and future leases of the premises to the bank.

The tenant defaulted on the loan.  The bank initiated foreclosure and recorded a trustee’s deed upon sale identifying itself as the successful bidder of the leasehold estate.  The bank transferred the leasehold estate to a limited liability company, whose managing member was the bank, and the asset was later sold to a second owner.

In August 2010, the general manager of the shopping center informed the bank that it was not notified of any transfer, which rendered the bank in default under the lease.  The general manager of the shopping center requested that the bank execute a tenant estoppel certificate, which listed the bank as the successor in interest of tenant and stated that the lease termination date is March 31, 2023.

The second owner received rent payments from the bank through July 2014.  After the second owner sold the property to the landlord in October 2014, the bank stopped paying rent and surrendered possession of the premises in December 2014, with the intent to terminate the leasehold estate.

The landlord filed a complaint against the bank and the limited liability company that purchased the leasehold estate, alleging causes of action for breach of contract and damages under California Civil Code section 1951.2 (lessor’s remedies upon breach by lessee).

The landlord moved for summary judgment on the issue of whether the bank had a contractual duty as the successor to the tenant to comply with the lease.  The trial court granted the landlord’s motion for summary judgment because the deed of trust and notice of sale specifically identified the lease, the lease provided that the bank was obligated by the lease terms upon foreclosure, and the bank elected to purchase the leasehold estate and succeeded to tenant’s rights and obligations.

This appeal followed.

The Appellate Court began its analysis by examining the general principles governing assumptions of a real property lease.

As you may recall, “[a]n assignee’s liability to the landlord turns on the nature of the assignment.  If the assignee takes possession of the premises but no more, privity of estate exists and he is bound by all lease covenants which run with the land.  Upon a subsequent assignment, privity of estate ends and, with it, all obligations to the landlord.”  Kelly v. Tri-Cities Broadcasting, Inc. (1983) 147 Cal.App.3d 666, 678.

However, if the assignee expressly agrees with the assignor to assume the obligations of the lease, the assumption agreement creates a new privity of contract between landlord and assignee, enforceable by the landlord as a third-party beneficiary, regardless of whether the landlord was a party to the assumption agreement.  As a result, the assuming assignee is required to perform all covenants of the lease for the remainder of its term, absent a release by the landlord.  See, e.g., Hartman Ranch Co. v. Associated Oil Co. (1937) 10 Cal.2d 232, 244-245.

In this case, there was no dispute that the deed of trust and sale upon deed created an assignment to the bank.  However, the landlord argued that the bank also assumed the lease obligations for the full term, because the foreclosure and purchase of the deed of trust that referenced the lease constituted an express assumption of the lease.

The Appellate Court disagreed with the landlord’s argument because an express assumption of a real property lease required specific affirmation by the assignee to bind itself to the leasehold obligations.  To establish a privity of contract, according to the Appellate Court, the assignee must expressly agree, in writing, to be bound by the specific terms of the lease.

Relying on Kelly v. Tri-Cities Broadcasting, the Appellate Court determined that there was no express assumption of the lease obligations in this case.  The bank was not a signatory to the lease.  The contract between the original owner and the tenant contemplated engaging a mortgage lender, but the Appellate Court held that the provisions cannot form a binding contract on a non-party to the lease.

In addition, the foreclosure documents did not contain an express agreement to assume the lease.  The deed of trust, notice of trustee’s sale, and deed upon sale reference the memorandum of lease, but did not provide any express terms by which the bank agreed to uphold the lease covenants or provisions in the memorandum of lease.

Therefore, the Appellate Court held that the language in the documents merely acknowledged the lease rather than assumed its obligations.

The Appellate Court noted that the landlord could have protected itself by requiring the mortgage lender to execute the lease or a document assuming the lease obligations.  According to the Appellate Court, as a signatory to the initial lease, the landlord was in the best position to protect itself by including provisions in the lease requiring consent and assumptions. But, as the Appellate Court noted, it did not do so.  The lease did not direct the tenant to obtain an assumption from the mortgage lender as it did in the event of a transfer of the leasehold estate.

Accordingly, the Appellate Court reversed the judgment and the order granting summary adjudication in favor of the landlord, and remanded the case for further proceedings.

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Eric Tsai practices in Maurice Wutscher’s Commercial Litigation and Consumer Credit Litigation groups, and in its Regulatory Compliance group. He concentrates his practice primarily on the defense of consumer and commercial financial services companies, including mortgage lenders and servicers, mortgage loan investors, third party debt collectors, and other financial services providers. He also counsels clients on regulatory compliance, licensing, and other consumer protection matters. Eric earned his undergraduate degree from the University of California, Irvine. Prior to attending law school, he worked as a loan officer for national direct lenders. He earned his Juris Doctor from California Western School of Law and thereafter obtained a Master of Laws (LLM) in Taxation from the University of San Diego School of Law. Eric publishes extensively on various issues affecting consumer lending and litigation, including both federal and California-specific developments. He is licensed to practice law in California, Nevada, and Oregon, and is admitted in all United States District Courts in the State of California, the United States District Court for the District of Oregon, the United States District Court for the District of Nevada, the U.S. Tax Court, and the Ninth Circuit Court of Appeals. He is also a licensed real estate broker in the State of California.