Exculpation Lost On Assignment?

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We’ve written about “exculpatory” clauses before. The on-line version of Black’s Law Dictionary explains such clauses as follows: “An agreed-to condition (1) preventing blame or liability on one party due to the improper behavior of the other party; (2) preventing liability on one party due to not meeting all of the contractual performance expectations.”

In past blog postings, we’ve pronounced such clauses as overwhelmingly common in leases and almost always included to protect landlord-parties. We’ve suggested tenant-oriented versions. And, we’ve suggested tenant-protective modifications to this ubiquitous landlord-tilted lease provision. If interested, click HERE to read our thoughts.

We thought we had shot our load (an expression more acceptable than its more unsavory version, one that originated with early rifles) – until about a month ago when we saw a decision out of a California Court of Appeals, one that can be seen by clicking: HERE. The facts may be unusual, but the lesson is unsettling. Ruminations may not agree with the outcome, but denial, in this case, seems to be a big river in Egypt and not an effective legal strategy.

In this case, a tenant obtained an almost $2 million judgment against its landlord, a limited partnership with a solvent corporate general partner. Interesting, but not a material factor, was that the judgment was granted because the landlord, in the lease negotiations, “failed to inform [the restaurant-tenant] that [it was] in negotiations to lease another space in the shopping center to a gym.” Both the restaurant and the gym signed leases and the gym’s customers sucked up all of the parking, driving the restaurant’s customers elsewhere and resulting in losses to the restaurant.

After the judgment was issued, the landlord lost the shopping center in a foreclosure. At that point, the judgment-holding tenant applied to have the judgment amended to include two of the now-former landlord-related parties, most importantly its general partner. In response, those parties cried: “Whoa! Article 39 of the lease says:

The liability of Landlord under this Lease shall be limited to Landlord’s interest in the Shopping Center. Tenant agrees to look solely to Landlord’s interest in the Shopping Center for the satisfaction of any liability, duty or obligation of Landlord with respect to this Lease, or the relationship of Landlord and Tenant hereunder, and no other assets of Landlord shall be subject to any liability therefor. In no event shall Tenant seek, and Tenant does hereby waive, any recourse against shareholders and/or constituent partners of Landlord and the partners, directors, officers or shareholders thereof, or any of their respective personal assets for such satisfaction.”

That argument didn’t impress one lower court and didn’t impress the reviewing California Court of Appeal. How could that be? After all, didn’t the lease say that the tenant waived recourse against the constituent partners of its landlord? Yes, it clearly did, but let’s follow the courts’ analysis.

In the words of the appellate court, “The general rule is that an assignment extinguishes the rights of the assignor and its third party beneficiaries.” Here, the landlord effectively assigned its lease by virtue of the foreclosure. The “protected parties” under the lease’s exculpatory clause, other than the landlord, were express third-party beneficiaries. The rights of such a beneficiary are no greater than that of the directly contracting party. Once the landlord no longer had a contractual relationship with its former tenant, i.e., once they were not both parties to the lease, the landlord had no contract to enforce. It was no longer a party to the lease. Thus, it no longer had the right to enforce the exculpatory provision and its general partner, a listed third-party beneficiary of that provision, lost its defense as well. Stated otherwise, a third-party beneficiary “cannot assert greater rights than those of the promissee under the contract.”

[Those brave enough to read the court’s decision will also see a discussion as to whether the lease was merged into the judgment. We’re leaving that one alone. Ruminations may be a law nerd, but we’re wise enough not to punish our readers with this kind of stuff.]

Where does this leave us? Perhaps exculpatory agreements need to be separate from the lease so that they survive an assignment by foreclosure or otherwise. Perhaps the lease’s near-standard clause needs to include survival language that would make the former (assigning) landlord and its related parties into express third-party beneficiaries of all subsequent landlords. That means adding all predecessor landlords and predecessor landlord-parties (however the provision already lists them) to the list of protected persons and entities. Would that work? We’re not sure, but it would be a better “shot” in states that think the same way as California now thinks. After all, the intention of these exculpatory clauses is clear: the tenant isn’t supposed to collect from partners, shareholders, etc. Ruminations invites our readers, especially the law professors on our subscription list, to weigh in. We know that courts in other states might reach a different result, but the basic concept that once a party assigns its interest in a contract, it no longer has rights directly under that contract seems pretty daunting.

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Comments

  1. In a few words … The United Socialist Republic of California … cause and affect.

  2. Joel Hall says:

    In the words of the scion of an unnamed U.S. President – “I love it”.

  3. Assignment ends the privity of estate, but privity of contract should continue between the original contracting parties.

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