A tenant who takes an assignment of a mortgaged commercial ground lease remains liable to the property’s landlord for future rents even after foreclosure of the tenant’s interest, the California Court of Appeal held in Vallely Investments, L.P. v. BancAmerica Commercial Corporation, 2001 WL 428188.
Vallely Investments, L.P. (Landlord) in 1978 entered into a long-term ground lease that eventually was assigned to Balboa Landing, L.P. (Balboa), with a lease term expiring in 2051. The lease permitted the lessee to assign or mortgage its interest, and in1986 Balboa mortgaged the lease to secure a $7 million development loan from BA Mortgage and International Realty Corp. (BA Mortgage). Balboa defaulted on the loan in 1988. BA Mortgage filed foreclosure proceedings, and Balboa filed for bankruptcy to stay the foreclosure.
In a transaction crafted by the parties to protect BA Mortgage’s senior lien position and avoid personal liability for Balboa’s limited partners, the lease was assigned to BancAmerica Commercial Corporation (BACC), a Bank of America subsidiary, to manage the property until BA Mortgage completed non-judicial foreclosure proceedings. Under the assignment BACC assumed all of Balboa’s lease obligations. BA Mortgage completed foreclosure, purchased the lease at the foreclosure sale, and eventually sold the lease to Edgewater Place, Inc. (Edgewater).
Edgewater ultimately defaulted, filed for bankruptcy, and rejected the lease. In 1998, Landlord retook possession and filed an action against BACC seeking a judgment that BACC was liable, as assignee, for rent due for the remainder of the lease term. The trial court entered judgment against Landlord, and Landlord appealed. The Court of Appeal reversed the trial court’s decision.
Assignment of the Lease Created Contractual Obligations to Landlord That Were Not Terminated By Foreclosure
The Court of Appeal’s analysis and decision turned on two basic factors: (1) BACC’s assumption of the lease created a contractual obligation between BACC and Landlord; and (2) even though foreclosure of the leasehold mortgage terminated BACC’s rights of possession under the lease, it did not terminate BACC’s obligation under its contract to pay Landlord rents due for the unexpired lease term.
BACC’s assumption of the lease created contract obligations to Landlord that went beyond the mere taking of possession of the leased premises, and included the obligation to pay future rents, the Court held. Although a mortgage foreclosure will terminate all interests and liens that are junior to the mortgage lien, it will not terminate interests senior to the mortgage. Here, Landlord’s interest, as owner of the property, was senior to BA Mortgage’s interest as holder of a leasehold mortgage. Thus, even though the foreclosure terminated obligations between BACC and Balboa, it did not terminate obligations between BACC and Landlord, whose interest as property owner was senior to both Balboa’s and BA Mortgage’s. The Court distinguished this case from one in which a landlord mortgages its ownership interest in property that is subject to a lease. In the latter situation the rights and obligations of a tenant generally are terminated if the landlord’s mortgage is foreclosed; however, the same reasoning does not hold true when a tenant mortgages its leasehold interest and that mortgage is foreclosed, the Court said.
In reaching its decision, the Court addressed numerous arguments raised by BACC to avoid liability, including BACC’s claim that it was merely an agent for BA Mortgage; that BACC was merely a surety for Edgewater and was discharged when Landlord and Edgewater modified certain payment provisions of the lease; and that Edgewater’s rejection of the lease in bankruptcy terminated Landlord’s rights against BACC. Calling BACC’s defensive arguments “able and inventive,” the Court nonetheless rejected them all to find BACC’s duties to Landlord under the lease intact, and entered judgment against BACC.