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Status of Sublease Upon Surrender, Forfeiture or Termination of Prime Lease

Parties contemplating lease terms that relate to subleasing or terms for an actual sublease should consider the implications that case law may have on the survival of a sublease upon the surrender, forfeiture, or termination of a prime lease. Failure to do so could result in in an unexpected outcome. An examination of the cases below illustrates this point.

Voluntary Surrender of Prime Lease Does Not Terminate Sublease – Buttner v. Kasser (1912) 19 Cal.App. 755.

In Buttner v. Kasser (1912) 19 Cal.App. 755, M.A. Lang (“Lang”) subleased its premises to Bay Front Improvement Company (“Bayfront”) who then subleased a portion of the premises, a cigar stand, to the Kasser Brothers. Later, the sublease between Lang and Bayfront was cancelled by mutual consent of Lang and Bayfront. However, the Kasser Brothers did not agree to cancel their sublease and continued to occupy the cigar stand.

Thereafter, a complaint was filed against the Kasser Brothers to recover the reasonable value of the Kasser Brothers’ use and occupation of the cigar stand following the cancellation of Lang and Bayfront’s sublease. Judgment was entered against the Kasser Brothers.

On appeal, the Kasser Brothers asserted that when a lessor accepts from its lessee, a voluntary surrender of the lessee’s term and consents to a voluntary cancellation of the lease, the lessor cannot ignore the rights of a subtenant under a valid sublease and compel the subtenant to pay the reasonable value of the use and occupation of the subleased premises.

The Appellate Court agreed with the Kasser Brothers and reversed the Trial Court’s judgment.

The Appellate Court held that:

“‘A tenant may surrender his estate to his landlord, but if he have since its commencement created some minor interest out of it, or have made an underlease, he cannot, by surrendering, destroy the charge or affect the estate of the underlessee.’” (Buttner, supra, 19 Cal.App. at p. 760, quoting Bailey v. Richardson (1885) 66 Cal. 416, 421-422.)

The Appellate Court also held that:

“To permit the subtenant to be charged for the value of the use and occupation, without regard to the terms of his lease, because his lessor had surrendered to the overlord, would be to permit his rights to be defeated by the voluntary action of his lessor. As before stated it is not doubted but that the subtenant may be defeated of his term by a forfeiture of the lease under which his lessor holds. No such condition exists in this case. It is simply a case of the cancellation of a lease by the mutual consent of the lessor and lessee after such lessee had made a valid sublease to a subtenant. While such cancellation is effectual as between the lessor and lessee, it cannot affect the rights of the subtenant.” (Buttner, supra, 19 Cal.App. at p. 761.)

Forfeiture of Prime Lease Terminates Sublease – Herman v. Campbell (1948) 86 Cal.App.2d 762.

In Herman v. Campbell (1948) 86 Cal.App.2d 762, the owners of real property (“Owner”) leased their property to an individual (“Lessee”) who then subleased a portion of the property to another individual (“Sublessee”). Lessee failed to cure defaults regarding rental payments and Owner terminated the lease between Owner and Lessee. Lessee relinquished all interest in the property, including any right to possession.

However, Sublessee claimed that she was entitled to remain in possession of the subleased premises for the duration of the term of the sublease because she performed all of her obligations under the sublease. Owner disputed Sublessee’s claim and asserted that Owner was entitled to possession of the premises occupied by Sublessee.

In affirming the Trial Court’s judgment awarding possession of the premises to Owner, the Appellate Court held that:

“The law which governs the instant case is stated in 32 American Jurisprudence, page 344, as follows: ‘the right of the sublessee to the possession of the premises as against the original lessor terminates with the lease or term of the original lessee, and since a subtenant holds the premises subject to the performance of the terms and conditions impressed upon the estate by the provisions of the original lease, his rights are generally held to be terminated when the original lessor declares a forfeiture of the original lessee’s term based upon the latter’s nonperformance of obligations imposed on him. Thus, if the original tenant has incurred a forfeiture of his lease, and for that reason the landlord annuls the lease, the landlord is entitled to the possession as against the sublessee.’ And further, at page 746: ‘Where a cause of forfeiture has arisen, the fact that the lessee consents to the enforcement of the forfeiture does not render the transaction a surrender as distinguished from a forfeiture so as to bring it within the rule that a lessee cannot by a surrender affect the estate or the interest of third persons held under him.”’ (Herman, supra, 86 Cal.App.2d at pp. 765-766.)

Default Under Prime Lease Does Not Terminate Sublease When Sublessee Is a Third-Party Beneficiary of Non-Disturbance Provisions in Prime Lease – Chumash Hill Properties, Inc. v. Peram (1995) 39 Cal.App.4th 1226.

In Chumash Hill Properties, Inc. v. Peram (1995) 39 Cal.App.4th 1226, the owner of real property (“Lessor”) leased its property to Climate One, Inc., the lessee. The lease provided lessee with the right to sublet all or any part of the property and included provisions stating that:

(1) if a sublessee cures all curable defaults of the lessee, the sublessee’s possession and use shall not be disturbed by Lessor or by mortgagee as long as (a) the sublessee performs its obligations under the sublease (b) the sublessee attorns to Lessor and mortgagee according to their respective interests and (c) lessee’s subsequent curable defaults are cured by the sublessee; and

(2) no sublessee qualifying under the non-disturbance provisions of the lease shall be ejected. 

The lease also stated that an assignment by lessee for the benefit of creditors or the filing of a voluntary or involuntary petition by or against lessee under any law for the purpose of adjudicating lessee a bankrupt shall be a default by lessee and a breach of the lease. 

Climate One, Inc. assigned its interest in the lease described above to Daphne’s Ltd (“Daphne”). Daphne executed a note in favor Carson Wayne Newton (“Newton”), which was secured by a deed of trust against the improvements Daphne made on the leased property. Thereafter, in 1984, Daphne subleased the property to Chumash Hill Properties, Inc. (“Sublessee”) pursuant to a written sublease. In 1987, Newton obtained a judgment of foreclosure on the deed of trust and took over Daphne’s lease payments to Lessor. In connection with the judgment, Sublessee’s sublease was modified so that Sublessee only possessed a portion of the property. In 1992, Newton filed for a voluntary chapter 11 bankruptcy, and Newton’s lease with Lessor was deemed rejected by the bankruptcy court. 

Thereafter, Lessor served Sublessee with a 30-day notice to quit, which asserted Lessor’s right to possession of the premises pursuant to Newton’s bankruptcy. Lessor did not allege any default by Sublessee in its obligations as a subtenant. Sublessee filed a lawsuit seeking declaratory and injunctive relief, and Lessor filed a cross-complaint for unlawful detainer. The Trial Court determined that Sublessee, as a third-party beneficiary of the non-disturbance provisions in the lease, was entitled to remain in possession of the subleased property.

In affirming the Trial Court’s decision, the Court of Appeals held that:

“Taking all of the foregoing provisions into consideration, the lease expressly and unambiguously protects the right of a nonbreaching sublessee to retain possession and use of the subleasehold upon a termination of the leasehold.” (Chumash Hill Properties, Inc., supra, 39 Cal.App.4th at pp. 1231-1232.)

And the Appellate Court also held that:

“Nondisturbance agreements between a lessor and a sublessee typically provide that ‘notwithstanding a default under or termination of the prime lease, the sublease will remain undisturbed as a lease between the prime lessor and sublessee if the sublessee is paying and performing its obligations under the sublease. One of the protections afforded to a sublessee by a nondisturbance agreement is that if the sublessor becomes a debtor under the Bankruptcy Code, and rejects the prime lease, the sublease will not fall inasmuch as it will be taken up by the prime lessor.’” (Chumash Hill Properties, Inc., supra, 39 Cal.App.4th at p. 1233, quoting Cherkis & King, Collier Real Estate Transactions and the Bankruptcy Code (1984) § 4.03, pp. 4-19 to 4-22.)

Even When Sublease States That If the Prime Lease Terminates For Any Reason the Sublease Also Terminates, the Sublease May Not Necessarily Terminate With the Termination of Prime Lease – Northridge Hospital Foundation v. Pic ‘N’ Save No. 9, Inc. (1986) 187 Cal.App.3d 1088.

In Northridge Hospital Foundation v. Pic ‘N’ Save No. 9, Inc. (1986) 187 Cal.App.3d 1088, the owner of real property (“Owner”) leased its property to W.T. Grant & Co. (“Grant”). The lease provided Grant with the right to extend Grant’s initial lease term for two successive ten-year terms and to sublease the property with the owner’s consent.

Grant, with the consent of Owner, subleased the property to Pick ‘N’ Save (“PNS”). The sublease was drafted by Grant, and provided that the original term of the sublease was to end one day prior to the initial term of the prime lease (i.e., Grant’s lease) and that PNS had the option to extend the sublease for two successive terms.

Paragraph 14 of the sublease stated that the sublease was subject to the prime lease, and that in the event the “[prime lease] shall terminate for any reason whatsoever, then this [sublease] shall also terminate simultaneously therewith and neither party hereunder shall acquire any right or cause of action against the other by reason of such termination.”

Owner and Grant entered into an agreement which stated that the prime lease was terminated, that the sublease is not extended, and that Owner would indemnify and hold harmless Grant from claims by PNS. Owner informed PNS that the termination of the prime lease terminated the sublease under paragraph 14 of the sublease. PNS protested the termination by letter from its counsel.

Owner sued for declaratory relief, claiming PNS was a tenant at sufferance and was liable for the difference between the fair rental value of the demised premises and the rental provided for under the sublease from the effective date of the alleged expiration of the sublease. PNS answered and claimed that there was a valid sublease and option to renew. The Trial Court found that paragraph 14 caused the sublease to terminate under its plain language and even if paragraph 14 could not be given its literal meaning, Grant had no obligation to exercise its option to extend the prime lease.

PNS appealed the Trial Court’s decision and asserted that the voluntary surrender of the prime lease by Grant to Owner under the agreement between Grant and Owner could not, in and of itself, terminate the sublease. 

The Appellate Court noted that the general rule is that the rights of a subtenant cannot be affected by a voluntary surrender of the prime lease, as set forth in Buttner v. Kasser (1912) 19 Cal.App. 755. The Appellate Court also considered Owner’s argument that when parties to a sublease agree that the termination of the prime lease terminates the sublease, the general rule of the Buttner case is not applicable. Accordingly, the issue before the Appellate Court was whether paragraph 14 of the sublease between Grant and PNS permitted a voluntary termination of the prime lease to terminate the sublease.

In reversing the Trial Court’s judgment, the Appellate Court concluded that because both the prime lease and the sublease contained an absolute option to renew, there was an implied agreement between the sublessor (i.e., Grant) and the sublessee (i.e., PNC) for the sublessor to protect its sublessee by renewing the prime lease so that the sublessee could renew the sublease, and that while paragraph 14 of the sublease is unambiguous by itself, when that paragraph is read in the light of existing case law, and in accordance with the rules on interpretation of written instruments, paragraph 14 is ambiguous and insufficient to cause a forfeiture. Therefore, the Appellate Court held that since the uncertainty is construed against the drafting party and the burden of establishing the forfeiture is on the claiming party, and since it appeared to be the general intent of the parties that PNS would be able to renew the sublease if PNS so chose, paragraph 14 must be construed against Owner and as not permitting a forfeiture of PNS’ rights. (Northridge Hospital Foundation, supra, 187 Cal.App.3d at pp. 1099-1101.)

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