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When Foreclosure Does not End Liability

June 3, 2013

Commercial real estate transactions can differ from residential real estate transactions in a variety of ways. For example, commercial lease tend to last longer than residential leases and multiple months of rent is often paid months in advance. While there are benefits to this method, this can also lead to complications later if a company were to go out of business or need to move before the lease has terminated. One way to alleviate this issue is to allow the party leasing to sublease or assign the contract to another party, giving the space and related responsibilities to someone else in a position to afford and maintain the property. This allows a tenant to be flexible in the case of a business change during the term of the lease. However, this option can complicate future issues because multiple subleases and assignments can run together.

Take for example, the California case of Vallely Investments v. BancAmerica Commercial Corporation. In this case, Vallely Investments (Vallely) sued for a declaration that BancAmerica Commercial Corporation (BACC), the assignee, was bound by the lease. Vallely owned a parcel of property, which it leased to Balboa Landing L.P. (Balboa). The lease allowed Balboa to transfer or assign its interest freely, or to get a mortgage. Any assignment had to be in writing, with notice to the Vallely. The person taking over contract was required to expressly accept and assume all of the terms and covenants of the lease. Balboa got a loan from BA Mortgage to develop the property using the deed of trust on the lease with Vallely as collateral, and then it defaulted on the loan. To avoid liability and to make sure the property was properly maintained, the lease was assigned to BACC, a wholly owned Bank of America subsidiary which would manage the property pending a nonjudicial foreclosure. BACC's goal was to hold the property only for the short period before the foreclosure sale. At the foreclosure sale, BA Mortgage was the successful bidder and it managed the property until selling the lease to Edgewater Place, Incorporated (Edgewater). Eventually, the contract with Edgewater was terminated early because it failed to pay the rent. Vallely then sued BACC for the rent because BACC took the lease over from Balboa.

The main issue in this case is whether foreclosure of a leasehold mortgage extinguishes the duties owed to the lessor, in this case Vallely, by an assignee, BACC, who assumes the lease. While BACC intended to be liable for the property only until the foreclosure, the contract that it signed did not make that specification. When it took over the lease, BACC also assumed the obligations of the prime lease, with the consent of the landlord, and came into privity of contract with the landlord, which allowed Vallely to enforce the assumption agreement as a third party beneficiary. This means that while foreclosure extinguished BACC's assignment, it did not have any impact on Vallely's rights. Vallely's right to enforce BACC's assumption agreement, as a third party beneficiary, occurred due to the foreclosure. Thus, the foreclosure terminated the privity of estate and privity of contract between BACC and Balboa, but it did not reach the privity of contract between BACC and Vallely. BACC assumed the lease obligations without qualification, and those contractual duties did not end with the foreclosure. It could have structured the transaction so that it shed all liability with the foreclosure, by taking the assignment without assuming the lease. But that is not what occurred in this instance. Therefore, the court found that BACC was liable for the rent on the remainder of the lease.

Real estate transactions vary in complexity, but having an attorney review your contracts can always help. If you have a real estate issue or question and are in the Sacramento area, please contact our office.

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