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Appellate Court Rules on Lease Obligations

One of the most vexing concerns investors have when buying real estate is whether they will end up being saddled with unexpected liabilities or obligations related to the property.  When it comes to commercial lease obligations, though, there is very little a real estate investor can do without the tenant’s consent, and the resulting costs can prove significant — as a case out of Massachusetts demonstrates.

Lessee Seeks Reimbursement From New Lessor

In August 2004, Bright Horizons Children’s Centers entered a lease with 400 Longwater Realty.  The lease included covenants dealing with the construction of a new building.

Longwater, as lessor, agreed to construct a base building and substantially complete its construction work by October 15, 2005.  Bright Horizons, as lessee, would do the fit-out work to make the building suitable for its intended use as a child care facility.  From the beginning, the building project was marred by delays.

On September 23, 2005, with the base building far from being substantially complete, Longwater conveyed its interest in the property to Sturtevant, making Sturtevant the successor lessor.

After further construction delays, Bright Horizons performed part of the base building work in addition to the fit-out work.  It subsequently made a written demand on Sturtevant for reimbursement of the costs incurred in performing the base building work.  It also requested payment of its “improvement allowance,” as specified in the lease, and rental credit for delays attributable to late delivery of the base building.  Sturtevant refused, and the parties went to court.

Sturtevant argued that a side agreement it had entered into with Longwater — the assignment and assumption agreement — absolved it of any and all construction-related lease obligations owed Bright Horizons.  The jury ruled in Sturtevant’s favor on the lease claim.

Appellate Court Rules for Lessee

On review, the Massachusetts Court of Appeals cited the “ancient rule” that, “a successor lessor, who takes by deed real property subject to a pre-existing valid lease, stands in the shoes of … its predecessor.”  In other words, it has the same rights and obligations under the lease as its predecessor.  Moreover, the lease at issue in this case expressly provided that the “covenants, agreements and conditions” set forth in it — whether to be performed by lessor or lessee — “shall be binding” on each other’s “successors and assigns.”

According to the court, Sturtevant’s assignment agreement with Longwater set aside the “black-letter law” that one party to a contract cannot alter or modify the rights or obligations of another party to the contract by unilateral action.  Such changes require the parties’ mutual consent.  In fact, the lease at issue, in this case, states that it “could not be modified or amended in any manner except by an instrument in writing executed by the parties hereto.”

The assignment agreement attempted to unilaterally alter and modify the lease terms, to the detriment of Bright Horizons, without Bright Horizons’ consent.  It could not, therefore, be used to carve out the covenants in question from the obligations Sturtevant “accepted” as a result of its purchase of the property.

The Court of Appeals vacated the trial court’s judgment and entered a new judgment for Bright Horizons.  It sent the case back to the lower court for determination of Bright Horizons’ damages.

No Picking Allowed

The Appellate Court stressed that real property buyers cannot lawfully cherry-pick the lease obligations they will assume.  When buying a property that may come with lease obligations, the best protection is to perform thorough due diligence into existing or potential liabilities.

For more information, contact Mike Kovacs or your ORBA advisor at 312.670.7444.

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