Can A Landlord Extract A Piece Of The Action
From A Tenant-seller In The Sale Of A Dry Cleaners?

In an action involving a 10 year dry-cleaning business lease in Garden Grove, California, the lessee proposed to sell the business to a prospective buyer and required the consent of the lessor to the assignment of the lease.  The assignment provision, however, contact a profit-shifting clause:

“[S]hould Tenant receive rent or other consideration either initially or over the term of the assignment or sublease, in excess of the minimum rent called for hereunder, or in case of the sublease of a portion of the Premises in excess of such rent fairly allocable to such portion, Tenant shall pay to Landlord an additional rent hereunder, one-half (½) of the excess of each such payment of rent or other consideration received by Tenant promptly after its receipt.”

A few years after entering into the lease, the lessee sold his business to a buyer and entered into a sublease with the buyer, approved by the lessor.  The sublease provided that it would terminate in the event the interest of the lessee under the original lease terminated for any reason.

Subsequently, the lessee filed a petition in bankruptcy and was ultimately discharged.  The lessor advised the buyer that the bankruptcy had terminated the sublease and that a new lease would have to be executed in order for the buyer to remain in possession of the premises.  The lessor presented a lease and assured the buyer that it was basically the same lease as the original lease.

The new lease, however, not only increased the percentage of additional rent to which the lessor was entitled, but also granted the lessor a percentage of the sales price of the business.

The new lease provision between the lessor and the buyer provided as follows:

“If in connection with the transaction involving the proposed assignment or sublease, tenant receives rent or other consideration, including without limitation any consideration for tenant’s business, business opportunity, good will, a covenant not to compete and/or the like, either initially or over the term of the assignment or sublease, in excess of all sums then payable hereunder, whether as minimum rent, percentage rent, or otherwise, . . . tenant shall pay to landlord as additional rent hereunder three-quarters (3/4) of the excess of each such payment of rent or other consideration received by tenant promptly after its receipt.”

A year after entering into the new lease, the buyer sold his dry-cleaning business to a second buyer for $120,000.  The escrow instructions allocated $80,000 to fixtures and equipment and $40,000 to a covenant not to compete.  The buyer and the second buyer determined that the existing lease provided for a rent higher than the current market rent, and that therefore the value of the lease added nothing to the sales price of the business.

The lessor demanded payment of three-quarters of the value of the covenant not to compete, or $30,000, to be paid to the lessor through escrow before the lessor would consent to the assignment of the lease.

The buyer and the second buyer closed the escrow without the lessor’s consent to the assignment.  Subsequently, the lessor would not accept checks signed by the second buyer.  As a result of the controversies between the parties, the second buyer reduced the price he was willing to pay for the business from $120,000 to $80,000.

Eventually, litigation erupted, with the matter ultimately reaching the appellate courts.

The court of appeal observed that “A party to a commercial lease who is trapped in a bad bargain has only one escape route left: to evoke the doctrines of adhesion and unconscionability.”  The court noted that this doctrine was codified in California, permitting the court to refuse to enforce an unconscionable provision in a contract:

“If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.”

In summarizing the law regarding unconscionable contracts, the court noted that an analysis of unconscionability has procedural and substantive elements, both of which must be present to invalidate a provision in a contract.

The procedural element includes (1) oppression “arising from an inequality of bargaining power which results in no real negotiation and ‘an absence of meaningful choice’; and (2) surprise “involving the extent to which the supposedly agreed-upon terms of the bargain are hidden in a prolix [unduly long] printed form drafted by the parties seeking to enforce the disputed terms.

The substantive element includes terms that are one-sided, lacking in justification, and “reallocate the risks of the bargain in a objectively unreasonable or unexpected manner.”

The court of appeal observed that in this case, “The profit-shifting clause was buried in diminutive print in the middle of one of five lengthy paragraphs under the heading “Assignment and Subletting.”  In addition, the buyer was assured by the lessor that the new lease was basically the same as the original.  The lessor, however, did not point out that “the profit-shifting clause in the new lease was very different,” specifying that the lessor was now entitled to 75% “of any consideration for the business itself.”

The court of appeal determined that the lessor’s “attempt to appropriate a portion of the sales price for the business was blatant overreaching.”  In addition, since the lessor’s refusal to consent was wrongful and resulted in the second buyer reducing the price he was willing to pay for the business from $120,000 to $80,000, the court affirmed the trial court’s determination that the buyer was entitled to $40,000 in damages.

The moral of the story?  Although transfer restrictions in commercial leases are generally not subject to attack, in view of the ability of the courts to find unconscionability under certain circumstances, commercial lessors may not gouge their tenants in the name of freedom of contract!

[This column is intended to provide general information only  and
is  not intended to provide specific legal advice; if you have  a
specific  question  regarding the  law,  you  should  contact  an
attorney  of your choice.  Suggestions for topics to be discussed
in this column are welcome.]


Reprinted from Fabricare
Myles M. Mattenson © 2007