Suite 1819
Philadelphia, PA 19103
Phone: (215) 399-1346
Facsimile: (215) 399-1347
contact@nochumson.com
By Alan Nochumson*
In many commercial real estate transactions, landlords and tenants make estoppel certifications representing that certain facts involving their legal relationship are correct.
Some of the more common statements are that a lease exists, that there are no defaults under the lease, and that rent is paid to a certain date. These statements are made to “estop” the party making the statement from later raising claims of which it knew or should have known at the time the certification was executed.
In Retail Brand Alliance, Inc.
v.
In Retail Brand
When the parties entered into the lease, the store was an empty
shell. Both the landlord
and the tenant had respective duties in the lease to turn the shell
into a retail store. The
landlord was required to install the basic features and layout of
the store and the tenant agreed to “fit out” the space at the
landlord’s expense. The
tenant was given a $340,000 “fit out” allowance under the terms of
the lease.
Before the landlord could begin construction of the space, the
tenant was required to provide to the landlord with detailed
architectural plans and specifications describing the construction
work that both parties would perform to fulfill their contractual
duties.
The landlord soon began work based upon the plans and specification
provided by the tenant. Shortly thereafter, the landlord discovered that these plans and
specifications contained “latent defects, errors, omissions and
inaccuracies and were false and misleading.”
The landlord retained the services of another architect to correct
the plans and specifications at an additional cost of $100,000. Due to the associated delay in the completion of the
construction of the store, the landlord did not collect any
percentage rent during this period of time.
Within a year after the store opened for business, the
tenant, with the landlord’s consent, assigned its interest in the
lease to another retail operator. Prior to doing so, the tenant did request reimbursement of
the $340,000 tenant allowance owed by the landlord. The landlord did not pay that amount prior to executing the
assignment agreement.
As part of the assignment agreement, the landlord executed an
estoppel certification representing that the tenant did not owe any
amounts under the lease and that there were otherwise no uncured
defaults committed by the tenant under the lease.
THE CASE
After assigning the space, the tenant filed a complaint in the
federal district court to recover the $340,000 due by the landlord
for the tenant allowance. The landlord filed a motion to dismiss the case, arguing that
the tenant assigned its interest in the allowance to new retail
operator in the space when it executed the assignment agreement. The
district court found this reading contrary to the plain language of
the assignment agreement and denied the landlord’s motion to
dismiss.
The landlord then answered the complaint and added a counterclaim
against the tenant for, among other things, breach of contract. In its breach of contract claim, the landlord sought the
excess renovation costs it incurred in converting the retail space
and the damages flowing from the delay in the construction of the
retail space. The tenant
moved to dismiss all of the counterclaims.
The district court found that the estoppel certification contained
within the assignment agreement barred the landlord from attempting
to collect the sought after expenses, since it represented that
there were no uncured defaults by the tenant when it executed the
agreement in the first place.
The district court based its decision on the plain language in the
certification. The
district court pointed out that, through the estoppel certification,
the landlord expressly represented that there were no “uncured
defaults” attributable to the tenant under the lease or conditions
that “would reasonably be expected to result in a default” by the
tenant. The district
court noted that the excess renovation costs were incurred by
landlord sometime before the store opened and predated the
assignment by almost a year.
The district court then rejected the landlord’s attempt to ignore
the plain meaning of the estoppel certification. In opposing the motion to dismiss the counterclaim, the
landlord argued that the estoppel certification was invalid and
unenforceable both because the tenant fraudulently induced the
landlord into entering the assignment agreement and due to its
unilateral mistake.
The landlord first argued that the tenant fraudulently induced the
landlord into making the estoppel certification through the tenant’s
unspoken suggestions that the tenant would not pursue payment for
the tenant allowance if the landlord consented to the assignment of
the lease. In support of
its theory, the landlord pointed out that, the landlord stopped
payment of the allowance to the tenant after learning that the
tenant intended to close the store, file for bankruptcy and thus
“dump” its lease, and that the tenant never sought payment of the
allowance or mentioned the allowance again until after the
assignment agreement was fully executed.
The district court rejected the landlord’s fraudulent inducement
argument based upon the legal theories of parol evidence rule and
ratification.
The parol evidence rule “bars prior or contemporaneous oral
representations or agreements about a subject that is specifically
dealt with in a written contract that covers the entire agreement of
the parties, absent fraud, accident or mistake.” As explained by the district court, parol evidence is
generally only permitted to show “fraud in the execution” and not
“fraud in the inducement.” In contrast to “fraud in the execution”, which deals with
terms of the written agreement which are omitted by fraud, accident
or mistake, “fraud in the inducement” occurs when ‘the party
proffering evidence of additional prior representations does not
contend that the parties agreed that the additional representations
would be in the written agreement, but rather claims that the
representations were fraudulently made and that but for them, he or
she never would have entered into the agreement.’
Since the landlord could not establish that the parties intended to
include the tenant’s waiver of the allowance in the assignment
agreement, the district court found that the counterclaim was barred
by the parol evidence rule because the landlord’s theory amount to
“fraud in the inducement” and not “fraud in the execution.”
The district court found that the fraudulent inducement claim also
lacked any merit because the landlord had ratified the assignment
agreement through its conduct over the past year. The district court emphasized that, since “[e]stablishing
fraud in the inducement does not render the transaction void but
only voidable, “[t]he defrauded party can ratify the contract if ‘it
accepts the benefits flowing from it, or remains silent, or
acquiesces in the contract for any considerable length of time after
the party has the opportunity to annul or avoid the contract.’”
The district court pointed out that the landlord has consistently
accepted the benefits of the agreement by treating the current
retail operator as a tenant and accepting rent payments.
The district court next rejected the landlord’s argument of
unilateral mistake. In
Pennsylvania, a contract may be invalidated for unilateral mistake
if the mistake is a “basic assumption” or the essence of the
contract and the party alleging the mistake did not bear the risk of
the mistake by being aware at the time the contract is made that the
party has “limited knowledge” of the facts to which the mistake
relates and treating this limited knowledge as sufficient.
Once a party has establishes the basic elements of a unilateral
mistake, there are two exceptions to the general rule that a party
must live with the result of the unilateral mistake. First, a unilateral mistake as to the contract can invalidate
an agreement procured through fraud. Second, a contract based on
unilateral mistake can also be rescinded “if the other party knows
or has reason to know of the unilateral mistake, and the mistake, as
well as the actual intent of the parties is clearly shown.”
The district court doubted whether the landlord could establish the
core elements of unilateral mistake. The district court noted that the mistake concerned payment
of the renovation costs, which did not go to the basic assumption to
assign the lease to a new tenant. Moreover, the district court concluded that the landlord
“bore the risk of its mistake by treating its limited knowledge as
sufficient” because the landlord, a sophisticated party, ‘believed’
that the tenant shared its belief about the tenant allowance but
never sought clarification or memorialize this ‘agreement’ in
writing.
The district court also stated that, even if the landlord court
could establish the elements of unilateral mistake, the landlord
could not show that it fell into one of the two narrow exceptions
outlined above. In its
counterclaim, the landlord did not allege that the tenant procured
the assignment through fraud but rather that the tenant knew or
should have been aware of the landlord’s mistaken assumption that
the parties had agreed that the landlord would consent to the
assignment if the tenant would forgo the allowance. The district court noted that the landlord puts forth no
evidence that the tenant’s silence concerning payment of the
allowance is the same as knowing that the landlord was mistaken
about a basic assumption of the contract.
LESSONS LEARNED
Retail Brand Alliance, Inc. is the classic example of a party to a contract ignoring the reality of its situation. At the very least, the landlord knew it could owe the $340,000 allowance to the tenant. Rather than directly dealing with this potentially uncomfortable situation, the landlord believed that the situation would somehow disappear. This mistaken strategy is even more damning considering that the landlord presumably had more leverage than the tenant prior to the execution of the assignment agreement. The landlord did not have to allow the tenant to assign the lease. Moreover, the tenant may have had some legal liability to the landlord for the substandard plans and specifications provided by the tenant’s architect during the construction of the store. Either way, the landlord basically gave away its rights under the lease for nothing instead of shielding itself from any further liability.
* Alan Nochumson is the sole shareholder of Nochumson P.C. where he specializes in real estate, litigation, employment and labor, and land use and zoning. Mr. Nochumson regularly speaks at and writes for trade and professional associations, local universities, and adult education programs on issues commonly confronted by businesses, individuals, and professionals. Mr. Nochumson is also President of Bear Abstract Services where he offers comprehensive title insurance, title examination, and closing services for transactions ranging from simple residential agreements of sale to complex commercial projects. He may be reached by telephone at (215) 399-1346 or by e-mail at anochumson@nochumson.com.