Nothing in life is guaranteed: implied waiver of a written guaranty.

A recent decision of the Appellate Division, First Department threatens to undermine the reliability of a document which is a stalwart of innumerable business transactions--the written guaranty. Although decided in the context of a lease dispute, the 44-page decision in Madison Avenue Leasehold, LLC v. Madison Bentley Associates LLC, Index No. 600192/04, reaches far beyond the arena of commercial real estate and potentially hamstrings the ability of any party to rely on a guaranty. Indeed, the 20-page majority decision provoked a searing 24-page dissent challenging not only the legal reasoning of the majority, but also sounding the alarm on important policy issues which flow from the precedent.

Beginning in June 2000, Madison Bentley Associates LLC ("Bentley") leased ground floor space in a building on Madison Avenue and 49th Street from the building's owner, Madison Avenue Leasehold LLC ("Madison"). The ten-year lease was negotiated by Madison and the principals of Bentley, Brian Miller and Arthur Miller. Bentley was one of only three authorized Bentley and Rolls Royce dealers in the New York State area, and it planned to use the space on Madison Avenue as a showroom. The Millers also owned a luxury car dealership on the west side of Manhattan.

Prior to executing the Madison Avenue lease, Rolls-Royce and Bentley Motor Cars, Inc. agreed to provide Bentley a partial rent subsidy for the first three years of the lease. As Bentley later conceded, without this rent subsidy, it could not make its monthly rent payment. To provide protection against the uncertain success of a luxury car dealership on the east side of Manhattan, Madison obtained a personal guaranty of the lease from the Millers for the payment of rent up to $1,682,980.67.

The guaranty specified that it was "an absolute and unconditional Guaranty of payment and performance." Importantly, it also provided that if Bentley was not "in monetary default under the Lease at any time" (emphasis supplied) during the first three years of the lease, then the guaranty would terminate. The Millers agreed in the guaranty "that if default shall at any time be made ... in the payment of any rent ... and if such default shall not be cured within ten (10) days after notice of such default shall have been given" to them, then they would "pay such rent to Madison and any arrears thereof...." The Millers further agreed that their obligations under the guaranty would "in no wise be terminated, affected, diminished or impaired by reason of the assertion, or the failure to assert, by Landlord against Tenant of any of the rights and remedies reserved to Landlord pursuant to the provisions of the Lease."

During the first three years of the lease, Bentley typically paid its rent either ten days late or on many occasions, twenty days late. Although Bentley's rent was always late, Madison did not issue any notices or take action regarding the late payments. When the rent subsidy expired on September 30, 2003 and Madison refused to make any rent concessions, Bentley stopped paying rent and vacated the premises, just three years and three months after the commencement date of the lease. Thereafter, Madison commenced an action in Supreme Court, New York County against the Millers seeking $1,682,980.67 pursuant to the guaranty, for rent owed by Bentley for the remainder of the lease term. The Millers moved for summary judgment on the ground that Bentley was never in monetary default under the lease and therefore, the guaranty had automatically expired. The Supreme Court granted Bentley's motion and the Appellate Division, First Department affirmed the dismissal of the complaint.

The Millers did not dispute that if a monetary default had occurred during the first three years of the lease, they were liable under the guaranty. They contended, however, that Madison's conduct in repeatedly accepting late rent payments constituted a waiver of the rent payment provision of the lease that required payment to be made by the first of each month. They then made the leap of logic that because the defaults had been waived, Bentley had never been in default, and consequently, the guaranty automatically terminated. The majority stated, "landlord's acceptance of the tendered rent with knowledge of the lease violation extinguishes the default as a matter of law .... Thus ... the conditions necessary to subject the guarantors to liability were never met...."

Madison countered that it was not required to take action against Bentley because the very purpose of the guaranty was to provide assurance that any rent due would ultimately be paid. Madison argued that as the principals of Bentley, the Millers were able to ensure that rent was paid on time, but simply failed to do so. As the dissent opined, "to insist on pain of waiver" that Madison notify Bentley of what it already knew made little sense. In all events, Madison argued, it could not have waived Bentley's monetary default because the lease contained a non-waiver provision.

The Millers and Madison--both sophisticated parties--agreed to non-waiver provisions, among others, that Madison should have reasonably expected to be enforced according to their terms. As the First Department held in Excel Graphics Technologies, Inc. v. CFG/AGSCB 75 Ninth Avenue, L.L.C., 1 A.D.3d 65, 70 (1st Dep't 2003), "the parties to a commercial lease may mutually agree that conduct, which might otherwise give rise to an inference of waiver, shall not be deemed a waiver of specific bargained-for provisions of a lease." Similarly, the Court of Appeals held in Jefpaul Garage Corp. v. Presbyterian Hosp., 61 N.Y.2d 442, 446 (1984), "while waiver may be inferred from the acceptance of rent in some circumstances, it may not be inferred, and certainly not as a matter of law, to frustrate the reasonable expectations of the parties embodied in a lease when they have the agreed otherwise."

There is no reason why non-waiver clauses should not apply to circumstances such as those here, to permit a landlord to accept untimely rent payments and continue the tenancy without "having such acceptance brandished as evidence of intent to waive a default." See, e.g., NL Indus., Inc. v. PaineWebber, Inc., No. 88 Civ. 8602 (MBM), 1989 U.S. Dist. LEXIS 13744, at *6 (S.D.N.Y. Nov. 20, 1989).

More significantly, Madison argued that even if it had waived both the rent and non-waiver provisions of the. lease, the waiver under the lease was irrelevant to enforcement of the guaranty, and Madison was protected by the provision in the guaranty providing that a failure to take action against Bentley did not affect the guaranty's enforcement. The Millers expressly agreed that their obligations under the guaranty would not be affected by reason of Madison's failure to assert any of its rights and remedies under the Lease. While the First Department held that the guaranty was not triggered and its terms, including the non-waiver provision, did not come into play, the guaranty contained no language that could be construed to mean that the Millers' obligations under it terminated because Madison waived the timely payment of rent provision in the lease. The Millers' guaranty was an "unconditional and absolute" guarantee of "full and prompt payment of all rent." Even if Madison waived timely payment under the lease, it did not waive full payment under the guaranty.

According to Madison--and in the dissent's view--the purpose of ensuring that the guaranty could be extended beyond the first three years of the lease term was to provide an additional layer of protection to Madison in the event Bentley proved to be unreliable in fulfilling its lease obligations. As the dissent put it, if Bentley paid rent on time during the first three years of the lease, Madison would have a substantial "degree of security" that Bentley could be "trusted to perform during the ensuing seven years," but conversely, the failure of Bentley to timely pay rent would "increase [Madison's] risk and lead it to seek the additional hedge of a continuing guaranty from the Millers."

The majority, however, focusing on what it perceived to be the intent of the parties, rather than the four corners of the guaranty, wrote that it was "disingenuous" for Madison to argue that the Millers should have "expected their obligations under the guaranty to be extended by a mere technical violation rather than by a material default." The court determined that because the guaranty was coextensive with the rent subsidy, the parties intended the term of the guaranty to be limited to three years unless Madison suffered some tangible monetary loss during those three years. Thus, the court concluded that the condition precedent to rendering the guaranty effective and imposing liability on the Millers was not fulfilled, and the guaranty, "together with its 'no waiver' provisions concerning [Madison's] enforcement of its rights and remedies, never had any force and effect."

In sharp contrast, the dissent found that the guaranty was unambiguous, noting that there was "nothing mysterious ... about the meaning of the term 'monetary default'". The dissent took issue with the majority's focus on the legal consequences of waiver and default under the lease, maintaining that only the legal consequences of a default under the guaranty were relevant. In the dissent's view, the guaranty unequivocally provided that if "at any time" there was a "monetary default" by Bentley during the first three years of the lease, then the Millers continued to be obligated under the guaranty. In addition, the dissent held, the guaranty "all but shouts" that the Madison's actions pursuant to the lease cannot affect the Millers' obligations under the guaranty.

The dissent was not only critical of the majority's legal conclusions, but of the policy implications of the court's decision. The dissent contended that the majority's application of the waiver doctrine would expose contracting parties to the very risks and uncertainties that they seek to avoid by entering into written contracts. Under the majority's analysis, the dissent argued, "contracting parties are encouraged to go to the time and expense of serving notices of default for any failure fully to perform as soon as legally permissible, regardless both of whether they have received assurances that payment or other performance is imminent and of how relatively inconsequential the particular default may be under the particular circumstances."

The concerns raised by the dissent are well-founded. In particular, as a result of the Madison Avenue Lease-hold decision, beneficiaries of guaranties can no longer be assured that a non-waiver of rights and remedies clause in their guaranties will ultimately protect them. This result runs counter to the very function guaranties typically perform--i.e., enabling otherwise high risk transactions to be considered economically feasible. Perhaps most critically, the decision will encourage every beneficiary of a guaranty immediately to look to the guarantor upon a default, without making any effort to resolve the matter with the primary obligor.

Although beyond the scope of this article, it is also worth noting that the decision may well have an impact reaching beyond guaranties to impact any contract provision which is contingent on the absence of a default historically. For example, a commercial tenant's right to exercise an option to renew or to expand is often contingent upon a prior history of no monetary defaults. If, as in this case, the landlord permits the defaults to be cured, has the landlord also forfeited its rights not to renew or expand the relationship with a habitually delinquent tenant? The instant decision, if it remains as law in the First Department, leaves the rights of many contracting parties uncertain.

What is unfortunately certain is that landlords and obligees under guaranties and other contracts will have to consider carefully the impact of allowing a default to be cured rather than immediately exercising all rights available at the time, including immediately engaging outside counsel and perhaps commencing litigation as a defensive measure prior to any resolution of defaults. This will undoubtedly produce disharmonious relationships between landlords and tenants, as well as other parties in guaranty and other contract situations, and certainly cannot be the result intended by the State's courts.

* Sara Gerber, an associate at Nixon peabody LLP assisted in the preparation of this article.

BY MARC L. FRIED AND ADAM B. GILBERT, PARTNERS, NIXON PEABODY LLP.