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POSSIBLE PITFALLS WITH SUCCESSOR LESSEES.

When a lessee's rights under a lease are assigned, the lessor typically requires the successor lessee to execute an "assumption agreement" promising to assume and perform all lessee obligations. The landlord thus ensures that the new lessee will be bound by all provisions of the lease.

However, sometimes an assignment is made from the original lessee to its successor, but the lessor neglects to require the successor to execute an assumption agreement. A successor can also obtain an assignment without an assumption agreement by purchasing a leasehold at a foreclosure sale after the original lessee has failed to pay a loan secured by the leasehold. In such cases, because there is no contract (i.e., no assumption agreement) between the lessor and the successor lessee, the successor is in "privity of estate" with the lessor, but is not in privity of contract."

Determining Obligation

Contrary to what many businesspeople might assume, although the original lessee may remain bound on all covenants in the lease, in situations without an assumption agreement some lease obligations may not be binding upon the successor lessee. Since there is a mere privity of estate, the successor lessee's taking possession of the premises does not give rise to a legally implied agreement that the successor lessee is assuming the entire lease and all of its covenants. Instead, taking possession creates an implied agreement only that the successor lessee is assuming those fundamental covenants and obligations which "run with the land" or "touch and concern the land." The successor's taking possession does not make it liable in damages for other lease obligations which are merely "contractual."

Ruling Basics

The most obvious example of such an obligation which "runs with," and "touches and concerns" the land--and thus remains in effect--is the obligation to pay rent. Similarly, when a lease calls for the lessee to maintain insurance, make repairs, or pay taxes, these obligations are also deemed to run with the land and will remain in effect. However, since they are tied to possession of "the land," only those items that come due after the successor lessee acquires its leasehold interest are binding and those items that came due beforehand are not. By the same rationale, if the successor lessee later ceases to hold an interest in "the land" by abandoning the premises or further transferring the lease, it will not be liable for any such payments coming due thereafter.

In practice, it can be difficult to identify which lease covenants run with the land and which ones are merely contractual. Under California law, for example, the courts have held that a lease provision for arbitration of rent disputes runs with the land, whereas a provision awarding attorney's fees to the prevailing party in litigation under the lease does not. In each case a careful review will have to be made under local law.

These basic rules as to which obligations bind a successor lessee without an assumption agreement do not change even if the original lease contained a covenant that the lessee would require an assumption agreement from any successor assignee. If an assignment without an assumption agreement nonetheless occurs, then the original lessee has breached this covenant and can be pursued for breach of contract (if it still exists and/or has any assets) by the lessor. However, the successor lessee will not have to assume the obligations that its predecessor was supposed to have required it to assume.

Practice Tips

All of this provides lessons for lessors and lessees. As lessors endeavor to draft their leases to specify that any assignment will be subject to their reasonable approval, they should also provide that a reasonable condition to approval will be that any successor lessee will be required to enter into an assumption agreement; and make sure that they always follow through and obtain ah assumption agreement whenever they are asked to approve an assignment.

As much as possible, lessors also should seek to protect themselves in situations when an assignment occurs non-contractually, such as when a leasehold is purchased at a foreclosure sale. Admittedly, there is probably no way to identify or obtain any agreement from future third-party foreclosure purchasers generally. However, a lessor being asked to consent to a lessee's pledge of its leasehold as collateral to an already identified lender should seek to require the lender to agree that, if it is the lender itself that later purchases at the foreclosure sale (which is frequently the case) then the lender agrees in advance to assume all lessee obligations.

From the lessee's standpoint, when a party has become a successor lessee without entering into an assumption agreement, it may wish to undertake a legal analysis if it is asked to meet the obligations arising before or after its possession or which do not fall within the categories of obligations that may not "run with the land."

While it is typical for an assumption agreement to be executed, on the occasions it is not, determining who is responsible for certain provisions of the lease can become quite confusing. Understanding beforehand who is responsible for certain obligations can help a landlord and a successor lessee be properly aware of any fees.

Perry D. Mocciaro is a partner with Cox, Castle, & Nicholson LLP in Los Angeles.
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Article Details
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Author:Mocciaro, Perry D.
Publication:Journal of Property Management
Article Type:Brief Article
Geographic Code:1USA
Date:Jul 1, 1999
Words:878
Previous Article:BUDGET PROPOSALS.
Next Article:ETIQUETTE AND THE DISABLED.
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