Just when you thought you were getting used to an eighty-page lease, new California cases are suggesting that Landlords now need to add language to protect against claims of fraud and misrepresentation.
WHAT ARE “INCORPORATION”, “INTEGRATION” OR “MERGER”
CLAUSES?
Most commercial real estate leases contain an “incorporation” “integration” or “merger clause”. While these clauses may vary and have different affect from state to state, they basically state that everything the parties have agreed to is contained in the written document only, that the landlord made no promises not contained in the lease document and, to the extent that any oral promises or representations were made, they are of no force or effect.
Up until a few years ago, this clause would effectively prevent either party to a lease from alleging that the other party made promises other than what was included in the, four-corners, of the lease[i].
IN CALIFORNIA, COMMERCIAL LANDLORD PROTECTIONS ARE BEING ERODED.
Over the last few years, the incorporation clause has been eroded in California, primarily based upon allegations of fraud. My concern is that these cases have now opened the door to allow any tenant to claim fraud, making lawsuits to enforce the terms of a lease, more difficult and expensive.
In the June 2019 case of Orozco v. WPV San Jose, LLC, (Vornado was a co-defendant), the tenant claimed that he would not have entered a 10-year lease, were it not for misrepresentations and fraud committed by the landlord’s leasing manager and property manager.
The following summary of the relevant facts were considered and apparently uncontested by the California Appellate court:
SUMMARY OF FACTS
On several occasions, prior to and at lease execution, the leasing manager stated that the landlord was not considering leasing to a competitor whose primary products directly competed with that of the tenant. In fact, during the lease negotiations the leasing manager had been negotiating with such a competitor and had signed a lease with the competitor prior to the tenant signing the lease.
During lease negotiations with the tenant, when asking about future tenants that the landlord was negotiating with, the manager stated that it was against company policy to divulge that information during ongoing negotiations. In fact, the landlord did not have such a policy and it was later admitted that the manager chose not to divulge that information as a “negotiation skill”.
The lease included multiple provisions that the landlord had not made any promises to Orozco about products offered by other tenants or future tenants at the center.
The tenant admitted that he did not fully read the 80-page lease, concluding that the essential terms were contained in the first few pages.
The tenant had extensive experience in the restaurant business and had already developed a successful chain of restaurants;
At the time of lease execution, the leasing manager knew that the second tenant would be selling directly competing products as part of its main offering.
The tenant did not request an exclusive provision.
About 30% into the tenant’s tenant improvements, the tenant discovered that the competitor was opening two doors down. When the tenant approached the property manager about the conflict, the tenant was told not to worry because the competitor was having financial troubles. As a result, the tenant completed its tenant improvements and opened for business.
The tenant’s sales went well and continued to increase until the competitor opened for business approximately 7 months later. Thereafter, the tenant’s business continued to decline. Ultimately, the tenant closed its business and abandoned the premises.
ARE THE FUNDAMENTALS OF LEASE INTERPRETATION CHANGING?
A fundamental concept in retail leasing has been that unless the tenant is granted an exclusive in the written lease, the tenant is not entitled to an exclusive. I have argued this concept in court, numerous times and have won on the issue, in each and every instance. Furthermore, I have argued and won cases, including one, earlier this year based upon the incorporation clause in the lease that allowed me to exclude any evidence of alleged oral promises made prior to the lease execution that were not incorporated into the written lease document.
Yet, in this case, the California Court of Appeal allowed the evidence of the oral representations, which the jury found to be false. The jury further found that, notwithstanding language in the lease, clearly making such oral promises unenforceable and the fact that the tenant didn’t even read the lease, the landlord was liable for the tenant’s damages and could rescind the lease.
THE COURT’S REASONING
The court of appeal, in affirming the trial court judgment, reasoned that:
Even if the tenant “had read the entire contract, he would not necessarily have been alerted to the landlord’s misrepresentations”
“The best reason for allowing for fraud…….. is that it is unlikely that the disputed term was bargained over or will be recited in the document”; and that
“This case is distinguishable” from other cases since in this case, the landlord’s representations were patently at odds with the express provisions of the written contract[ii].
WHY IT MATTERS
It is the court’s reasoning that causes me concern and suggests that landlord’s may need to add language in their leases that excludes specific representations. For example, in this case, it might have been helpful if, the lease included language, that specifically represented by the tenant, that the landlord has not made any representation that in any way can be interpreted or implied to mean that the tenant will have the exclusive right to sell certain products enumerated in the lease.
I would add the further language that the failure to specify or identify other tenants or potential tenants currently negotiating a lease in the center or in the future should not be construed or otherwise obligate the landlord from disclosing those tenants or the products that they intend to sell in the center. Further it should be stated in the lease that the tenant has not requested an exclusive or has requested but has not be granted an exclusive. And finally, I would highlight the importance of this provision by making the language bold and providing a space for the tenant’s initials below the provision, indicating that the tenant paid special attention to the provision.
The risk in putting in more specific language is that you cannot contemplate everything that might be sold that can be competitive and by specifying certain categories, you may be implying that other things may be excluded.
What did the landlord do wrong in this case? To begin with, the landlord’s agents lied, on a number of occasions and clearly hid things that the tenant was clearly interested in. The court clearly considered the ample evidence of fraud when considering the affect of the tenant’s failure to read the entire lease, when it stated that the tenant’s “failure to read the entire lease is not dispositive, given the ample evidence of fraud.” Perhaps if the evidence weren’t so strong, the court would have given more weight to the tenant’s own negligence.
There are a number of other issues raised in this case that I take some exception to, including whether or not the tenant’s reliance on the representations of the landlord’s agent was reasonable in light of the fact that the agent was not a fiduciary of the tenant and the fact that the tenant failed to read the entire lease. These issues will be addressed in another article and CRE Radio & TV live.
THE QUESTION YOU SHOULD ASK YOURSELF
Finally, I think that it is fair to ask what you would have done had you been the tenant or represented the tenant. Leave a comment below or send a comment to howard@creradio.com
END NOTES
[i] There are some exceptions to the general rule, including lease ambiguities and post-execution conduct evidencing waiver, estoppel. These issues are for a later discussion.
[ii] This seems to contradict the appellate court’s opinion in which the court stated that the lease “clearly stated that (the tenant) was not making any promises about any of the other tenants at the (center).”
THE AUTHOR:
Howard F. Kline is a Nevada licensed real estate advisor with SVN The Equity Group, located in Las Vegas Nevada. He has also been a licensed California attorney for over 42 years, primarily focused on commercial real estate and has been a licensed California broker and a licensed New York real estate agent. He is also the founder and host of CRE Radio & TV, an online commercial real estate
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