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Center 48 Limited Partnership v. The May Department Stores Company

355 N.J. Super. 390, 810 A.2d 610 (App. Div. 2002)

LEASES; GUARANTIES; MISTAKES— A mistake in a lease that doesn’t actually, as opposed to hypothetically, increase the liability of the tenant or its guarantor will not invalidate the lease or the guaranty, and if there has been substantial performance under the lease, recision may be denied because is an equitable and discretionary remedy.

A department store entered into a lease at a shopping center. In the lease, the landlord warranted and represented that it was the owner, in fee simple, of the leased premises and the lease stated that the tenant was relying on that warranty and representation in executing and delivering the lease. Contemporaneously with the execution of the lease, the tenant’s parent company executed a guaranty agreement, unconditionally guarantying the lease. The guaranty expressly stated that no modification of the lease would “in any way release [the parent company] from liability [thereunder], or terminate, affect, or diminish the validity of [the] Guaranty, except to the same extent, but only to such extent, that the liability or obligation of Tenant [was] so released, terminated, affected or diminished.” Notice to the guarantor of lease modifications was waived.

At some point, the landlord’s transaction with the owner of the property (which was to be developed into a shopping center pursuant to the Lease) changed from a sale to a land lease due to capital gain considerations. That meant that at the time that the department store signed its lease, the land was actually owned by a third party and not the landlord. The tenant asserted that it did not know that its landlord did not own the land even though a memorandum of ground lease had been recorded. The guarantor claimed that it and its subsidiaries “tried to avoid subleasing property on which it operated a store because subleasing created a risk that the subtenant might lose its right to occupy the premises through no fault of its own, such as if the ground lease was terminated or if the tenant under the ground lease defaulted.” In cases where it did enter into a sublease, “it insisted on assurances, typically in the form of a non-disturbance agreement with the landowner, whereby the owner agreed that the subtenant may continue to occupy the premises even if the lessee under the ground lease lost its lease with the owner.” The department store’s possession of the property was never in fact disturbed by the ground lessor or anyone else. The store continuously operated the premises until it filed for bankruptcy. Even after the bankruptcy, it continued to operate its store. Eventually, pursuant to a bankruptcy court order, the tenant rejected the lease on the property.

Subject to a reservation of rights, the parent company, which no longer owned the department store tenant, honored its guaranty and voluntarily paid all of the obligations. When the landlord finally found a replacement tenant, the new annual rent fell short of what would have been payable under the old lease, and the landlord sought to recover the difference from the guarantor. Eventually, the matter of exactly how much money the guarantor owed was presented to a court. The guarantor argued that it was not liable at all, arguing “the guaranty agreement was not enforceable because there had been no meeting of the minds and that, alternatively, [the guarantor] was entitled to rescind the agreement because of a unilateral mistake.” Specifically, the guarantor argued that “ownership of the underlying property had been an essential material fact of the guaranty agreement and because the lease agreement had warranted that the [landlord’s] predecessor was the owner, this was a risk fundamentally different than what the guarantor had agreed to assume.” It further claimed that, as guarantor, it had been prejudiced because its subsidiary “never received a non-disturbance agreement from the property owner.” The lower court did not believe the guarantor’s claims were sufficient to set aside the guarantee. On appeal, the Appellate Division was “called upon to decide whether a modification of the underlying lease – whereby the lessor became a long term leasehold rather than fee owner – operate[d] to discharge the guarantor.” It concluded “that in order to effect a discharge of the guarantor, an alteration or modification of the underlying lease must either injure the guarantor or actually increase the guarantor’s risk or liability.” It determined that the modification “neither injured the guarantor nor increased its risk or liability under the contract of guaranty.”

“It is fundamental that the guarantor is not bound beyond the strict terms of its promise and its obligation cannot be extended by implication.” The guaranty agreement “provided that it was made solely in consideration of [the landlord] having entered into the lease at [the guarantor’s] request.” Consequently, the Court rejected the argument that the guarantor “gave its guaranty in reliance on the representation contained in the lease that [the landlord] owned the land.” This left only the question as to whether the change in the landlord’s interest “from a property owner to a ground lessee should have operated to discharge [the guarantor] from liability under the guaranty.” Essentially, since the guarantor “expressly agreed that any modification of the lease would not release it from liability or ‘terminate, affect or diminish the validity of’ the guaranty except if [its subsidiary’s] liability was ‘released, terminated, affected or diminished,’ and while the change may have theoretically increased [the guarantor’s] risks under the guaranty, it never resulted in any actual injury or prejudice to it.” What was more, was that the court recognized that had the ground lease been terminated, the subsidiary would have been released from any further obligation to pay rent and this would have operated to discharge the guarantor from liability under the guaranty agreement. Consequently, “any increased risk ... was more illusory than real.”

The guarantor also argued that “there was never was a meeting of the minds, or alternatively, that a contract may be rescinded where there had been a unilateral mistake.” Here, the alleged “mistake” was that it thought the landlord owned the land. Although, “[c]ontracts may be rescinded where there is original invalidity, fraud, failure of consideration, or material breach of default, ... [t]he remedy is discretionary with the court and should not be granted where there has been substantial performance of the contract.”

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