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GFS/Morristown Limited Partnership v. Vector Whippany Associates

A-1370-06T3 (N.J. Super. App. Div. 2009) (Unpublished)

MORTGAGES; DEFAULTS — A lender has great latitude when acting on behalf of its borrower, as landlord, in stepping into the shoes of the landlord pursuant to a mortgage and assignment of leases.

A real estate partnership purchased a building in 1984, financing its purchase with a loan. It leased the entire property for ten years (expiring at the end of 1996) with three five-year renewal options. The landlord then refinanced the property and executed a mortgage and promissory note as well as a collateral assignment of leases and rents agreement. The tenant agreed to sign a subordination of lease agreement which would make the lease subject and subordinate to the mortgage. The landlord and the mortgagee entered into a new loan agreement changing the loan’s maturity date and providing for a liquidated damages payment in the event of default under the loan.

Later, the tenant sold the operating division that had occupied the building and assigned the lease to its buyer. The assigning tenant remained liable for the rent payments. The new tenant contacted the landlord and submitted a proposal to extend the lease in return for a reduction in the rent. The landlord responded that it could not accommodate the tenant unless it could get a reduction in mortgage payments to reflect the reduced rent. The mortgagee considered the loan to be “under water,” with the value of the property well below the amount of the mortgage. It informed the landlord that, conceptually, it could reduce the interest payments as requested. The landlord then indicated to the assignee that it would negotiate a lease extension and reduce the rental payments but only if it received a written modification of the loan. Numerous discussions between the parties then took place, but no deal was put in writing. Finally, when the tenant sent a partial rent payment rather than the full amount due, the landlord brought an eviction action. As a result of its reduced cash flow, the landlord couldn’t pay its lender. The lender sent the landlord a notice of loan default and directed the tenant to make all future rent payments directly to the lender. It also sent a letter to the tenant demanding full payment of the rent, and instituted an action seeking to confirm its authority to modify and extend the lease in accordance with the rights it had been granted by the collateral assignment of leases.

The Chancery Division granted the lender the right to negotiate directly with the tenant pursuant to the provisions of its assignment of leases and rents. The lender and the tenant then entered into a lease extension to December 31, 2008. The lender signed the amended lease in the landlord’s name and agreed to pay a portion of a contested brokerage commission.

On appeal, the Appellate Division found that the lower court acted prematurely in permitting the lender to execute a lease amendment because the landlord’s default had not yet been determined, but nevertheless held that the amended lease could remain in effect on a pendente lite basis.

In a foreclosure action that followed, the lower court found that the lender and the landlord were never able to resolve the various issues implicated in the reduction of mortgage debt service. It also found that the tenant had reduced its rental payments in order to force the lender to agree to the reduced debt service by the landlord. According to the lower court, the landlord, by its non-acceptance of the proposal, and its subsequent failure to pay the loan, triggered a default leading to acceleration of the remaining principal. The lower court detailed the amounts due, which included interest and liquidated damages. The landlord appealed.

In the appeal, the Appellate Division reversed the lower court’s holding that the tenant had not breached the original lease when it sent revised rent payments relying on the landlord’s proposal. It held that a memo sent by the landlord, while a writing, did not constitute a modification of the lease because it specifically stated that the landlord did not intend to be bound by the writing and that it was merely a “proposal.” Also, the proposal was made expressly contingent on the receipt of approvals from the lender that were never obtained. Thus, the Court ruled that the tenant unilaterally breached its lease when it sent partial rent payments. For that reason, it remanded the matter to the lower court to amend the judgment against the tenant.

The Court affirmed the lower court in all other respects. First, it agreed that the lender was justified in stepping into the shoes of the landlord when the landlord defaulted on the mortgage. Second, it rejected the landlord’s claim that the damages calculation should be modified because it was flawed. The Court found that the proofs did not establish that the tenant would have remained at the property without a substantial rent reduction and any exercise of the renewal options was dependent upon the tenant’s election and was not automatic. Thus, the Court determined that any claims that the landlord was damaged because it did not receive increased rents after the expiration date were meritless. Third, the Court ruled that any reduced rental payments made by the tenant could be used to partially offset the mortgage payments due to the lender. Fourth, the Court rejected the landlord’s argument that the lender acted in bad faith by conspiring with the tenant to eliminate the landlord’s interest in the property. It ruled that there was insufficient evidence to support such a contention. It noted that the lender even brought an action against the tenant for non-payment of rent. The Court also rejected the landlord’s contention that the lender impaired the value of the mortgage collateral. Fifth, the Court viewed such a defense as only being available in a suretyship situation which was not the case here. Sixth, the Court also held that there was no “pattern of evasion” by the lender and thus no breach by it of an implied duty of good faith and fair dealing. It noted that “rather than playing possum,” the lender was actively engaged in attempting to reach an agreement. It also found that although the landlord claimed that the lender failed to make concessions, the landlord did not offer to make any concessions with the tenant to reach an amended lease arrangement. Seventh, the Court further disagreed with the landlord’s claim that the tenant needed its written consent before it cancelled or modified the original lease by virtue of the subordination agreement. It determined that the subordination agreement made the lease subordinate to the mortgage and that the lender had the right to modify the lease despite the subordination agreement. Eighth, the Court found that the lender was justified in accelerating the mortgage, as the landlord’s failure to pay approximately $32,000 to the lender in interest payments was neither minor nor technical. Ninth, as to the landlord’s claim that there were inadequacies and inconsistencies in the lower court’s findings, the court found that the landlord was really raising a “weight of the evidence” argument and ruled that the lower court’s holdings were supported by substantial credible evidence. Finally, the Court held that it was within the lower court’s discretion to find that the landlord’s witnesses were not believable as they were found to have testified falsely in connection with several material facts.

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