Dover Mobile Estates v. Fiber Form Products, Inc.

• Decision Date: 31 May 1990
• Docket Number: No. H005714,H005714
• Court: California Court of Appeals Court of Appeals
• Parties: DOVER MOBILE ESTATES, Plaintiff and Appellant, v. FIBER FORM PRODUCTS, INC., Defendant and Respondent.

Page 183

270 Cal.Rptr. 183

220 Cal.App.3d 1494

DOVER MOBILE ESTATES, Plaintiff and Appellant, v. FIBER FORM PRODUCTS, INC., Defendant and Respondent.

No. H005714.

Court of Appeal, Sixth District, California.

May 31, 1990.

As Modified June 7, 1990.

Laurence B. Mitchell, Mitchell & Stock, San Jose, for plaintiff and appellant.

Roy Bolton, Los Gatos, for defendant and respondent.

ELIA, Associate Justice.

Appellant Dover Mobile Home Estates filed suit to recover rent from respondent Fiber Form Products. A court trial resulted in judgment in favor of Fiber Form. In its appeal, Dover argues that (1) a trustee's sale did not terminate Fiber Form's lease; (2) Fiber Form breached the covenant of good faith and fair dealing and (3) the trial court erred in denying its motion to tax costs. We affirm.

FACTS AND PROCEDURAL BACKGROUND

In 1985, tenant Fiber Form entered into a five year lease with landlord Old Town Properties, Inc. The lease provided that it was subordinate to any deeds of trust or mortgages placed on the property unless the mortgagee or beneficiary elected to have the lease be superior. ¹

Old Town subsequently encumbered the property with a second deed of trust to Saratoga Savings & Loan Association. Old Town defaulted. Saratoga Savings & Loan foreclosed and, at a December 3, 1986 trustee's sale, Income Property Investments, Inc. (hereafter Dover) purchased the property. ² Dover knew of Fiber Form's lease before it purchased the property. In fact, the lease was of "supreme importance to its decision to purchase." A trustee's deed was recorded on December 5, 1986.

On December 4, 1986, Dover notified Fiber Form that it had purchased the property. It told Fiber Form to direct future rent payments to Dover's management company. The parties did not enter into a new lease but Fiber Form continued to pay rent per the lease.

On March 9, 1987, Fiber Form and Dover discussed reducing the monthly rental. The discussion was prompted by a downturn in Fiber Form's business. Fiber Form allegedly advised Dover that the foreclosure extinguished the lease and contended that it was operating under a month to month lease. Dover denies that such notice occurred but alleges that Fiber Form requested a one-year delay in the rent increase scheduled to take effect, pursuant to the lease, on May 1, 1987. Dover offered to delay the increase if Fiber Form extended the lease an additional year. This proposal was never accepted.

On June 1, 1987, Fiber Form gave Dover 30 days written notice of its intent to vacate. Fiber Form subsequently vacated the premises and stopped paying rent.

Dover filed suit against Fiber Form for rent and conversion. The trial court determined that the trustee's sale terminated the lease and entered judgment for Fiber Form in the action to recover rent. Costs for attorney's fees in the amount of $7,255.95 were awarded to Fiber Form. This appeal ensued.

DISCUSSION

A. TERMINATION OF THE LEASE

Fiber Form argues that it became a month to month tenant after the trustee's sale because the sale extinguished the lease. Dover, on the other hand, contends that the lease was not terminated but was ratified because Fiber Form continued to pay rent after the trustee's sale. For reasons we shall state, we conclude that the trustee's sale extinguished the lease so that Fiber Form became a month to month tenant, thereby allowing Fiber Form to terminate on 30 days notice.

Title conveyed by a trustee's deed relates back to the date when the deed of trust was executed. (Bank of America v. Hirsch Merc. Co. (1944) 64 Cal.App.2d 175, 184, 148 P.2d 110.) The trustee's deed therefore passes the title held by the trustor at the time of execution. (Hohn v. Riverside County Flood Control etc. Dist. (1964) 228 Cal.App.2d 605, 612, 39 Cal.Rptr. 647.) Liens which attach after execution of the foreclosed trust deed are extinguished. The purchaser at the trustee sale therefore takes title free of those junior or subordinate liens. (Id. at p. 613, 39 Cal.Rptr. 647; Carpenter v. Smallpage (1934) 220 Cal. 129, 133, 29 P.2d 841; see generally, Mortgage & Deed of Trust Practice, (Cont.Ed.Bar, 2d ed. 1990) pp. 90-92.)

A lease is generally deemed to be subordinate to a deed of trust if the lease was created after the deed of trust was recorded. (Bank of America v. Hirsch Merc. Co., supra, 64 Cal.App.2d at p. 184, 148 P.2d 110; Miller & Starr, Cal. Real Estate 2d; § 8:82, p. 422.) On the other hand, "when the lease was executed and recorded prior to the recordation of the deed of trust, or if the beneficiary of the deed of trust had notice of an unrecorded lease at the time the trust deed was recorded, the lien of the trust deed is junior to the estate of the lessee...." (Miller & Starr, Cal. Real Estate 2d; § 8:82, p. 422, fn. omitted.)

A lease may also be deemed subordinate by virtue of a subordination agreement. (See e.g. Tanner v. Title Insurance & Trust Co. (1942) 123 P.2d 497, 500, mod. 20 Cal.2d 814, 129 P.2d 383; Bank of America v. Hirsch Merc. Co., supra, 64 Cal.App.2d at p. 182, 148 P.2d 110; Security-First Nat. Bank v. Marxen (1938) 28 Cal.App.2d 446, 453, 82 P.2d 727; Civ.Code, § 2934.) "Subordination agreements are often used to adjust the priorities between commercial tenants and the mortgagee of the real estate, ... Absent such an adjustment, priorities will be governed by the recording acts and related common law principles." (Nelson & Whitman, Real Estate Finance Law (2d ed. [Lawyer's Ed.] 1985) § 15.11, p. 1114.)

A lease which is subordinate to the deed of trust is extinguished by the foreclosure sale. (Bank of America v. Hirsch Merc. Co., supra, 64 Cal.App.2d at p. 182, 148 P.2d 110; Dugand v. Magnus (1930) 107 Cal.App. 243, 247, 290 P. 309; McDermott v. Burke (1860) 16 Cal. 580, 590; Miller & Starr, Cal. Real Estate 2d; § 8:82, p. 422-424.) A foreclosure proceeding destroys a lease junior to the deed of trust, as well as the lessee's rights and obligations under the lease. (Nelson & Whitman, Real Estate Finance Law (2d ed. [Lawyer's Ed.] 1985) § 15.11, p. 1114.) As stated in section 15.1 of the Restatement Second of Property, Landlord and Tenant (1977), "[i]f the sale of the landlord's interest is forced by one having a paramount title to that of the tenant, such as a mortgagee whose interest existed at the time the lease was made, the tenant's interest will be defeated by the sale." (Id. at p. 90.)

In this case the lease itself provides that it is subordinate to the deed of trust. Section 21.1 provides, "[t]enant agrees that this Lease shall be subordinate to any mortgages or deeds of trust ... that may hereafter be placed upon the premises, ..." Although section 21.1 does give the mortgagee or beneficiary the option to elect "to have this Lease superior to its mortgage or deed of trust ...", that option was never exercised. Accordingly, it is clear that the lease is subordinate to the deed of trust and was therefore extinguished by the trustee's sale.

Dover argues that cases supporting the proposition that a subordinate lease is terminated by foreclosure were decided before 1945 and therefore do not consider "changes in real property transactions in modern times." (See e.g. Bank of America v. Hirsch Merc. Co., supra, 64 Cal.App.2d 175, 148 P.2d 110, Carpenter v. Smallpage, supra, 220 Cal. 129, 29 P.2d 841 and McDermott v. Burke, supra, 16 Cal. 580.) We disagree.

The rule that a trustee's sale extinguishes a lease subordinate to the trust deed is not an antiquated principle. For example, in Gross v. Superior Court (1985) 171 Cal.App.3d 265, 217 Cal.Rptr. 284, the court quoted the following from the 1860 case McDermott v. Burke, supra, 16 Cal. at p. 589: " '[T]he legal rights of the lessee were extinguished by the proceedings in the foreclosure suit and sale following the decree thereon.... There is no privity of contract or of estate between the purchaser upon the decree of sale and the tenant. The purchaser may, therefore, treat the tenant as an occupant without right, and maintain ejectment for the premises.... The relation between the purchaser and tenant is that of owner and trespasser, until some agreement, express or implied, is made between them with reference to occupation.' " (Id., 171 Cal.App.3d at p. 272, 217 Cal.Rptr. 284.) Gross approved McDermott by acknowledging that "in the situation after foreclosure, no landlord-tenant relationship would exist." (Ibid.)

Similarly, in People v. Little (1983) 143 Cal.App.3d Supp. 14, 19, 192 Cal.Rptr. 619, the court acknowledged that foreclosure "wipes out" all liens, encumbrances, and leases subsequent in time to the trust deed so that there is no landlord tenant relationship between a foreclosure purchaser and the occupant of the premises. A number of other authorities affirm the rule that a subordinate lease is terminated by foreclosure. (See e.g. Miller & Starr, Cal. Real Estate 2d; § 8:82, p. 422-424; Mortgage & Deed of Trust Practice, (Cont.Ed.Bar, 2d ed. 1990) §§ 5.27, 5.41, pp. 266, 276; Rest.2d Property, Landlord and Tenant (1977) § 15.1, p. 90; Nelson & Whitman, Real Estate Finance Law (2d ed. [Lawyer's Ed.] 1985) § 15.11, p. 1114.)

We find no reason to question the continued validity of this rule. The fact that foreclosure terminates a subordinate lease comports with basic notions of priorities and notice. If the trust deed is recorded before the lease is created, then the tenant enters into the lease with notice that the lease will be subordinate. Alternatively, if the tenant and landlord expressly agree that the lease should be subordinate, as is the case here, then the tenant is aware of the possibility that its lease could be extinguished by foreclosure. Indeed, Fiber Form expressly agreed that the lease was subordinate to any trust deeds and therefore it risked having foreclosure terminate the lease. That Fiber Form, rather than Dover, ultimately desired that the lease be terminated upon foreclosure should be of no import.

Dover...