Kendall v. Ernest Pestana, Inc.

• Decision Date: 05 December 1985
• Docket Number: S.F. 24851
• Citation: 40 Cal.3d 488,709 P.2d 837,220 Cal.Rptr. 818
• Court: California Supreme Court
• Parties: , 709 P.2d 837, 54 USLW 2320 Jack KENDALL et al, Plaintiffs and Appellants, v. ERNEST PESTANA, INC., Defendant and Respondent.

Page 818

220 Cal.Rptr. 818

40 Cal.3d 488, 709 P.2d 837, 54 USLW 2320

Jack KENDALL et al, Plaintiffs and Appellants, v. ERNEST PESTANA, INC., Defendant and Respondent.

S.F. 24851.

Supreme Court of California,

In Bank.

Dec. 5, 1985.

Morgan, Morgan, Towery, Morgan & Spector, W. Robert Morgan and Barbara Spector, San Jose, for plaintiffs and appellants.

Fred Crane, Riverside, and Michael V. Hesse, Costa Mesa, as amici curiae on behalf of plaintiffs and appellants.

Frank P. Nicoletti and Tiernan & Nicoletti, San Jose, for defendants and respondents.

Pillsbury, Madison & Sutro, Walter R. Allan, Vaughn R. Walker and Christopher R. Ball, San Francisco, as amici curiae on behalf of defendant and respondent.

BROUSSARD, Justice.

This case concerns the effect of a provision in a commercial lease ¹ that the lessee may not assign the lease or sublet the premises without the lessor's prior written consent. The question we address is whether, in the absence of a provision that such consent will not be unreasonably withheld, a lessor may unreasonably and arbitrarily withhold his or her consent to an assignment. ² This is a question of first impression in this court.

I.

This case arises on appeal from an order sustaining a demurrer without leave to amend. ³ We review the allegations of the complaint applying the established principle that a demurrer "admits the truth of all material factual allegations in the complaint...." (Alcorn v. Anbro Engineering, Inc. (1970) 2 Cal.3d 493, 496, 86 Cal.Rptr. 88, 468 P.2d 216; Committee on Children's TV, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 213-214, 197 Cal.Rptr. 783, 673 P.2d 660.)

The allegations of the complaint may be summarized as follows. The lease at issue is for 14,400 square feet of hangar space at the San Jose Municipal Airport. The City of San Jose, as owner of the property, leased it to Irving and Janice Perlitch, who in turn assigned their interest to respondent Ernest Pestana, Inc. ⁴ Prior to assigning their interest to respondent, the Perlitches entered into a 25-year sublease with one Robert Bixler commencing on January 1, 1970. The sublease covered an original five-year term plus four 5-year options to renew. The rental rate was to be increased every 10 years in the same proportion as rents increased on the master lease from the City of San Jose. The premises were to be used by Bixler for the purpose of conducting an airplane maintenance business.

Bixler conducted such a business under the name "Flight Services" until, in 1981, he agreed to sell the business to appellants Jack Kendall, Grady O'Hara and Vicki O'Hara. The proposed sale included the business and the equipment, inventory and improvements on the property, together with the existing lease. The proposed assignees had a stronger financial statement and greater net worth than the current lessee, Bixler, and they were willing to be bound by the terms of the lease.

The lease provided that written consent of the lessor was required before the lessee could assign his interest, and that failure to obtain such consent rendered the lease voidable at the option of the lessor. ⁵ Accordingly, Bixler requested consent from the Perlitches' successor-in-interest, respondent Ernest Pestana, Inc. Respondent refused to consent to the assignment and maintained that it had an absolute right arbitrarily to refuse any such request. The complaint recites that respondent demanded "increased rent and other more onerous terms" as a condition of consenting to Bixler's transfer of interest.

The proposed assignees brought suit for declaratory and injunctive relief and damages seeking, inter alia, a declaration "that the refusal of ERNEST PESTANA, INC. to consent to the assignment of the lease is unreasonable and is an unlawful restraint on the freedom of alienation...." ⁶ The trial court sustained a demurrer to the complaint without leave to amend and this appeal followed.

II.

The law generally favors free alienability of property, and California follows the common law rule that a leasehold interest is freely alienable. (See Kassan v. Stout (1973) 9 Cal.3d 39, 43, 106 Cal.Rptr. 783, 507 P.2d 87; 49 Am.Jur.2d, Landlord and Tenant, § 398 (1980).) Contractual restrictions on the alienability of leasehold interests are, however, permitted. (See Kassan v. Stout, supra.) "Such restrictions are justified as reasonable protection of the interests of the lessor as to who shall possess and manage property in which he has a reversionary interest and from which he is deriving income." (Schoshinski, American Law of Landlord and Tenant (1980) § 8:15, at pp. 578-579. See also 2 Powell on Real Property, p 246, at p. 372.97.)

The common law's hostility toward restraints on alienation has caused such restraints on leasehold interests to be strictly construed against the lessor. (See Schoshinski, supra, § 8.16, at pp. 583-588; 2 Powell, supra, p 246, at pp. 372.97, 372.100.) Thus, in Chapman v. Great Western Gypsum Co. (1932) 216 Cal. 420, 14 P.2d 758, where the lease contained a covenant against assignment without the consent of the lessor, this court stated: "It hardly needs citation of authority to the principle that covenants limiting the free alienation of property such as covenants against assignment are barely tolerated and must be strictly construed." (Id., at p. 426, 14 P.2d 758.) ⁷ This is particularly true where the restraint in question is a "forfeiture restraint," under which the lessor has the option to terminate the lease if an assignment is made without his or her consent. (See Karbelnig v. Brothwell (1966) 244 Cal.App.2d 333, 341, 53 Cal.Rptr. 335; Ser-Bye Corp. v. C.P. & G. Markets, supra, 78 Cal.App.2d at p. 919, 179 P.2d 342; Civ.Code, § 1442 ["A condition involving a forfeiture must be strictly interpreted against the party for whose benefit it is created."]; 2 Powell, supra, p 246, at pp. 372.100-372.101.)

Nevertheless, a majority of jurisdictions have long adhered to the rule that where a lease contains an approval clause (a clause stating that the lease cannot be assigned without the prior consent of the lessor), the lessor may arbitrarily refuse to approve a proposed assignee no matter how suitable the assignee appears to be and no matter how unreasonable the lessor's objection. (See, e.g., B & R Oil Co., Inc. v. Ray's Mobile Homes, Inc. (1980) 139 Vt. 122, 422 A.2d 1267; Dress Shirt Sales, Inc. v. Hotel Martinique Associates (1963) 12 N.Y.2d 339, 190 N.E.2d 10, 239 N.Y.S.2d 660; Jacobs v. Klawans (1961) 225 Md. 147, 169 A.2d 677; Segre v. Ring (1961) 103 N.H. 278, 170 A.2d 265; Gruman v. Investors Diversified Services (1956) 247 Minn. 502, 78 N.W.2d 377; 31 A.L.R.2d 831 (1953); 51C C.J.S. § 36(1).) The harsh consequences of this rule have often been avoided through application of the doctrines of waiver and estoppel, under which the lessor may be found to have waived (or be estopped from asserting) the right to refuse consent to assignment. ⁸

The traditional majority rule has come under steady attack in recent years. A growing minority of jurisdictions now hold that where a lease provides for assignment only with the prior consent of the lessor, such consent may be withheld only where the lessor has a commercially reasonable objection to the assignment, even in the absence of a provision in the lease stating that consent to assignment will not be unreasonably withheld. (See Boss Barbara, Inc. v. Newbill (1982) 97 N.M. 239, 638 P.2d 1084; Jack Frost Sales v. Harris Trust & Sav. Bank (1982) 104 Ill.App.3d 933, 60 Ill.Dec. 703, 433 N.E.2d 941, 949; Fernandez v. Vazquez (Fla.App.1981) 397 So.2d 1171; Warmack v. Merchants Nat'l Bank of Fort Smith (1981) 272 Ark. 166, 612 S.W.2d 733; Funk v. Funk (1981) 102 Idaho 521, 633 P.2d 586; Hendrickson v. Freericks (Alaska 1980) 620 P.2d 205; Homa-Goff Interiors, Inc. v. Cowden (Alabama 1977) 350 So.2d 1035; Shaker Bldg. Co. v. Federal Lime and Stone Co. (1971) 28 Ohio Misc. 246, 277 N.E.2d 584; Rest.2d Property, § 15.2(2) (1977); 21 A.L.R.4th 188 (1983).) ⁹

For the reasons discussed below, we conclude that the minority rule is the preferable position. Although this is an issue of first impression in this court, several decisions of the Court of Appeal have reflected the changing trend in the law on this question. In Richard v. Degen & Brody, Inc. (1960) 181 Cal.App.2d 289, 5 Cal.Rptr. 263, the court adopted the majority rule: " '[W]here a subletting or assignment of the leased premises without the consent of the lessor is prohibited, he may withhold his assent arbitrarily and without regard to the qualifications of the proposed assignee, unless ... the lease provides that consent shall not be arbitrarily or unreasonably withheld....' " (Id., at p. 299, 5 Cal.Rptr. 263, quoting 51 C.J.S. § 36.) Richard was not followed or cited on this point until the decision in Laguna Royale Owners Association v. Darger (1981) 119 Cal.App.3d 670, 174 Cal.Rptr. 136, which questioned the "continuing vitality" of the rule in Richard and then distinguished it on its facts. (Id., at p. 681, 174 Cal.Rptr. 136.) ¹⁰ The court in Laguna Royale rejected the contention that an approval clause confers an absolute right to withhold consent: "We hold that in exercising its power to approve or disapprove transfers or assignments Association must act reasonably, exercising its power in a fair and nondiscriminatory manner and withholding approval only for a reason or reasons rationally related to the protection, preservation and proper operation of the property and the purposes of Association as set forth in its governing instruments." (Id., at p. 680, 174 Cal.Rptr. 136.)

Two years later, in Cohen v. Ratinoff (1983) 147 Cal.App.3d 321, 195 Cal.Rptr. 84, the same district of the Court of Appeal that had decided Richard (the second district) directly confronted and rejected the rule of that case. The court held that "where, as here, the lease provides for assignment or subletting only...