P.S.G. Ltd. Partnership v. August Income/Growth Fund VII

• Decision Date: 14 June 1993
• Docket Number: No. 20431,20431
• Citation: 855 P.2d 1043,1993 NMSC 27,115 N.M. 579
• Parties: P.S.G. LIMITED PARTNERSHIP, a New Mexico limited partnership, Cross-Plaintiff-Appellant, v. AUGUST INCOME/GROWTH FUND VII, a California limited partnership, et al., Cross-Defendants-Appellees, and P.S.G. LIMITED PARTNERSHIP, a New Mexico limited partnership, Third-Party-Plaintiff-Appellant, v. AUGUST FINANCIAL PARTNERS, August Management, Inc., a California corporation, et al., Third-Party-Defendants-Appellees.
• Court: New Mexico Supreme Court

Page 1043

855 P.2d 1043

115 N.M. 579

P.S.G. LIMITED PARTNERSHIP, a New Mexico limited partnership, Cross-Plaintiff-Appellant, v. AUGUST INCOME/GROWTH FUND VII, a California limited

partnership, et al., Cross-Defendants-Appellees, and P.S.G. LIMITED PARTNERSHIP, a New Mexico limited partnership, Third-Party-Plaintiff-Appellant, v. AUGUST FINANCIAL PARTNERS, August Management, Inc., a

California corporation, et al.,

Third-Party-Defendants-Appellees.

No. 20431.

Supreme Court of New Mexico.

June 14, 1993.

[115 N.M. 580] Crider, Calvert & Bingham, P.C., David G. Reynolds, Albuquerque, Hatch, Allen & Shepherd, P.A., Steven S. Scholl, Albuquerque, for August Income Growth Fund VII.

Modrall, Sperling, Roehl, Harris & Sisk, Martha Brown, Kenneth L. Harrigan, Albuquerque, for August Management, Inc.

Irell & Manella, Sheldon Eisenberg, Paul T. Tsuchiya, Los Angeles, CA, for August Management, Inc.

OPINION

RANSOM, Chief Justice.

On motion of P.S.G. Limited Partnership, we granted this interlocutory appeal, see SCRA 1986, 12-203, to decide the extent of damages PSG as successor lessor may recover as liquidated, contractual damages against sublessees of property on which the Radisson Inn was constructed in Albuquerque.

In 1980, PSG's predecessor in interest, Ever Ready Oil Company, leased its property to Gary Willey, doing business as Village Properties, for approximately $1500 per month. In 1984 Willey assigned the ground lease to Hotel Development Corporation, an entity in which he was the principal. HDC immediately entered into a real estate mortgage and security agreement to obtain a construction loan from ITT Commercial Credit Corporation. Ever Ready subordinated its fee and lease interests to ITT, but expressly excepted its right to ground lease rental payments from the subordination agreement. After its acquisition of the lease by assignment in January of 1985, PSG entered into an amended lease with HDC, allowing another corporation in which Willey was the principal, South-West Commercial Leasing Company, to assume the original lease and allowing HDC to become the sublessee of South-West--a novation with the effect, significantly that HDC was no longer in privity of contract with PSG. This agreement was expressly conditioned upon HDC's ability to sell the hotel to August Income/Growth Fund VII (AIGF VII). South-West charged HDC approximately $9000 per month for the sublease even though South-West continued to be obligated for only $1500 per month to PSG. The lease and the sublease both contained a liquidated damages clause for breach of the lease wherein liquidated damages in the same amount as the reserved rents would be due in monthly installments until the premises could be re-leased. HDC and AIGF VII entered into a purchase agreement for the sale of the hotel, and AIGF VII took assignment of the sublease from HDC. HDC and AIGF VII then negotiated a transfer agreement with ITT. Under the transfer agreement, the construction loan obligations of HDC were nonrecourse as against either PSG or AIGF VII, but both had the right to cure a default. PSG assented to the assignment and to the transfer agreement.

At this point, then, only South-West had a contractual duty to make lease payments to PSG under the amended lease, and only HDC had a contractual duty to make mortgage payments to ITT on the construction loan. AIGF VII stopped making the $9000 ground lease payments to South-West, and South-West then defaulted in making its $1500 payments to PSG. AIGF VII also failed to make mortgage payments to ITT as apparently required in the purchase agreement, and HDC defaulted in its commitment to ITT, resulting in the grant to ITT of a summary judgment of foreclosure against all parties. Just before foreclosure, after terminating South-West's leasehold interest, PSG succeeded to the rights of South-West as sublessor under the sublease that had been assigned by HDC to AIGF VII. This gave PSG privity of contract to sue AIGF VII for lost rents and liquidated damages of $9000 per month rather than for only $1500 per month that it could claim against South-West. Willey, South-West, and HDC all failed to answer the foreclosure complaint and PSG's crossclaim (under the lease) against South-West. PSG crossclaimed (under the sublease) against AIGF VII for liquidated damages for lost rents over the balance of the lease term and for consequential damages resulting from loss of its property. PSG also sued AIGF VII's assignees--August Management, Inc. (AMI) and August Managers Associates (AMA). A foreclosure sale was held in October of 1990, the Order approving the sale was entered on January 1, 1991, and the redemption period expired on February 3, 1991.

In a partial summary judgment, the trial court limited PSG's potential damages against AIGF VII for lost rents to the date of the foreclosure sale and denied the claim for consequential damages. Since the only issue before the court was a question of law, the court must have determined that the foreclosure extinguished all liabilities arising after termination of the lease. We reverse the holding of the court on the legal issue, but we affirm the narrow decision denying consequential damages based on the sublease alone. Our reversal is based upon the liquidated damages clause. We hold that contractual damages were recoverable after termination of the lease, continuing until the end of the redemption period in February 1991.

The issue. The question on interlocutory appeal is: When the lessor of a subordinated ground lease is not a party to the mortgage, to what extent, if any, does the foreclosure of that mortgage limit the sublessee's liability to the sublessor for direct and consequential damages caused by breach of its contractual obligations under the sublease?

Sublessee's position. AIGF VII and co-defendants AMI and AMA (collectively, "sublessee") argue, in short, that because the public foreclosure sale of the real estate securing ITT's senior lien extinguished both PSG's subordinate sublease and the status of PSG as landlord, all rights and obligations under the sublease were terminated and there is no factual or legal basis for a claim under the sublease. AMI and AMA also argue that a junior lienholder's entitlement to further rental payments is cut off once a mortgagee takes possession and perfects its senior lien on the rents, regardless of the expiration of the redemption period. They cite Boise Joint Venture v. Moore, 106 Or.App. 83, 806 P.2d 707 (1991) (decided under Idaho law). "[O]nce its status as landlord terminated, BJV lost its right to rely on the agreement between the parties. Idaho law subordinates contract law to the common law landlord-tenant rules...." Id. 806 P.2d at 708. They also cite Dover Mobile Estates v. Fiber Form Products, Inc., 220 Cal.App.3d 1494, 270 Cal.Rptr. 183, 186 (1990), which states:

A lease which is subordinate to the deed of trust is extinguished by the foreclosure sale. A foreclosure proceeding destroys a lease junior to the deed of trust, as well as the lessee's rights and obligations under the lease. 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 [cmt. h].)

Id. (citations omitted) (alteration in original).

Contract rights distinguished from leasehold rights. If PSG's claims were based only on its property rights flowing from privity of estate under the sublease, AIGF VII's arguments regarding extinguishment would be dispositive because the foreclosure action destroyed all possessory claims that were junior to the senior lien. Dover is not persuasive in the disposition of this case, however, because Dover was an action to recover rent based on the leasehold rights and not an action for damages based on contract provisions. This is a crucial distinction because in an action for rents the lease must be in force, but in an action for damages the lease may be terminated. The Dover court explained that because the lease had been terminated, there was neither privity of contract nor of estate between the lessee and the foreclosure purchaser and therefore no landlord-tenant relationship. Id. The court did not discuss the contract rights of the original lessor and lessee and stated that its decision comported with the basic notions of priorities and notice--both property law concepts. Id.

To better understand the distinction between property rights and contract rights in a lease, it must be understood that a lease is both a conveyance and a contract. See generally 1 Milton R. Friedman, Friedman on Leases Sec. 1.1 (3d ed. 1990) [hereinafter Friedman on Leases ]. A lease is "both the conveyance of a protected possessory interest to the tenant and a contract specifying numerous rights and duties of the parties...." 2 Richard R. Powell, Powell on Real Property p 221(2), at 16-11 (rev. ed. 1993). Two kinds of rights exist under a lease: property rights (which include the right to receive or sue for unreceived rents, the right to occupy the leasehold, and the reversionary right in the leasehold) and contract rights (which include the right to sue for breach of the various express and implied covenants, and the right to consequential damages resulting from breach of the lease contract).

It is apparent that before deciding whether a lessor of a subordinated lease is barred from seeking recovery for damages after a foreclosure action, a court first must determine what kind of action is claimed. If it is a property action for unpaid rent after the foreclosure or for possession of the property the claim is barred as a matter of law because of the termination of the lease by the foreclosure. If it is a contract action for damages for breach of a...