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The Covenant of Good Faith and Fair Dealing in Leases (Use Provisions)

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The Covenant of Good Faith and Fair Dealing in Leases (Use Provisions) THE COVENANT OF GOOD FAITH AND FAIR DEALING IN LEASES (USE PROVISIONS) Mark A. Senn, Esq. TABLE OF CONTENTS Page I. INTRODUCTION.............................................................................................................. 1 II. IMPLIED COVENANTS .................................................................................................. 1 III. IMPLIED COVENANT OF GOOD FAITH AND FAIR DEALING ..........................1 IV. WHERE THE COVENANT APPEARS ......................................................................... 2 V. SCHOLARLY VIEWS...................................................................................................... 3 VI. CASE LAW ........................................................................................................................ 4 A. CONTINUOUS OPERATION......................................................................................................................... 4 1. There is no implied covenant of good faith and fair dealing................................................................... 4 2. There is no covenant where there is a contrary provision ...................................................................... 4 3. When there is no implied covenant of continuous operation, the covenant of good faith and fair dealing will not support it ........................................................................................ 5 4. The covenant does not apply when there is a change in the manner of use ............................................ 5 5. The covenant does not require the landlord to lose money.....................................................................6 6. Occasionally, the covenant requires continuous operation. ................................................................... 7 B. CHANGES IN USE (NON-RETAIL LEASES)................................................................................................... 8 C. LANDLORD’S USE OF ITS PROPERTY ......................................................................................................... 9 D. LANDLORD’S RIGHT OF ACCESS ............................................................................................................. 10 VI. CONCLUSION ............................................................................................................... 10 -i- Mark A. Senn, Esq. I. INTRODUCTION The implied covenant of good faith and fair dealing arises often in the enforcement of use provisions in leases. The ensuing discussion considers the covenant as it arises in leases generally and in use provisions specifically. After an examination of the origins and scholarly views of this covenant, the case law illustrates its role and effect. The case law permits the conclusion that the covenant invites judges to redraft leases but rarely leads to that result and that the covenant is not necessary to the decision of the cases in which it is involved. II. IMPLIED COVENANTS A leading California case held that implied covenants will be found if (A) after examining the lease as a whole the covenant is so obvious that the landlord and tenant had no reason to state it, (B) an implication arises from the language of the lease, and (C) there is a legal necessity. Lippman v. Sears, Roebuck & Co., 44 Cal.2d 136, 280 P.2d 775 (1955). That case involved a lease in which the minimum rent was insubstantial and the expected percentage rent was intended to bring the total rent to a fair market rent. In that situation, the court said, the tenant’s covenant to operate in good faith will be implied in order to assure that the landlord receives percentage rent. To be more precise, the tenant was required to operate as the lease contemplated or as it had and not to discontinue operations. Good faith was immaterial. The loose employment of those words recurs. This doctrine is also called the substantial (or insubstantial) minimum rent doctrine. III. IMPLIED COVENANT OF GOOD FAITH AND FAIR DEALING As early as 1933, a New York case suggested that in every contract there is an implied covenant to refrain from conduct calculated to or having the effect of injuring or destroying the rights of the other party to receive the fruits of the contract; this was called “good faith.” Kirke La Shelle Co. v. Paul Armstrong Co., 263 N.Y. 79, 188 N.E. 163 (1933). The Restatement (Second) of Contracts, § 205 provides “every contract imposes on each party a duty of good faith and fair dealing in its performance and its enforcement.” The comments to § 205 refer to the definition of “good faith” in the Uniform Commercial Code, which says, “‘good faith’ means honesty in fact in the conduct or transaction concerned.” A Connecticut court has described good faith in this way: The phrase “good faith” is used in a variety of contexts, and its meaning varies somewhat with the context. Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party; it excludes a variety of types of conduct characterized as involving “bad faith” -1- Mark A. Senn, Esq. because they violate community standards of decency, fairness or reasonableness. MC Corp v. Deprofio, 1991 W.L. 303793 (Conn. Super. 1991) at 17. Professor Corbin has described the covenant: “While it is true that courts impose an obligation of good faith in every aspect of the contractual relationship . the obligation of good faith is ‘constructive’ rather than ‘implied’ because the obligation is implied by law and cannot be disclaimed.” Corbin on Contracts, § 654A(B) (2nd ed. 1993). Despite the nearly universal implication of this covenant in leases, a Texas appellate court has followed that state’s supreme court in specifically rejecting the implication of a general duty of good faith and fair dealing in all contracts where there is no special relationship between the parties. Trinity Professional Plaza Assoc. v. Metrocrest Hospital Authority, 987 S.W.2d 621 (Tex. – Eastland 1999). A United States district court has concluded that Indiana law does not imply a covenant of good faith in an unambiguous contract, suggesting that the covenant is an aid to construction of an ambiguous one, but not a rule of law. Rothe v. Revco D.S., Inc., 976 F. Supp. 784 (S.D. Ind. 1997). The covenant is applicable to the exercise of discretion in the performance of a lease and, conversely, is not relevant to required conduct as to which no discretion is allowed. Consequently, as the cases often say, an express covenant will preclude an implied covenant on the same matter. The problems arise, however, when the covenant of good faith and fair dealing creates an obligation to act in a way that was not expressly required and perhaps impliedly not required. IV. WHERE THE COVENANT APPEARS The covenant arises in leases in connection with provisions dealing with (in approximate descending order of frequency): use; assignments1; renewals2; options3; subordination4; pass-throughs5; franchisor-franchisee relations when a lease is also involved6; condition of the premises7; holding-over8; termination for convenience9; satisfaction of contingencies10; mitigation11; conduct12; changes in signage13; and recapture.14 This discussion considers only the role of the covenant in use provisions. However, use provisions and assignment provisions often arise in tandem because a tenant proposes to assign its lease for a different use after its own use has proven unsuccessful. As a result, many of the cases in this discussion involve both uses and assignments. The common joinder of these provisions is best illustrated by the two California statutes that treat them quite similarly. Civil C. §§ 1997.240 – 1997.270 (regarding use) and Civil C. §§ 1995.010 – 1995.340 (regarding assignments). Almost all of these cases arise in retail leases in which the nature of the user and use is an important part of the agreement. Two cases arose in leases of medical space in which the user was, of course, a significant consideration. -2- Mark A. Senn, Esq. V. SCHOLARLY VIEWS In an early and influential law review article, Professor Summers offered what has become known as the “excluder analysis”: Good faith, as judges generally use the term in matters contractual, is best understood as an “excluder” – a phrase with no general meaning or meanings of its own. Instead, it functions to rule out many different forms of bad faith. It is hard to get this point across to persons used to thinking that every word must have one or more general meanings of its own – must be either univocal or ambiguous. Summers, “‘Good Faith’ in General Contract Law and the Sales Provisions of the Uniform Commercial Code,” 54 VA L. Rev. 195 (1968). Although instances of bad faith are perhaps easier to see, good faith can be defined – perhaps vaguely – as it was in comment a to § 205 of the Restatement (Second) of Contracts as being “faithfulness to an agreed common purpose and consistency with the justified expectation of the other party; it excludes a variety of types of conduct characterized as involving ‘bad faith’ because they violate community standards of decency, fairness or reasonableness.” See Mc Corp., 1991 W.L. 303793 at 17. A scholarly comment by Professor Burton is: The good faith performance doctrine may be said to permit the exercise of discretion for any purpose – including ordinary business purposes – reasonably within the contemplation of the parties. A contract thus would be breached by failure to perform in good
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