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New Worrisome Development in Lease Payment Guarantee

Many Landlords rely on lease payment guarantees from the individual principals of a tenant entity that is leasing space. A recent case decided by the New York Appellate Division, First Department in Manhattan raises problems for landlords who rely on such guarantees. Madison Avenue Leasehold, LLC vs. Madison Bentley Associates LLC, ___ A.D.2d ___, 811 N.Y.S. 2d 47 (1st Dep’t March 14, 2006) (“Madison/Bentley”).

In Madison/Bentley, the landlord sued a commercial tenant and its principals, alleging that the tenant breached the lease and that the individual guarantors of the lease were therefore individually liable under their guarantees. By their terms, the guarantees were to be effective only if there was a “monetary default” by the tenant during the first three years of the lease term. The Court that held even though the tenant was repeatedly in default because it often paid rent late, those defaults under the lease were waived because the landlord accepted the rent payments when they were paid late. The Court found that “when rent is accepted with the knowledge of particular conduct which is claimed to be a default, the acceptance of such rent constitutes a waiver by landlord of the default, unless landlord has promptly demanded correction of the disputed conduct”.

This decision is curious, because both the lease and guaranty in Madison/Bentley contained “non-waiver” clauses; under a “non-waiver” clause, a course of conduct by the parties cannot be deemed a change, amendment or waiver of any provision of the lease. The Court in this case held that parties may waive even a “non-waiver” clause. The court concluded that since the Landlord did not raise the timeliness of the Tenant’s rent payments until after the third anniversary of the lease, such a course of conduct “clearly establishes waiver of the timely payment provision as a matter of law.” Therefore the Court decided that the condition precedent for extending the guaranty beyond the first three years of the lease term was never fulfilled and the guaranty in question ceased to have any force and effect upon the third anniversary of the lease. As the court went on to say:

“Once waived, the default in timely payment of rent is extinguished and cannot later be revived, like a phoenix, into a material default for the purpose of extending the period of the collateral guaranty…”

Particularly troublesome is the fact that the guaranty in Madison/Bentley had very strong protective language designed to preclude exactly this kind of result. The Guarantors had agreed

to an ‘absolute and unconditional Guaranty of payment and performance’, which was enforceable ‘without the necessity for any suit or proceedings on Landlord’s part of any kind or nature whatsoever against Tenant, without the necessity of any notice of non-payment, non-performance or non-observance (except as expressly required under the terms of this Guaranty), or… of any other notice or demand to which the Guarantor might otherwise be entitled, all of which the Guarantor expressly waives…’

Additionally, the guaranty specified that it would not be ‘terminated, affected, diminished or impaired by reason of the assertion, or the failure to assert, by Landlord against Tenant of any of the rights or remedies reserved to Landlord pursuant to any provisions of the Lease.’

Finally, the [guaranty] agreement provided that the guaranty would ‘in no way be affected, modified or diminished by reason of…any modification or waiver of or change in any way of the terms, covenants, conditions or provisions of the Lease by Landlord and Tenant, or by reason of any extension of time that may be granted by Landlord to Tenant, or by reason of any dealings or transaction or matter or thing occurring between Landlord and Tenant…’

811 N.Y.S.2d at 56. Despite this clear language, the court nevertheless held that the failure to document the earlier defaults was a waiver.

The dissent in Madison/Bentley pointed out that if the majority’s “waiver” theory were to achieve wide acceptance, Landlords would then have to jump through many procedural hoops and create lots of paper to ensure that guarantees remain in place and meaningful. As Justice James A. McGuire noted:

Indeed, under [the majority’s] analysis, Madison [the Landlord] and all similarly situated contracting parties are encouraged to go to the time and expense of serving notices of default for any failure fully to perform as soon as legally permissible, regardless both of whether they have received assurances that payment or other performance is imminent and of how relatively inconsequential the particular default may be under the particular circumstances…Rather than induce contracting parties to travel down the less than sunny path to litigation at the drop of a hat, the law should encourage accommodation and reasonable forbearance. To say the least, no net gain results (except possibly to lawyers) from the approach of the majority and the motion court.

811 N.Y.S.2d at 56.

Perhaps this case involved only a court bending over backwards to avoid any personal liability for the guarantors where no serious monetary defaults happened during the first three years of the lease, and that this case is just another example of the often stated maxim that “bad facts make bad law.” If not, and if the doctrine espoused by the majority opinion is accepted elsewhere, then landlords may have to worry a lot more about the practical effect of certain lease guarantees and their various provisions.

Lawyers sometime get criticized or faulted for advising clients to continuously “paper a case” or for making incessant demands to create documents. This case’s outcome supports the advice that we give for the need to memorialize defaults in writing.

If you have questions about the foregoing article please feel free to call Aaron C. Kinderlehrer at 212-981-2307 or send an email to akinderlehrer@sillerwilk.com.

This article was prepared as a service to our clients and friends. This article does not constitute legal advice and should not be relied upon as legal advice by the reader or any other party.