Kendall v. Ernest Pestana, Inc.

OPINION BY BROUSSARD: This case concerns the effect of a provision in a commercial lease 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. This is a question of first impression in this court.

I.

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. 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. 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. . . ." 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, para. 246[1], 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, para. 246[1], at pp. 372.97, 372.100.) Thus, in Chapman v. Great Western Gypsum Co. (1932) 216 Cal. 420 [14 P.2d 758, 85 A.L.R. 917], 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.) 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; Civ. Code, § 1442 ["A condition involving a forfeiture must be strictly interpreted against the party for whose benefit it is created."]; 2 Powell, supra, para. 246[1], 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. 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.

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.

For the reasons discussed below, we conclude that the minority rule is the preferable position.

III.

The impetus for change in the majority rule has come from two directions, reflecting the dual nature of a lease as a conveyance of a leasehold interest and a contract. (See Medico-Dental etc. Co. v. Horton & Converse (1942) 21 Cal.2d 411, 418 [132 P.2d 457].) The policy against restraints on alienation pertains to leases in their nature as conveyances. Numerous courts and commentators have recognized that "[in] recent times the necessity of permitting reasonable alienation of commercial space has become paramount in our increasingly urban society." ( Schweiso v. Williams, supra, 150 Cal. App. 3d at p. 887.)

Civil Code section 711 provides: "Conditions restraining alienation, when repugnant to the interest created, are void." It is well settled that this rule is not absolute in its application, but forbids only unreasonable restraints on alienation. ( Wellenkamp v. Bank of America (1978) 21 Cal.3d 943, 948 [148 Cal. Rptr. 379, 582 P.2d 970]; Cohen v. Ratinoff, supra, 147 Cal. App. 3d at p. 329; Laguna Royale Owners Assn. v. Darger, supra, 119 Cal. App. 3d at p. 682.) Reasonableness is determined by comparing the justification for a particular restraint on alienation with the quantum of restraint actually imposed by it. "[The] greater the quantum of restraint that results from enforcement of a given clause, the greater must be the justification for that enforcement." ( Wellenkamp v. Bank of America, supra, 21 Cal.3d at p. 949.) In Cohen v. Ratinoff, supra, the court examined the reasonableness of the restraint created by an approval clause in a lease: "Because the lessor has an interest in the character of the proposed commercial assignee, we cannot say that an assignment provision requiring the lessor's consent to an assignment is inherently repugnant to the leasehold interest created. We do conclude, however, that if such an assignment provision is implemented in such a manner that its underlying purpose is perverted by the arbitrary or unreasonable withholding of consent, an unreasonable restraint on alienation is established." ( Id., 147 Cal. App. 3d at p. 329, italics added.)

One commentator explains as follows: "The common-law hostility to restraints on alienation had a large exception with respect to estates for years. A lessor could prohibit the lessee from transferring the estate for years to whatever extent he might desire. It was believed that the objectives served by allowing such restraints outweighed the social evils implicit in the restraints, in that they gave to the lessor a needed control over the person entrusted with the lessor's property and to whom he must look for the performance of the covenants contained in the lease. Whether this reasoning retains full validity can well be doubted. Relationships between lessor and lessee have tended to become more and more impersonal. Courts have considerably lessened the effectiveness of restraint clauses by strict construction and liberal applications of the doctrine of waiver. With the shortage of housing and, in many places, of commercial space as well, the allowance of lease clauses forbidding assignments and subleases is beginning to be curtailed by statutes." (2 Powell, supra, para. 246[1], at pp. 372.97-372.98, fns. omitted.)

The Restatement Second of Property adopts the minority rule on the validity of approval clauses in leases: "A restraint on alienation without the consent of the landlord of a tenant's interest in leased property is valid, but the landlord's consent to an alienation by the tenant cannot be withheld unreasonably, unless a freely negotiated provision in the lease gives the landlord an absolute right to withhold consent." (Rest.2d Property, § 15.2(2) (1977), italics added.) A comment to the section explains: "The landlord may have an understandable concern about certain personal qualities of a tenant, particularly his reputation for meeting his financial obligations. The preservation of the values that go into the personal selection of the tenant justifies upholding a provision in the lease that curtails the right of the tenant to put anyone else in his place by transferring his interest, but this justification does not go to the point of allowing the landlord arbitrarily and without reason to refuse to allow the tenant to transfer an interest in leased property." (Id., com. a.) Under the Restatement rule, the lessor's interest in the character of his or her tenant is protected by the lessor's right to object to a proposed assignee on reasonable commercial grounds. (See id., reporter's note 7 at pp. 112-113.) The lessor's interests are also protected by the fact that the original lessee remains liable to the lessor as a surety even if the lessor consents to the assignment and the assignee expressly assumes the obligations of the lease. ( Peiser v. Mettler (1958) 50 Cal.2d 594, 602 [328 P.2d 953, 74 A.L.R.2d 1]; Samuels v. Ottinger (1915) 169 Cal. 209, 212 [146 P. 638].)

The second impetus for change in the majority rule comes from the nature of a lease as a contract. As the Court of Appeal observed in Cohen v. Ratinoff, supra, "[since] Richard v. Degen & Brody, Inc. [espousing the majority rule] was decided, . . . there has been an increased recognition of and emphasis on the duty of good faith and fair dealing inherent in every contract." ( Id., 147 Cal. App. 3d at p. 329.) Thus, "[in] every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. . . ." ( Universal Sales Corp. v. Cal. etc. Mfg. Co. (1942) 20 Cal.2d 751, 771 [128 P.2d 665]. See also Bleecher v. Conte (1981) 29 Cal.3d 345, 350 [213 Cal. Rptr. 852, 698 P.2d 1154].) "[Where] a contract confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion in good faith and in accordance with fair dealing." ( Cal. Lettuce Growers v. Union Sugar Co. (1955) 45 Cal.2d 474, 484 [289 P.2d 785, 49 A.L.R.2d 496]. See also, Larwin-Southern California, Inc. v. JGB Investment Co. (1979) 101 Cal. App. 3d 626, 640 [162 Cal. Rptr. 52].) Here the lessor retains the discretionary power to approve or disapprove an assignee proposed by the other party to the contract; this discretionary power should therefore be exercised in accordance with commercially reasonable standards. "Where a lessee is entitled to sublet under common law, but has agreed to limit that right by first acquiring the consent of the landlord, we believe the lessee has a right to expect that consent will not be unreasonably withheld." ( Fernandez v. Vasquez, supra, 397 So.2d at p. 1174; accord, Boss Barbara, Inc. v. Newbill, supra, 638 P.2d at p. 1086.)

Under the minority rule, the determination whether a lessor's refusal to consent was reasonable is a question of fact. Some of the factors that the trier of fact may properly consider in applying the standards of good faith and commercial reasonableness are: financial responsibility of the proposed assignee; suitability of the use for the particular property; legality of the proposed use; need for alteration of the premises; and nature of the occupancy, i.e., office, factory, clinic, etc. (See Fernandez v. Vasquez, supra, 397 So.2d at p. 1174; Cohen v. Ratinoff, supra, 147 Cal. App. 3d at p. 330; Rest.2d Property, § 15.2, reporter's note 7 at pp. 112-113; Annot., 54 A.L.R.3d 689 (1973); 1 Friedman on Leases (1974) § 7.304c.)

Denying consent solely on the basis of personal taste, convenience or sensibility is not commercially reasonable. ( Broad & Branford Place Corp. v. J. J. Hockenjos Co., 132 N.J.L. 229 [39 A.2d 80, 82]; Fernandez v. Vasquez, supra, 397 So.2d at p. 1174; Rest.2d Property, § 15.2, reporter's note 7 at pp. 112-113.) Nor is it reasonable to deny consent "in order that the landlord may charge a higher rent than originally contracted for." ( Schweiso v. Williams, supra, 150 Cal. App. 3d at p. 886. See Bedford Inv. Co. v. Folb, supra, 79 Cal. App. 2d 363; 1010 Potomac Assoc. v. Grocery Manufacturers (D.C. App. 1984) 485 A.2d 199, 208-210; Funk v. Funk, supra, 633 P.2d 586; Fernandez v. Vasquez, supra, 397 So.2d at p. 1174; Chanslor-Western O. & D. Co. v. Metropolitan San. D. (1970) 131 Ill.App.2d 527 [266 N.E.2d 405]; Ringwood Associates, Ltd. v. Jack's of Route 23, Inc. (1977) 153 N.J. Super. 294 [379 A.2d 508].) This is because the lessor's desire for a better bargain than contracted for has nothing to do with the permissible purposes of the restraint on alienation -- to protect the lessor's interest in the preservation of the property and the performance of the lease covenants. "'[The] clause is for the protection of the landlord in its ownership and operation of the particular property -- not for its general economic protection.'" ( Ringwood Associates v. Jack's of Route 23, Inc., supra, 379 A.2d at p. 512, quoting Krieger v. Helmsley-Spear, Inc. (1973) 62 N.J. 423 [302 A.2d 129], italics added.)

IV.

In conclusion, both the policy against restraints on alienation and the implied contractual duty of good faith and fair dealing militate in favor of adoption of the rule that where a commercial 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 assignee or the proposed use. Under this rule, appellants have stated a cause of action against respondent Ernest Pestana, Inc.

The order sustaining the demurrer to the complaint, which we have deemed to incorporate a judgment of dismissal.