Opinion
D039603.
7-18-2003
GREGORY E. LAWRENCE, JR. et al., Plaintiffs and Appellants, v. BEVERLY A. MARIS, Defendant and Appellant.
The parties have cross-appealed from a judgment granting declaratory relief, but finding no breach of the subordination agreement, in a long-term ground lease. The issues raised in the cross-appeals are: (1) whether there was a valid subordination agreement that permitted the lessee to refinance for purposes other than improvements to the property; (2) whether the lessor breached the subordination agreement by refusing to sign loan documents; and (3) whether the lessee is entitled to fees and costs as the prevailing party. We answer each of these questions in the affirmative.
I.
FACTUAL
AND PROCEDURAL BACKGROUND
In 1977, Joseph and Beverly Maris owned a plot of undeveloped real property in Encinitas, California. They entered into negotiations to lease the property to a real estate partnership, El Camino Consortium ("ECC"), for construction of an office building. ECC preferred to purchase the property outright. However, Mr. and Mrs. Maris were unwilling to sell because they wanted the cash flow from a long-term lease and they believed the property was a good investment for their retirement. Their primary objective was to obtain a steady stream of income from the property.
Mr. and Mrs. Maris retained real estate attorney Ludlow Keeney to draft the ground lease agreement. The parties eventually signed a 55-year ground lease with an initial monthly rent of $ 1,000 and periodic adjustments to reflect increases in the consumer price index. The lessee was responsible for all taxes, assessments, utilities, and insurance on the property during the term of the lease. The lease authorized the lessee to construct improvements on the property and provided that all improvements would belong to the lessee for the term of the lease. It also authorized the lessee to assign or transfer its interest in the property.
Article XI of the lease provided for subordination of the lessors interest in the property. Article 11.01 authorized the lessee "from time to time" to encumber the property (including any improvements) by a deed of trust, mortgage, or other security interest, with the lessors interest in the property being "inferior and subject to" any such "fee mortgage." Article 11.02 required the lessor to "cooperate in all respects" with the lessee and with any lender or prospective lender in effecting such a fee mortgage, including executing any subordination agreements or loan documents within 15 days of a request by the lessee.
Article 11.02 further provided that the lessors obligation to agree to encumber the property was subject to the following 10 conditions: (i) the lessor would not be personally liable for any loan; (ii) the lessee could not be in default on the lease; (iii) "the amount of the fee mortgage secured for construction of original improvements on the Premises shall not exceed $ 360,000, and any permanent (take— out) fee mortgage(s), or modifications or consolidations thereof, shall not exceed in the aggregate eighty percent (80%) of the lenders appraisal of the land and improvements"; (iv) "the amount of any fee mortgage secured for construction of improvements shall be disbursed through a lender-approved fund control, and shall be used for the constructions of improvements only . . . ."; (v) the lessee would furnish the lessor "with a true copy of the fee mortgage, promissory note secured thereby and all other instruments required by lender"; (vi) any loan would be from an institutional lender and would be within the range of usual and customary terms and conditions; (vii) interest, points, fees, and charges would not exceed the norm; (viii) all improvements financed by any construction fee mortgage would be of a type allowed by the governmental agency having jurisdiction; (ix) any "permanent ( take-out) fee mortgage" (including any refinancing) would be a "self-liquidating mortgage" to be paid off in equal payments over a period not longer than three months from the end of the lease term; and (x) the lessor would preserve the right to cure any default on any fee mortgage.
Article 15.03 stated that the lease agreement "contains the entire agreement between the parties." Article 15.06 provided that the prevailing party in any action to enforce or interpret the lease agreement would be entitled to recover costs and reasonable attorney fees.
Attorney Keeney testified that his intention in drafting the lease agreement was to cap the initial construction loan at $ 360,000 and to limit any subsequent refinancing loan to 80 percent of the property value. According to Keeney, while the agreement specifically provided that the initial construction loan could be used only for improvements of the property, there was no similar restriction on the proceeds of any refinance. Based on his custom and practice, Keeney would have put such a restriction in the agreement if he had intended there to be one. His intention was to limit the purposes for which the proceeds of the initial construction loan could be used, but not the proceeds of subsequent refinancing loans. Keeney believed his clients interests were adequately protected by the other conditions for refinancing set forth in Article 11.02.
Real estate broker Valdo Howard negotiated the lease on behalf of ECC. His understanding of the subordination agreement was that it preserved the lessees option to refinance the property to take money out, subject to the 80 percent loan-to— value ratio, which would ensure that the property would never be over-financed.
Mrs. Maris did not participate in the negotiations for the lease. She knew that she and her husband would have to subordinate their interest in the property for the initial construction loan, but she could not recall any discussion about subsequent loans.
After the lease was signed, ECC constructed an office building on the property. In 1979, ECC sold its interest in the property to plaintiffs Gregory and Phyllis Lawrence and Lawrence Eden (hereafter referred to as lessees). Mr. Maris passed away in 1982.
In 1999, the lessees decided to refinance the property to get equity out and diversify their investments. Eden obtained a proposal for a $ 784,000 loan from Quaker City Federal Savings and Loan ("Quaker City"), an institutional lender. A condition of the loan was that Mrs. Maris (hereafter referred to as Maris) subordinate her interest in the property pursuant to the terms of the lease. In April 1999, Eden informed Maris of his intention to refinance the property and asked her to honor the subordination clause. Her lawyer contacted Eden and told him the loan was "too risky" because Maris was advancing in years and needed security. The lawyer suggested that the lessees consider buying out Mariss interest in the property. Through Eden, the lessees responded with an offer to purchase Mariss interest in the property for $ 250,000. However, they never received any counteroffer from Maris.
Escrow opened on the Quaker City loan in early June 1999. Quaker City obtained an appraisal of the property for the loan. The appraisal report valued the leasehold interest at $ 1,120,000.
Mariss attorney, James Palacek, took the position that Maris had no obligation to subordinate her interest in the property unless the proceeds of the refinancing loan were going to be used to improve the property. He also objected to the fact that Quaker Citys initial loan proposal called for a balloon payment, in violation of Article 11.02(ix) of the lease agreement. In July 1999, Eden obtained a new proposal from Quaker City for a fully amortized, 20-year loan, with no balloon payment.
Palacek demanded to see financial data on the income and operating expenses of the office building. Eden initially declined to provide this financial data because he did not believe Maris had any right to it under the lease agreement, and he did not want to undermine his bargaining position in possible negotiations to purchase her interest in the property.
Eden informed Palacek that the property had been appraised at over $ 980,000, the minimum necessary to provide the 20 percent equity cushion required under the lease agreement. Eden offered to provide Palacek with a written statement to this effect. However, Palacek said he was not concerned about the appraisal and he did not need it. Eden began to experience difficulties obtaining responses from Palacek to his inquiries regarding the loan. In an attempt to alleviate any possible concerns, Eden added a term to the loan documents making the lease agreement controlling over any conflicting provisions of the loan.
Eden and Quaker City continued to have trouble getting Palacek to respond to their inquiries about the loan. Eden sent some of the loan documents to Palacek on September 29, 1999, together with a cover letter invoking the provision in the lease requiring a response from the lessor within 15 days. Palacek did not respond. On October 27, 1999, Eden sent a complete package of the loan documents to Palacek for Mariss signature, with a cover letter explaining that Quaker City had imposed a final deadline of November 1, 1999 to receive the signed documents. The loan documents were in final form but were marked "DRAFT" because Quaker City had to make sure the language was acceptable to all parties before drawing up the final documents. Palacek did not respond to Edens letter, and Maris never signed the loan documents.
On November 4, 1999, Eden sent a draft complaint to Palacek and a letter stating that he intended to file the complaint against Maris on November 15, 1999. On November 9, 1999, Palacek responded with a letter in which he again requested financial data about the building and stated that Maris would not execute loan documents without the data. Eden finally agreed to provide income and expense statements for the property, on the condition that Maris sign a confidentiality agreement. Eden sent the confidentiality agreement to Palacek on November 18, 1999, with a letter stating that he would provide the income and expense statements once Maris signed the confidentiality agreement. Eden never received any response to the letter from Palacek. Palacek did not communicate with Eden again until January 2000, after the lawsuit was filed and served.
Palacek did not testify at trial.
Quaker City finally cancelled the loan because the loan documents were never signed. According to the loan officer, Quaker City would have proceeded with the loan if Palacek had cooperated. According to plaintiffs, they suffered $ 32,410 in damages as a result of the loan cancellation.
At trial, Maris testified that she did not sign the Quaker City loan documents because she felt that a $ 784,000 loan was very high and it was her understanding after speaking with her son that the lease agreement prohibited the lessee from refinancing for any amount greater than $ 360,000. She admitted she was "scared to death" by the amount of the loan. Maris also believed that the lease prohibited refinancing for any purpose other than improving the property. However, Maris testified that the only reason she did not sign the loan papers was because of her belief that there was a $ 360,000 limit on the amount of any refinancing loan, and that her position would not have changed if she had received the appraisal report and the financial data on the building.
Robert Bell, an experienced real estate attorney with Luce, Forward, Hamilton & Scripps, testified as plaintiffs expert on ground leases. He testified that the terms of a subordination agreement are subject to negotiation between the parties, and that one of the negotiated terms is whether to prohibit refinancing for purposes other than improvements to the property. According to Bell, there is nothing wrong with allowing a tenant to take equity out of a long-term ground lease. In Bells opinion, the other provisions of the subordination agreement pertaining to refinancing were adequate to protect the lessors interests.
Bell testified that the most likely scenario in the event of a default on the loan would be that the lender would foreclose on the leasehold, step into the shoes of the existing lessee, and become the new ground lessee. According to Bell, Maris could also declare a default on the ground lease in the event of a default on the loan. She could then bring an unlawful detainer action or put in a receiver to obtain control of the rents on the property. Bell further testified that the lease agreement did not contain the provisions necessary for the lessees to obtain leasehold financing without encumbering the lessors fee.
At the time of trial, the lessees were receiving $ 17,000 in monthly gross rents on the building. Their monthly overhead was $ 2,200 and the monthly rent payments to Maris were $ 2,768. The new loan would increase the lessees monthly mortgage payments from $ 3,000 per month to $ 6,500 per month, for a net positive cash flow of approximately $ 5,500 per month.
Danny Marschall, a real estate appraiser and consultant, testified as an expert for plaintiffs. In his opinion, the subordination agreement in the ground lease was fairly typical of such agreements. Marschall believed the refinancing provisions spelled out in the subordination agreement adequately protected both parties.
Brian Bergmark, a CPA and financial consultant, testified as an expert for Maris. Based on his financial analysis, Bergmark believed Maris would be put in a riskier, less desirable, financial situation as a result of the proposed loan.
Real estate attorney David Barkin testified as an expert for Maris. In his opinion, it is not typical to require a lessor to subordinate his interest in the property for a non-improvement loan. Barkin also believed that a 20 percent equity cushion was insufficient to protect the lessor against possible downturns in the real estate market.
The lessees filed suit against Maris on December 4, 2000. The complaint alleged two causes of action. The first cause of action was for declaratory relief regarding their right to refinance the property and the lessors obligation to subordinate pursuant to Article XI of the lease agreement. The second cause of action was for damages for breach of the lease agreement.
The trial court issued a statement of decision and order after trial. The court found that Article XI of the lease agreement was a valid subordination agreement which permitted the use of refinancing loan funds for purposes other than improvements to the property. However, the court found that Maris did not breach the agreement by refusing to sign the loan documents. The court reasoned that by failing to provide Maris with the documentation upon which Quaker City relied in determining the loan amount, plaintiffs had failed to comply with an express condition precedent set forth in Article 11.02(v) of the lease agreement. Thus, the court ruled for plaintiffs on their first cause of action for declaratory relief regarding the validity of the subordination agreement, but against plaintiffs on their second cause of action for damages for breach of the lease. The court also found there was no prevailing party for purposes of costs and fees because each side had been partially successful in the litigation.
II.
DISCUSSION
A. The Subordination Agreement Is Valid And Permits Refinancing For Purposes Other Than Improvements To The Property
Maris argues that a lessee may never require the lessor to subordinate to new financing if the new loan would increase the lessors risk and reduce the lessors security in the property. According to Maris, the subordination agreement should not be interpreted to permit refinancing for purposes other than improvements to the property because this would increase her risk without enhancing her security. Maris asserts that such a result could "never be just and reasonable to the ground lessor" under Handy v. Gordon (1967) 65 Cal.2d 578, 55 Cal. Rptr. 769, 422 P.2d 329. We disagree.
A subordination agreement is an agreement by which one party agrees that his interest in real property shall have a lower priority than another interest. (Miscione v. Barton Development Co. (1997) 52 Cal.App.4th 1320, 1327, citing Blacks Law Dict. (6th ed. 1990) p. 1426. col. 2.) Subordination agreements are most commonly used when the seller of real estate finances the sale and agrees to subordinate his lien to a trust deed for construction financing. Subordination agreements are useful to facilitate funding for construction, because institutional lenders are generally limited to making loans secured by a first lien. (Roskamp Manley Associates, Inc. v. Davin Development & Investment Corp. (1986) 184 Cal. App. 3d 513, 517, 229 Cal. Rptr. 186.)
Subordination agreements may also be used in a long-term lease. (Grenert, Ground Lease Practice (1971) §§ 1.75-1.79, pp. 65-67.) As part of the lease agreement, the lessor may agree to subordinate his reversionary interest in the property to any future trust deed securing a construction loan taken out by the lessee. This enables the lessee to use the lessors property interest as well as his own leasehold as security for the loan. (Id. at § 1.72, p. 62.) Such an arrangement benefits both parties by making it easier for the lessee to obtain financing to make improvements to the property, which will ultimately revert back to the lessor at the end of the lease term. (See Matthews v. Hinton (1965) 234 Cal. App. 2d 736, 741, 44 Cal. Rptr. 692.)
One commentator has given the following explanation why ground lessors would agree to a subordination clause: "With respect to a ground lease, the owner stands to lose his fee interest in the land in the event of default on the leasehold mortgage. It may well be asked why one would consent to such an agreement. The answer is quite simple. Land is worth much more if it is developed. The sales price or the ground rent agreed upon in such situations is arrived at using a value for the land as if it were developed. The owner of the land receives a higher selling price or a higher rental by entering into an agreement with a developer. Development of the land is probably the only way an owner will realize the lands full potential. In the mind of the owner, development is therefore a necessity and the only way that funds can be made available for development is by his agreeing to subordination. (In a ground lease situation, several other bonuses accrue. The owner avoids a sale of the land and the attendant tax consequences arising out of a sale. Also, his land is embellished with a permanent improvement which he or his heirs will eventually own when the term of the lease expires.)" (Lambe, Enforceability of Subordination Agreements (1984) 19 Real Prop. Prob. & Tr. J. 631, 633.)
Because construction financing is short-term, subordination agreements typically apply not only to the initial construction loan but also to "take-out" or "permanent" financing to repay or discharge the construction loan. (Grenert, supra, § 2.90, p. 149.) Such agreements may also give the lessee the right to refinance an existing loan on terms and conditions negotiated by the parties. (Id. at § 2.93, pp. 152-153.)
Subordination agreements are particularly risky to a seller or lessor during the initial construction of improvements to the property. When a developer first takes out a construction loan for improvements, the property is over-encumbered. Before the improvements are completed, the liens exceed the value of the property. If the construction is not completed and there is a foreclosure, the seller or lessor may be at risk of losing his interest in the property. (Miller, Star & Regalia, Subordination Agreements in California (1966) 13 U.C.L.A. L.Rev. 1298, 1299.)
The leading case on enforceability of subordination agreements in California is Handy v. Gordon, supra, 65 Cal.2d 578. In Handy, the buyer sued for specific performance of a written contract to purchase real property. Under the contract, the sellers had agreed to finance a loan to the buyer secured by a deed of trust on the property. The contract contained a provision that required the sellers to subordinate their lien to trust deeds for loans to be obtained by the buyer for construction and permanent financing. After the contract was signed, the sellers sought to rescind and the buyer sued for specific performance. (Id. at pp. 579-580.)
The Supreme Court refused to order specific performance, finding that the contract was not "just and reasonable" to the sellers within the meaning of Civil Code section 3391. (Handy v. Gordan, supra, 65 Cal.2d at pp. 581-582.) The Court reasoned that "an enforceable subordination clause must contain terms that will define and minimize the risk that the subordinating liens will impair or destroy the sellers security. [Citations.] Such terms may include limits on the use to which the proceeds may be put to insure that their use will improve the value of the land, maximum amounts so that the loans will not exceed the contemplated value of the improvements they finance, requirements that the loans do not exceed some specified percentage of the construction cost or value of the property as improved, specified amounts per square foot of construction, or other limits designed to protect the security." (Id. at p. 581.)
Civil Code section 3391 provides in relevant part: "Specific performance cannot be enforced against a party to a contract [P] . . . [P] if it is not, as to him, just and reasonable. . . ."
The Handy court concluded that the contract at issue did not afford sufficient protection to the sellers to warrant specific performance, for the following reasons: (1) it did not restrict the buyers use of the funds to making improvements to the property; (2) there was no assurance that the amount of the loans would not exceed the value of the improvements; (3) there was no assurance that the total amount of the loans would be low enough to allow the sellers to bid on the property in the event of a foreclosure; and (4) the sellers did not receive a down payment to "cushion" their position, and the first payment of principal was deferred for a period of three years. In these circumstances, the court found that "the contract leaves defendants with nothing but plaintiffs good faith and business judgment to insure them that they will ever receive anything for conveying their land." (Id . at p. 582.)
The trial court here correctly concluded that the subordination agreement fully complies with the requirements of Handy. Unlike Handy, the lessors obtained exactly the benefits they bargained for in the lease agreement: an immediate stream of rental income for 55 years, regular cost of living adjustments, and a long-term investment in the property and its improvements. The lessors accepted these benefits for 22 years before the lessees invoked their right to refinance under the lease agreement.
Unlike Handy, this is not an action for specific performance subject to the requirements of Civil Code section 3391. (See Schneider v. Ampliflo Corp. (1983) 148 Cal. App. 3d 637, 639, 196 Cal. Rptr. 172 [noting that Handy is limited to suits for specific performance and "is not a holding that a subordination clause . . . is not enforceable by other means"]; Yackey v. Pacific Development Co. (1979) 99 Cal. App. 3d 776, 783, 160 Cal. Rptr. 430 [noting that a claim of unfairness under Handy "may be asserted only in an action for specific performance"].) This case also differs from Handy in that it involves a long— term ground lease, not a sale of real property. However, the trial court and the parties have all regarded Handy as controlling. In light of our finding that the subordination agreement satisfies the requirements of Handy, we need not consider the legal significance of the distinctions between this case and Handy.
The subordination agreement also contained specific and well-defined provisions limiting the terms of the initial construction loan and any subsequent loans. The agreement limited the construction loan to a maximum of $ 360,000, to be disbursed through a fund control and used only for construction purposes. The agreement also limited subsequent refinancing loans to 80 percent of the property value, giving the lessors a 20 percent equity cushion. The agreement further specified that any refinancing loan had to be obtained through an institutional lender, on the usual and customary terms and conditions, with interest and fees not to exceed the norm, to be paid off by the end of the lease term. Finally, the agreement preserved the lessors right to cure any default. Taken in their totality, these provisions adequately protected the lessors reversionary interest in the rental property.
We also agree with the trial court that the subordination agreement permits refinancing for purposes other than improvements to the property, subject to the conditions set forth in Article 11.02 of the lease. The proper interpretation of a lease presents a question of law which we must independently review using basic principles of contract law. (Principal Mutual Life Ins. Co. v. Vars, Pave, McCord & Freedman (1998) 65 Cal.App.4th 1469, 1477.) "In doing so, we apply certain well-known rules of contract interpretation. A contract must be interpreted to give effect to the mutual intention of the parties at the time the contract was made." (Id. at p. 1478, citing Civ. Code, § 1636.) "Subordination agreements, like contracts in general, are subject to the rule that they must be interpreted to enforce the objective intent of the parties." (Bratcher v. Buckner (2001) 90 Cal.App.4th 1177, 1186.)
In ascertaining the intent of the parties, we look first to the language of the subordination agreement. (Civ. Code, §§ 1638, 1639.) The agreement addresses both a construction loan and refinancing loans. Article 11.02(iv) specifically provides that the funds from a construction loan "shall be used for the construction of improvements only." However, the lease agreement contains no similar limitation on the use of proceeds from a refinancing loan. The inclusion of an explicit restriction on the use of construction loan proceeds, without any similar restriction on the proceeds of refinancing loans, logically indicates that the parties must not have intended such a restriction to apply to a refinancing loan. We are not at liberty to add such a restriction where none exists on the face of the contract; a court cannot add terms to a written contract that is intended "as a complete and exclusive statement of the terms of the agreement." (Code Civ. Proc., § 1856, subd. (b); see also Protective Equity Trust # 83, Ltd. v. Bybee (1991) 2 Cal.App.4th 139, 150 ["rights of priority under an agreement of subordination extend to and are limited strictly by the express terms and conditions of the agreement"].)
Even if there were any uncertainty in the agreement, we would have to resolve it against Maris because it was her attorney who drafted the lease agreement. (Civ. Code, § 1654.) In cases of contractual uncertainty not resolved by other rules of construction, section 1654 requires that the language of the contract be interpreted most strongly against the party whose attorney drafted the agreement. (Sands v. E.I.C., Inc. (1981) 118 Cal. App. 3d 231, 235, 173 Cal. Rptr. 342.) Uncertainties in the construction of a lease must therefore be resolved strictly against the lessor who prepared the document. (Edmonds of Fresno v. MacDonald Group, Ltd. (1985) 171 Cal. App. 3d 598, 604, 217 Cal. Rptr. 375; Cooper v. Mart Associates (1964) 225 Cal. App. 2d 108, 116, 37 Cal. Rptr. 145; Carter v. Adler (1955) 138 Cal. App. 2d 63, 71-72, 291 P.2d 111.)
The parol evidence admitted at trial supports our interpretation of the lease agreement. Parol evidence is admissible to resolve ambiguities in a fully integrated written contract, though not to contradict or add to its terms. (Code Civ. Proc., § 1856; Esbensen v. Userware Internat., Inc. (1992) 11 Cal.App.4th 631, 636-637; 2 Witkin, California Evidence (4th ed. 2000) §§ 74-75, pp. 192-195.) According to Attorney Keeney, who drafted the lease agreement, his standard practice would have been to include an explicit restriction on the use of refinancing proceeds if the parties had wanted such a restriction. Based on his custom and practice, Keeney testified that his intent was "not to limit the purposes for which the proceeds of a refinancing loan could be used." This parol evidence was uncontradicted, and is consistent with the language of the lease agreement. Thus, the unrefuted evidence indicates that the parties mutually intended to permit refinancing for purposes other than to make improvements to the property.
Relying upon language from Miller v. Citizens Savings & Loan Assn. (1967) 248 Cal. App. 2d 655, 56 Cal. Rptr. 844, Maris contends that a subordination agreement cannot be construed to permit financing for purposes other than improvements to the property unless this intent is expressly set forth in the agreement. In Miller, the buyer purchased 18 undeveloped lots from the seller for a total of $ 100,000, financed primarily by a purchase money deed of trust with a subordination clause. The buyer then obtained a $ 349,500 construction loan, secured by individual deeds of trust for each of the 18 lots. These trust deeds and related subordination agreements were duly recorded. The buyer used most of the loan proceeds to construct houses on the lots, but used some of the proceeds for its own purposes rather than for construction. (Id . at pp. 657-659.)
Because the original subordination agreement was restrictive in nature, and there was no evidence that the parties intended a novation by entering into separate subordination agreements for each of the individual parcels, the court concluded that the proceeds of the construction loan could be used only for the purposes expressly set forth in the original subordination agreement. (Miller, supra, 246 Cal. App. 2d at pp. 662-664.) The court observed that allowing the use of construction funds for purposes other than improvements to the property "would be so unusual and so unlikely that we would require it to be spelled out with particularity . . . .A subordination agreement should be construed, unless it expressly provides otherwise, as permitting the loan proceeds to be used only for such purposes." (Id. at p. 663.)
We agree that it would be unusual for a subordination agreement to permit the use of an initial construction loan for purposes other than improvements to the property. In Miller, the property was immediately over-encumbered as soon as the liens were imposed to secure the construction loan. (Miller , supra, 248 Cal. App. 2d at pp. 658-659 & 663, fn. 4.) The whole purpose of a construction loan is to add improvements to the property that will make its value exceed the amount of the liens. Thus, in the absence of any contrary indication, the Miller court correctly concluded that it is reasonable to assume the parties to a subordination agreement intend the proceeds of an initial construction loan to be used solely to improve the property.
However, the same reasoning does not necessarily apply to the refinancing provisions of a subordination agreement in the context of a long-term ground lease. The parties to such a lease may agree that once the construction has been completed and the value of the property has increased, the lessee shall be permitted to refinance in order to take equity out of the property. Once the lessees risk and efforts have built up the value of the property and the leasehold, it would be reasonable for the parties to permit the lessee to take money out of his long-term investment. (See Grenert, Ground Lease Practice (2001 update) § 1.78, at p. 34 [noting that subordination to future refinancing "may not always be to finance improvements"].) In these circumstances, the rationale of Miller does not justify a legal presumption against refinancing for purposes other than making improvements to the property.
As a general rule, the terms of a ground lease are subject to negotiation between the parties. (Grenert, Ground Lease Practice (1971) § 1.12, p. 21.) In particular, the financing and subordination provisions of a ground lease "result from hard, detailed bargaining in which the outcome is determined by the unique characteristics of the transaction, the parties, and their attorneys." (Id. at Comment to § 2.90, p. 149.) According to the evidence at trial, one of the negotiated provisions of a ground lease would be whether to permit refinancing for purposes other than improvements to the property.
As long as the subordination clause contains provisions protecting against over-encumbrance of the property, such as the 20 percent equity cushion and the other conditions of refinancing present here, we see no reason to presume that the parties to a long-term ground lease intended to restrict the purposes of a refinancing, in the absence of any restrictive language in the lease agreement. "It is within the power of the subordinator to refuse to subordinate if the terms of the subordination are not acceptable to him." (Rockhill v. United States (Md. App. 1980) 288 Md. 237, 418 A.2d 197, 204.) To read an implied restriction on refinancing into the subordination agreement, even though none is present in the language of the lease, would have much the same effect as judicially rewriting the parties contract.
Instead, we shall apply the usual rules of contract interpretation to ascertain the parties mutual intentions. Having done so, we find that the parties intended to permit refinancing for purposes other than making improvements to the property. We therefore affirm the judgment as to the first cause of action for declaratory relief regarding the validity and interpretation of the subordination agreement.
Other courts have enforced subordination agreements that did not limit all of the loan proceeds to construction or improvements to the property. (See, e.g., Schneider, supra, 148 Cal. App. 3d at pp. 639-640; Weiss v. Brentwood Savings & Loan (1970) 4 Cal. App. 3d 738, 740, 744, 84 Cal. Rptr. 736.) In Republican Nat. Life Ins. Co. v. Lorraine Realty Corp. (Minn. 1979) 279 N.W.2d 349, the court rejected an argument that a subordination clause was unenforceable for various reasons, including that it "failed to limit the subordination to construction loans or to loans for improvements of the leased premises." (Id. at p. 352, fn.1.) The court noted that the case involved "an executed contract upon which the parties have already relied." (Republican , supra, 279 N.W.2d at p. 353.) "We feel that where the ground lessors have reaped the benefits of the contract for over a decade, they are estopped from denying the validity of the subordination clause." (Id. at p. 354.)
B. The Trial Court Erred In Finding No Breach Of The Subordination Agreement
Article 11.02 of the lease imposed a duty upon Maris to "cooperate in all respects" with the lessees and any prospective lender in obtaining loans in compliance with the subordination agreement. In their second cause of action, plaintiffs alleged that Maris breached her duty to cooperate by refusing to sign the Quaker City loan papers. Despite its finding that the subordination agreement was valid and enforceable, the trial court concluded that Maris did not breach the agreement. The trial court reasoned that a condition precedent to her performance was that the lessees provide her with "any documentation that the lender relies upon in determining the loan amount." The court concluded that this condition precedent was expressly set forth in Article 11.02(v) of the subordination agreement.
We reject the trial courts interpretation of the subordination agreement. Article 11.02(v) provided: "LESSEE shall furnish LESSOR with a true copy of the fee mortgage, promissory note secured thereby and all other instruments required by lender." (Italics added.) Contrary to the trial courts ruling, this provision does not mean that the lessee must provide to the lessor "any documentation that the lender relies upon in determining the loan amount." An "instrument" is defined as "[a] written legal document that defines rights, duties, entitlements, or liabilities, such as a contract, will, promissory note, or share certificate." (Blacks Law Dict. (7th ed. 1999) p. 801, col. 2; see also Plaza Freeway Ltd. Partnership v. First Mountain Bank (2000) 81 Cal.App.4th 616, 621-625 [defining "instrument" in similar terms].) Thus, the phrase "all other instruments required by the lender" plainly refers to other legal documents to be executed by the parties in order to finalize the loan. It does not refer to documents such as the appraisal report or financial data used by the lender in determining the loan amount.
The trial court apparently believed that the subordination agreement gave Maris a right to contest whether the loan exceeded 80 percent of the property value, and thus to receive the appraisal and other documentation relied upon by the lender in determining the loan amount. However, Article 11.02(iii) of the lease agreement provided only that the amount of the refinancing "shall not exceed in the aggregate eighty percent (80%) of the lenders appraisal of the land and improvements." (Italics added.) This language indicates that the parties agreed to be bound by the lenders appraisal of the property.
The agreement says nothing about giving Maris a right to contest the lenders appraisal. The parties to a subordination agreement may delegate to the lender the power to make such a determination. (See Handy, supra, 65 Cal.2d at p. 581 ["the parties to a contract of sale containing a subordination clause may delegate to the vendee or third party lenders power to determine the details of subordinating loans"].)
In sum, nothing in the lease agreement supports the trial courts finding that a condition precedent to Mariss performance was that she be provided with all documentation relied upon by the lender. Nor are we at liberty to read any such provision into the contract by implication. "The rule is that provisions of a contract will not be construed as conditions precedent in the absence of language plainly requiring such construction." (Rubin v. Fuchs (1969) 1 Cal.3d 50, 53, 81 Cal. Rptr. 373, 459 P.2d 925.)
Further, according to the uncontradicted evidence at trial, Maris had no concern about the property appraisal. She never contended that the loan amount exceeded 80 percent of the property value. In fact, her attorney told Eden he was not concerned about the appraisal and did not need the appraisal report. In these circumstances, even if we had found that providing the appraisal report to Maris was a condition precedent to her performance, we would still conclude the condition precedent had been waived. (See Doryon v. Salant (1977) 75 Cal. App. 3d 706, 711— 712, 142 Cal. Rptr. 378 [finding waiver of condition precedent to performance under contract].)
As an alternative ground for the trial courts decision, Maris contends she had no obligation to execute the Quaker City loan documents because they were marked as "DRAFT" documents, and she was never provided with the final loan papers. However, Quaker City required Maris to approve the language of the draft loan documents before drawing up the final documents and to indicate such approval by signing the documents marked "DRAFT." The subordination agreement imposed a duty upon Maris to "cooperate in all respects" with the lender; her duty of cooperation was not limited to signing final loan papers. Thus, Maris had a duty to sign the draft loan papers unless she had a valid objection under the subordination agreement. Maris never signed the loan papers or made known her objection to the loan.
Further, the evidence establishes that Mariss real reason for refusing to sign the loan papers was untenable as a matter of law. Maris testified at trial that the only reason she refused to sign the papers was because she believed a refinancing loan was subject to the same $ 360,000 maximum as the initial construction loan. This is simply not a defensible interpretation of the subordination agreement. Article 11.02(v) makes a clear distinction between the initial construction loan, which was limited to $ 360,000, and subsequent loans, which are limited to 80 percent of the property value. Even Mariss attorney has not attempted to defend her interpretation of the lease, either in the trial court or on appeal. Thus, the uncontradicted evidence establishes that Maris breached her duty to cooperate under the subordination agreement by refusing to sign the Quaker City loan papers. We therefore reverse the judgment as to the second cause of action and remand to the trial court with directions to determine damages and enter judgment for plaintiffs on the breach of contract claim.
In the trial court, Maris argued that various provisions contained in the loan documents exceeded the scope of the subordination agreement. She has not pursued these arguments on appeal. In any event, the loan documents expressly provided that any conflict with the ground lease would be resolved in favor of the lease agreement. Thus, the provisions of the loan had to be consistent with the subordination agreement to have any effect.
McDONALD, Acting P. J.
The majority opinion incorrectly inserts a provision into the ground lease by implication that must be explicit, and in so doing permits the risk of a failed project to be shifted from the entrepreneurial lessee to the investor lessor without a clear showing the parties intended that result. Furthermore, the majority opinion incorrectly rejects the applicability of the just and reasonable rule of Handy v. Gordon (1967) 65 Cal.2d 578, 55 Cal. Rptr. 769, 422 P.2d 329 to this case on the ground the cause of action is for declaratory relief and damages rather than specific performance.
The majority opinion interprets the ground lease to require the lessor to encumber its fee interest in the ground lease property to secure a $ 784,000 personal loan to the lessee, none of the proceeds of which will be used to improve or otherwise benefit the property. The result of this interpretation is that if the lessee defaults on the loan, to prevent foreclosure of lessors ownership of the property the lessor will be required to repay the lessees loan for which neither the property nor the lessor received any benefit. "Such an arrangement [is] so unusual . . . we would require it to be spelled out with particularity." (Miller v. Citizens Sav. & Loan Assn. (1967) 248 Cal. App. 2d 655, 663, 56 Cal. Rptr. 844.)
The ground lease in this case does not with particularity "spell out" the requirement that the lessors fee may be encumbered to secure a loan to the lessee that will not be used to improve or benefit the property; there is no mention in the ground lease of lessees loan proceeds being used for any purpose other than improvement of the property.
The majority opinion creates by implication a provision in the ground lease requiring the lessor to encumber its fee to secure a nonimprovement loan to the lessee by interpretation of Article XI of the ground lease. Article XI requires the lessor from time to time to encumber its fee interest in the property subject to the ground lease with a trust deed to secure a loan made to the lessee. The loan for construction of the original improvements on the property may not exceed $ 360,000, and any take-out permanent loan or modifications or consolidations of the permanent loan may not exceed 80 percent of the lenders appraisal of the land and improvements. Other than reference to a loan for construction of original improvements on the property and a take-out permanent loan to replace the construction loan, Article XI makes no reference to the use by the lessee of the proceeds of the loan it contends the lessor must secure by a trust deed encumbrance on the lessors fee interest in the property. The majority opinions interpretation is based on the premise that if the ground lease does not restrict the use of the lessees loan proceeds to the improvement of the property, they may be used by the lessee for any purpose. That premise is incorrect and contrary to California law. The correct rule, articulated in Miller, is that unless the ground lease expressly and explicitly provides that the lessees loan proceeds may be used for purposes other than improvement of the property, the lessor cannot be compelled to encumber its fee interest to secure a nonimprovement loan to the lessee.
Most of the case and statutory law in this area concerns the subordination of a sellers purchase money deed of trust given to secure the balance of the purchase price to a subsequent deed of trust given by the buyer to secure construction and take-out loans. The effect of the subordination is to place the construction lenders trust deed in a first priority position relative to the sellers purchase money trust deed. However, the same principles applicable to trust deed subordination have been held applicable to a ground lease that permits the lessees lender to encumber the lessors fee interest in the property to secure a loan to the lessee. (See Airport Plaza, Inc. v. Blanchard (1987) 188 Cal. App. 3d 1594, 1600, 234 Cal. Rptr. 198.) In the ground lease context, the term "subordination" is not literally accurate but is commonly used. (Grenert, Ground Lease Practice (Cont. Ed. Bar 1971) § 1.75, p. 65.)
The legal principle that controls this case is set forth in Miller v. Citizens Sav. & Loan Assn., supra, 248 Cal. App. 2d at pp. 662-663, which describes the business context of executory subordination agreements as follows:
"Subordination arrangements are in the nature of a mutual enterprise, wherein the vendor provides the land, the purchaser the know how and the purchasers lending agency the capital, for the mutually beneficial purpose of developing the land and disposing of it (usually by sale; occasionally by rental), to provide a fund out of which the vendor is paid for his land, the lender is repaid its loan with interest, and the purchaser receives compensation for his efforts and skill. Because of their nature, The law is well settled that rights of priority under an agreement of subordination extend to and are limited strictly by the express terms and conditions of the agreement. [Citations.] (Irvine v. California Cotton Credit Corp. (1937) 18 Cal. App. 2d 761, 763 .) While it may not be impossible that a vendor has agreed to subordinate his purchase money lien to a lien secured by the purchaser to be used for purposes entirely apart from the mutual enterprise, such an arrangement would be so unusual and so unlikely that we would require it to be spelled out with particularity. Typically the loan proceeds are to be used for purposes which will promote the mutual enterprise and which will either enhance the vendors equity in case he must foreclose his lien, or will provide funds from which he will be paid. A subordination agreement should be construed, unless it expressly provides otherwise, as permitting the loan proceeds to be used only for such purposes." (Fns. omitted.)
The majority opinion cites the Miller case to support the proposition that ground lease subordination agreements could permit loan funds to be used for purposes other than improvements to the property. That proposition may be correct, but in my view it ignores the impact of the last sentence: "A subordination agreement should be construed, unless it expressly provides otherwise, as permitting the loan proceeds to be used only for . . . purposes" of the mutual enterprise, which is the development and maintenance of the property subject to the ground lease. (Ibid.)
The reason for this rule is clear. The substantial risk the lessor incurs by encumbering its fee interest to secure lessees nonimprovement loan should not be imposed on the lessor unless the ground lease unequivocally permits the lessee to use loan proceeds for purposes other than improvements to the property. The risk is that if the lessee defaults on the loan the lessor will be required to repay what essentially is a personal loan to the lessee to avoid losing its entire interest in the property on foreclosure by the lessees lender. The majority opinion ignores the risk in this case for several illusory reasons:
1. The risk is limited to construction loans because the fee is over-encumbered until construction is completed and the rule of the Miller case is therefore limited to construction loans (maj. opn., pp. 18-19);
2. After the construction is completed the lessees risk and efforts have increased the value of the property and the Miller rule no longer applies because it is reasonable to permit the lessee to take money out of the project (citing Grenert, Ground Lease Practice (2001 update) § 1.78, at p. 34) (maj. opn., p. 19); and
3. The lessor is protected by the 20 percent equity "cushion" because the amount of the lessees loan cannot exceed 80 percent of the value of the property (maj. opn. p. 15).
The three rationales of the majority opinion to depart from the Miller rule are less than persuasive. With regard to the first, the construction loan encumbrance increases from zero only as construction funds are disbursed for payment of construction costs of improvements to the property and the value of the property proportionally increases. A construction loan therefore does not necessarily over— encumber the property. In contrast, a loan to the lessee, none of the proceeds of which are used to improve the property, immediately increases the amount of the encumbrance on the lessors fee with no increase in the value of the property. The rule of the Miller case is more strongly applicable to nonimprovement loans than to construction loans.
With regard to the second rationale, the majority opinions reference to section 1.78 of the Grenert 2001 update is illuminating. That reference is to a trust deed on the lessees leasehold interest in the ground lease, not to a trust deed on the lessors fee interest as suggested by the majority opinion. It may be reasonable for the lessee to recover its investment by encumbering its leasehold interest in the ground lease; it is not reasonable for the lessee to recover its investment by encumbering the lessors fee interest in the property. If the lessee defaults on its loan secured by the lessees leasehold interest, the lessor need not cure the default to protect its interest. On foreclosure the lender becomes the lessee but has no right to foreclosure on the lessors fee interest. Grenert cites Airport Plaza, Inc. v. Blanchard, supra, 188 Cal. App. 3d 1594 in this context. The Airport Plaza case held that the ground lease lessee had no right to encumber even its leasehold interest in the ground lease absent an express provision in the ground lease so permitting.
With regard to the third rationale, the so-called 20 percent "cushion" gives the lessor cold comfort. Even if the lessees loan does not exceed 80 percent of the value of the property, on the lessees loan default the lessor must keep current or pay in full the lessees lender to protect its fee interest from foreclosure. In either event, the lessor is paying a debt of the lessee for which neither the lessor nor the property has received any value or benefit.
If the mutual enterprise of the lessor and lessee, which is development of the property subject to the ground lease, remains successful for the term of the ground lease, the detriment to the lessor in permitting lessees nonimprovement loans to be secured by an encumbrance on the lessors fee interest is limited. Under those circumstances the income to the lessee from the project will generally be sufficient to amortize the lessees loan and pay the ground rent to the lessor; the detriment to the lessor is that the lessor is unable to use the fee interest as collateral for its financing. The risk is that the project may become unsuccessful for any of a variety of reasons, including the cyclical downturns in the real estate market that may be expected during the long term of a ground lease. There is a continuing risk that income from the project will be insufficient to service the lessees loan and perhaps even to pay the ground lease rent. Under those circumstances, on default of the lessees loan the lessor will be required to utilize its nonproject resources to cure the default to protect its interest in the property. In doing so it is repaying a personal loan made to the lessee for which there was never any prospect of increasing the value of the property. If the lessor needs to use the property as collateral to obtain financing to repay the lessees loan, it may be unable to do so; the 20 percent cushion existing in good times may not exist in a real estate downturn and the lessor will not be able to obtain a new loan in an amount sufficient to pay the lessees loan. In any event, the lessor is either paying the lessees debt or losing the property entirely. It is this risk that requires provisions in the ground lease explicitly providing that the lessor has agreed to assume.
The Miller rule is precisely germane to this case and the reasons given by the majority opinion that it is not appear ephemeral. Because the ground lease in this case does not explicitly provide that the lessor agrees to encumber its fee interest to secure a nonimprovement loan made to the lessee, I would hold that under the Miller rule the lessor is not required to do so.
Because the provisions of the ground lease in this case do not require the lessor to encumber its fee interest to secure a nonimprovement loan to the lessee, it is unnecessary to reach the issue of whether the just and reasonable rule of Handy v. Gordon would invalidate the provisions of the ground lease that imposed that requirement. Nevertheless, Handy v. Gordon does apply to this action for declaratory relief and the just and reasonable rule of Handy v. Gordon is not met under the ground lease in this case as interpreted by the majority opinion.
There is no purpose for the instant declaratory relief action other than to lay the foundation for specific enforcement of Article XI of the ground lease to require "subordination" of the lessors fee to a nonimprovement loan the lessee will seek in the future. Therefore, this declaratory relief action is the equivalent of a specific performance action within the meaning of Handy v. Gordon. Because of the risks the lessee seeks to impose on the lessor, without any prospect of benefit in assuming the risk, I believe the proposed subordination is not just and reasonable within the meaning of the Handy v. Gordon principle.
For the reasons set forth above, among others, I dissent from the majority opinion. Notes:
Alternatively, the majority opinion incorrectly, in my view, finds the Handy v. Gordon just and reasonable rule satisfied in this case.
A retirement of the lessees loan presumably could be arranged by a new loan obtained by the lessor secured by the lessors fee interest in the property. Of course, without retiring the lessees loan, the so-called 20 percent equity cushion in the property is valueless to the lessor for financing purposes because it is encumbered by the trust deed securing the lessees loan.
C. Plaintiffs Are Entitled To Costs and Attorneys Fees
In view of our holdings, plaintiffs are the prevailing party on both of their causes of action. They are therefore entitled to recover costs and attorney fees, under Article 15.06 of the lease agreement. The trial court is directed to award plaintiffs their costs and attorney fees on remand.
DISPOSITION
The judgment is affirmed as to the first cause of action for declaratory relief. The judgment is reversed as to the second cause of action for breach of contract. The matter is remanded to the trial court with directions to determine damages, costs, and attorney fees, and to enter judgment for plaintiffs on their breach of contract claim. Lawrence et al. are entitled to costs on appeal.
I CONCUR: McINTYRE, J., and McDONALD, J., Dissenting.