Landlord’s Limitations in Preventing Tenant’s Sale of Business
Landlord-tenant relationships can be difficult. What should be a relatively simple relationship based on contractual obligations often turns sour. To make matters worse, COVID-19 has created a litany of financial problems worldwide which has further strained already stressful situations. Due to the pandemic, many small businesses have struggled to make rent if not already completely shuttered. Some business owners have been able to successfully sell their business or find a new lessee to take over their tenancy to make ends meet. However, some business owners, due to unreasonable landlords, have been unable to sell their business and are stuck in a strange predicament where they are seemingly forced to slowly bleed out money.
This article will explore how much power a landlord has in preventing the assignment of a tenant’s lease.
I recently encountered this specific issue with two prospective clients as they were hoping to offload their business and move on with their lives. Both of these clients each owned and operated a restaurant in the same building with the same landlord. However, despite their best efforts to work with the landlord and having found viable assignees with solid business plans, the landlord simply refused without any good reason. The only complaint the landlord presented to these tenants is that he did not trust the potential assignees. It is difficult enough to find someone to buy your business and take over your lease, but it has unquestionably been a struggle during the pandemic. Tenant one and tenant two—over the course of twelve and fifteen years, respectively—had dutifully and timely paid rent and continued on with their respective businesses despite other alleged inequities on behalf of the landlord. However, the landlord in this case likely found the two existing tenants to be very reliable sources of income and refused to take on the uncertainty of new tenants.
Limitless Discretion?
If the situation above seems unreasonable, you are likely not alone. However, landlord’s do not have unmitigated discretion and cannot prevent the sale of a tenant’s business without good reason or a provision in the lease restricting transfer. In fact, a tenant’s right to assign her interest in the lease remains unrestricted unless the subject lease includes a restriction. (Cal Civ Code § 1995.210.) Conversely, the lease may include restriction provision which may absolutely prohibit transfer. (Cal Civ Code § 1995.230.) In either of these situations, the answer is fairly cut and dry; transfer may be fully prohibited or wholly unrestricted depending on the language of the lease.
But what if the restriction provision requires a landlord’s consent? Does the landlord have full control of the outcome of a tenant’s request to assign the lease? The courts have discussed this issue at length prior to codifying some of the rulings into law.
For instance, the court in Cohen stated that the duty of good faith and fair dealing prohibits landlords or lessors from arbitrarily or unreasonably withholding consent to an assignment. (Cohen v. Ratinoff, 147 Cal.App.3d 321, 329 (1983).) A lease is generally considered both a leasehold conveyance and a contract. (Medico-Dental etc. Co. v. Horton & Converse, 21 Cal.2d 411, 418 (1942).) Because a lease is also a 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, which means that in every contract there exists an implied covenant of good faith and fair dealing.” (Universal Sales Corp. v. California Press Mfg. Co., 20 Cal.2d 751, 771 (1942).) “This covenant not only imposes upon each contracting party the duty to refrain from doing anything which would render performance of the contract impossible by any act of his own, but also the duty to do everything that the contract presupposes that he will do to accomplish its purpose.” (Harm v. Frasher, 181 Cal.App.2d 405, 417 (1960).)
Arguably, being able to sell one’s business for a profit is an eventual fruit of a contract. As such, the implied covenant of good faith and fair dealing protects a tenant’s right to assignment of a lease. Although this right is not absolute, assignments are specifically allowed whenever there’s prior written consent from the lessor. (147 Cal.App.3d at 329.) “Accordingly, we hold that where, as here, the lease provides for assignment or subletting only with the prior consent of the lessor, a lessor may refuse consent only where he has a good faith reasonable objection to the assignment or sublease, even in the absence of a provision prohibiting the unreasonable or arbitrary withholding of consent to an assignment of a commercial lease.” (Id. at 330.) Some examples of a good faith reasonable objection include the “inability to fulfill terms of the lease, financial irresponsibility or instability, suitability of premises for intended use, or intended unlawful or undesirable use of premises.” (Id. at 329.) This reasoning was repeated in Schweiso v. Williams, 150 Cal.App.3d 883, 886 (1984) and in Kendall v. Ernest Pestana, 40 Cal.3d 488, 497 (1985) before being codified into law as Cal Civ Code §§ 1995.210-1995.270.
A key takeaway here is that in a situation where the existing lease contains a provision prohibiting the assignment of a lease without the consent of a lessor, the lessor needs to act reasonably in withholding consent. This presumption of reasonableness is what allows for freedom of contract between parties of commercial real property leases as intended by Cal Civ Code §§ 1995.210-1995.270. Determining whether the lessor is unreasonable is a question of fact, and the outcome will depend on whether a lessor’s withholding consent was objectively unreasonable. (Moore v. Wells Fargo Bank, N.A., 39 Cal.App.5th 280, 291 (2019).) Going back to the facts of the two tenants above, if the lessor refused consent because he simply did not trust the potential assignees—despite said assignees allegedly having solid business plans, good credit histories, or whatever else positive attributes—the tenants might each have a strong case to show the lessor is being objectively unreasonable. The burden to prove that will ultimately lie on each tenant and the outcome will depend on the facts surrounding the withholding.
It is also important to note that Cal Civ Code § 1995.230 allows for lease provisions where a tenant may be absolutely prohibited from transfer. (Cal Civ Code § 1995.230; See also Harara v. ConocoPhillips Co., 377 F.Supp.2d 779, 787 (N.D.Cal. 2005); “A lease term actually prohibiting transfer of the tenant’s interest is not invalid as a restraint on alienation.” Cal Civ Code § 1995.230.) In light of this, it is imperative that you carefully review the lease before signing to make sure you haven’t unintentionally placed yourself in a bind.
